Politics & Policy

Yellen Punt Prompts Panic

Fed chief isn't changing anytime soon, but even a hint of a taper is enough to scare people.

The spring of 2014 has not yet begun, but a jittery Wall Street was spooked Wednesday by the prospect that interest rates might rise “as soon as” the spring of 2015.

That was the immediate response to Federal Reserve chairwoman Janet Yellen’s first press conference since taking office. Yellen’s mere suggestion that the Fed might someday pursue a less inflationary policy has been blamed for a drop in the Dow Jones Industrial Average, and armchair central bankers are jumping on the rookie Fed chief for talking the market down.

Fed watchers were quick to blame Yellen’s rambling responses for the fall, which took the Dow from a high of 16,363.32 down to 16,126.29 — a decline of less than 2 percent but nevertheless enough to create a furious response from observers who fear a world without perpetual public support for Wall Street. The Dow reinflated late in the day to close at 16,222.17.

Yellen critics differed on what she did wrong, however. BusinessWeek’s Peter Coy charged her with committing the “rookie mistake” of “speaking too clearly.” TheStreet.com’s Richard Gobel, on the other hand, said the Fed chairwoman is “confusing us all.” MarketWatch’s Rex Nutting split the difference by pointing out that while Yellen spoke for an hour, the market “only heard three words: ‘around six months.’”

Yellen was referring to her vague ambition to complete the “taper” of the Fed’s quantitative-easing program, which has quadrupled the U.S. monetary base since 2007, and afterward ease up on the Fed’s unprecedented suppression of interest rates. The winding down of QE could be completed this this fall, Yellen hinted [pdf], and interest-rate hikes could begin half a year after that:

YELLEN: I ‐‐ I simply meant to say that if we continued to reduce the pace of our asset purchases in the manner that we have, in measured steps, that the program would be winding down next fall.

QUESTION: In this coming fall, you mean, not the fall of next year. Was that…


YELLEN: Yes, this coming fall.

QUESTION: … just to be clear. I just wanted to be clear about that. Then once you do wind down the bond‐buying program, could you tell us how long a gap we might expect before the rate hikes do begin?

YELLEN: So, the language that we use in this statement is considerable, period. So, I ‐‐ I, you know, this is the kind of term it’s hard to define, but, you know, it probably means something on the order of around six months or that type of thing. But, you know, it depends ‐‐ what the statement is saying is it depends what conditions are like.

We need to see where the labor market is, how close are we to our full employment goal. That will be a complicated assessment, not just based on a single statistic.

Both goals — winding down quantitative easing and raising interest rates — were speculated about for years by Yellen’s predecessor, Ben Bernanke, using much the same language Yellen used Wednesday, but little came of it. The QE program, in which the Fed increases the monetary base by buying bonds from banks, began to wind down in December. Fed purchases dropped from a rate of $85 billion per month to $75 billion at the Fed’s December meeting, then to $65 billion in its January announcement. The rate of purchases announced at Wednesday’s meeting is $55 billion per month.

The Fed’s accommodationist policies have succeeded in reinflating the real-estate and stock markets — both of which remained overvalued by historical standards even at the depth of the recession — but it has done little to spur economic growth as measured by new-business formation, job creation, or other measures.

Yellen is fortunate that few observers grasp the falsehood at the center of the Fed’s “dual mandate” of managing inflation and maximizing employment. This mandate is based on an antique economic theory called the “Phillips Curve,” which posited an inverse relationship between inflation and unemployment.

The Phillips Curve, a relic of Keynesian mythology, has been abandoned by economists after repeatedly failing to bear out in reality — most notably during the stagflation of the 1970s and the unprecedented economic stagnation of the past eight years. Since 2006, Bernanke has quadrupled the monetary base, and inflation — which is widely described as being under control or even too low — has in fact robbed the dollar of 16 percent of its value, according to the Bureau of Labor Statistics’ inflation calculator. Yet the economy has moved sideways, unemployment remains at 6.7 percent, and household net worth is about where it was prior to the recession, amounting to a massive disappearance of buying power with no discernible positive effects on the economy.

