Politics & Policy

The Fed in the Age of Yellen

It can improve its policy, but not by listening to doom-mongering gold bugs.

Someday the U.S. government’s currency monopoly might end. But probably not in my lifetime. I am willing to concede, though, that before our yellow sun goes red giant — the Republic will endure, my friends! — America might find itself awash in a competitive, Hayekian market of private currencies, perhaps the digital descendants of Bitcoin. It could happen.

But until it does, we’re going to have a central bank. And the world’s reserve currency will always be fiat money unless we return to barter. So rather than entertaining fantasy notions of ending the Fed, it’s better to think about how to improve the Federal Reserve’s performance in the aftermath of the Great Recession and financial crisis.

#ad#But apparently that subject was not on the minds of Republican senators who questioned Janet Yellen last week during her confirmation hearing to replace Ben Bernanke as Fed chairman. Instead, the GOP lawmakers expressed various flavors of skepticism about the bank’s bond-buying, or quantitative-easing (QE), program. QE and the general continuation of a low-interest-rate policy, they worried, was punishing savers, benefitting Wall Street at the expense of Main Street, creating dangerous bubbles, and risking higher inflation.

But inflation is running below the Fed’s 2 percent target, and the stock market is at a reasonable historical valuation. Unemployment, on the other hand, remains far above its supposedly natural rate. But Republicans – unlike Yellen — showed surprisingly little interest in how the Fed might more effectively help the economy reach its potential and create more jobs. Nor did the Republicans show any comprehension of the Fed’s valuable role in boosting economic growth the past few years. Perhaps they expected Yellen to express regret for the Fed’s action, much like former Fed bond trader Andrew Huszar did last week in a Wall Street Journal op-ed, “Confessions of Quantitative Easer.”

But no apologies are necessary.

First, each time the Fed has engaged in a new round of bond buying, good things have happened. With QE on, stocks, rates, confidence, and inflation expectations have all generally risen, reflecting anticipation of higher economic growth. QE off, just the opposite has tended to happen. Look to markets rather than models when gauging the effectiveness of Fed policy.

Second, the combination of tight money and fiscal austerity has been a disaster for the euro zone. The region has already suffered a double-dip recession and might be headed for a third. Unlike the Fed, the European Central Bank (ECB) has cut interest rates only slowly and eschewed its own QE at the behest of Germany. The U.S., on the other hand, has been slowly growing for more than four straight years. Since the ECB’s two rate hikes in 2011, when unemployment was around 10 percent in both the euro zone and the U.S., the euro zone’s jobless rate has risen above 12 percent and ours has fallen close to 7 percent.

Third, consider how America has weathered its own considerable fiscal austerity. Despite the second straight year of sequester-driven spending cuts and large hikes in labor, investment, and payroll taxes, average monthly jobs gains of 186,000 are now running ahead of last year’s 183,000-per-month pace. If you use the new “GDPplus metric” from the Federal Reserve Bank of Philadelphia — it blends gross domestic product and income accounts — real GDP growth averaged 2.3 percent in 2012 and has averaged 2.7 percent so far in 2013, according to calculations from economist Scott Sumner. What happened to the 2013 recession some Keynesians and supply-siders were worried about? The Fed happened.

Now the Bernanke Fed has been far, far from perfect. Its passive tightening in 2008 helped turn a modest downturn into the Great Recession. (That definitely requires an apology.) And its on-and-off approach to bond buying has reduced QE’s effectiveness.

But the Fed’s success as well as its failures during Bernanke’s time as Fed boss should inform any congressional effort to modify the Fed’s dual inflation-employment mandate during Yellen’s tenure. Republicans would please doom-mongers everywhere if they stepped backward by linking Fed policy to the price of gold. Call this the deflation caucus. Fed-reform plans along these line would help make permanent the stagnant “new normal” economy.

Better to at least consider the views of, you know, actual monetary economists — particularly those on the left and right who think the Fed should consider a 4–5 percent annual-nominal-income, or nominal-GDP, target, instead of that 2 percent inflation target. That would help provide a stable macroeconomic climate for business and consumers. The Fed is getting a change of leadership. It probably needs a change of mission, as well.

— James Pethokoukis, a columnist, blogs for the American Enterprise Institute.

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