Yellen was a popular choice for Fed chief because she is especially committed to these catastrophic policies. Nevertheless, quantitative-easing fatigue and growing unease at interest rates that are in no way reflective of earthly reality have given rise to speculation that even Yellen may have to become less aggressive in devaluing the dollar. Wednesday’s comments amounted to a mush-mouthed acknowledgment of these concerns, but Yellen’s desire to punt on the hard choices was applauded by inflation believers. Jared Bernstein, whose disastrous tenure as Vice President Joe Biden’s economic adviser gave rise to the infamous phrase “recovery summer,” rejoiced that inflation “hawks” — who are always and everywhere in eclipse — were, once again, in eclipse.

Others were less enchanted. The Wall Street Journal’s Real Time Economics blog gave ironical treatment to Yellen’s claim that cold winter weather was an “important factor” in holding back the economy. In ValueWalk.com’s assessment of the Federal Open Market Committee’s statement, David Merkel observed, “You almost never see anyone claim good weather boosted results.”

The most significant move of the day, and the best hint as to Yellen’s plans, was the FOMC’s decision to abandon its 6.5 percent unemployment threshold, which the Fed indicated in 2012 would be the threshold at which it would consider raisign rates. By removing this discipline, Yellen is free to continue robbing the dollar of its purchasing power.

Also undiscussed by Yellen and nearly all her critics was the horrible effect of monetary accommodation on Americans who work for a living. As noted above, you would need to be earning at least 16 percent more greenbacks than you were in 2006 to keep up with inflation. This is not true for the vast majority of Americans. By taking the Census Bureau’s Household Income data for 2012 (the most recent year available) and using the BLS inflation calculator to reverse-inflate those numbers back to 2006 levels, we can see that across all income levels, Americans are doing worse. The bottom-quintile income of $20,599, for example, comes to $18,087.40 in 2006 dollars. A fourth-quintile income of $104,096 comes to only $91,403.75 in 2006 dollars. Across all income levels, the reverse-adjusted 2012 levels are lower than the adjusted 2006 income levels the Census Bureau lists.

Although monetarists maintain that inflation is a key component of modern economics, it has in fact been understood, and loathed, for centuries. In The Wealth of Nations, economist Adam Smith discusses inflation at length — always describing it as debauchment of the currency that enriches the king at the expense of his subjects. Then-presidential candidate Ronald Reagan made a similar point in a 1980 debate with President Jimmy Carter.

Yellen believes that inflation is too low, a faith in which she receives eager support from the media. But the belief that managed inflation can bring economic benefits — or even that inflation is a natural rather than monetary phenomenon — is the real source of the kind of troubles Yellen has already begun to manifest in her first big public appearance.

Devaluing the currency is not just an activity without any end point but one without any purpose. In the century-plus history of the Federal Reserve, the dollar has lost more than 95 percent of its value, and a simple comparison with pre-Fed history indicates that this devaluation brought no economic benefits that would not have come about anyway. In the hundred years prior to the Fed’s creation, the United States expanded from a handful of states on the eastern seaboard to a continent-spanning nation, acquired both Alaska and Hawaii, abolished slavery, built the transcontinental railroad, became an unprecedented world power, and experienced levels of economic growth and social mobility that it has never again matched — all of those achievements having been accompanied by steady deflation that left the dollar worth more in 1913 than it had been in 1813.

Yellen’s problem isn’t that she couldn’t make the markets see her point. It’s that she can’t see what’s right in front of her nose.

— Tim Cavanaugh is news editor of National Review Online. Follow him on Twitter and Facebook.

UPDATE: This article has been revised to correct and expand details about the winding down of the Fed’s quantitative easing program.​


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