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As Janet Yellen prepares to take over at the Fed, the omens are good
Jan 11th 2014 | WASHINGTON, DC | From the print edition
WHEN Ben Bernanke became chairman of the Federal Reserve (America s central
bank) eight years ago, unemployment had just slipped below 5%, growth had
clocked in at 3.5% and inflation was stable. The expansion in economic
activity appears solid, the Fed declared the day before he took office. Yet
beneath the surface a crisis was brewing and the worst slump since the 1930s.
For Janet Yellen (pictured), who was confirmed by the Senate on January 6th to
succeed Mr Bernanke next month, the situation is the opposite. Unemployment is
7%, growth has struggled to get past 2% and inflation is too low. Yet beneath
the surface are tantalising signs that, as Barack Obama put it: 2014 can be a
breakthrough year.
It may have begun sooner. Booming exports and investment in business equipment
suggest that economic growth may have topped 3% (annualised) in the fourth
quarter. If so, then GDP for all of 2013 would have grown by 2.7%, the first
time since the recession that it has performed as well as the Fed predicted
(see chart 1).
What they re telling Yellen
The central bank s crystal-ball-gazers expect growth to reach 3% this year;
private-sector seers say 2.8%. Recent experience calls for scepticism. Almost
every year since 2008 both the Fed and private economists have predicted an
uptick, only to be disappointed. This year, however, they disagree less about
the prospects for unemployment and inflation. Such harmony usually foreshadows
greater accuracy, according to Goldman Sachs, a bank.
The chief reason for optimism is that fiscal policy will switch from being a
gale-force headwind to a stiff breeze. Higher taxes and federal spending cuts
knocked 1.5 percentage points off growth in 2013. This year, Goldman reckons
fiscal drag will total just 0.4 points (see chart 2). It may be even less: as
The Economist went to press, Congress was debating a three-month renewal of
extended unemployment benefits.
Household balance-sheets offer another reason to be upbeat. Thanks to rising
stock and house prices, household net worth is back at a record high. Low
mortgage rates, defaults and belt-tightening have brought household debt
burdens almost back to their long-term trend. Thanks to rising prices, the
number of homes worth less than their mortgage dropped from 10.5m at the end of
2012 to just 6.4m in the third quarter of last year, reckons CoreLogic, a
property-data firm (see chart 3). That should boost consumer spending and
encourage banks to lend more.
The Fed has already tweaked its prescription for the recovering economy by
reducing ( tapering , in central-banker-speak) its purchases of bonds with
newly created money, from $85 billion to $75 billion a month a process known as
quantitative easing . It expects to be buying none at all by late this year.
At the same time, however, it plans to keep interest rates near zero until
2015, and perhaps longer if inflation, now around 1%, fails to move back to its
2% target.
All this presents Ms Yellen with two distinct challenges: what to do if the
optimists are right, and what to do if they are wrong. Benjamin Mandel of
Citigroup notes that, using a conventional policy rule, even the Fed s
forecasts of unemployment and too-low inflation would call for interest rates
to start rising in mid-2014 and reach nearly 3% by the end of 2015. As Fed
staff recently pointed out, the central bank is defying such conventional rules
on purpose: it wants to keep bond yields lower today, to stimulate growth.
Nonetheless, as the economy improves, the incoming boss may face pressure to
raise rates before she wants to. Several reserve bank presidents are already
grumbling about the Fed s leisurely schedule. The bank also has several
vacancies coming up that may be filled by people less patient than Ms Yellen.
Mr Obama is considering naming Stanley Fischer, a former governor of the Bank
of Israel, to be the Fed s vice-chairman. He has been sceptical of low-rate
promises. If markets doubt a commitment to stay the course, rising bond yields
could endanger the recovery.
The second challenge is just the opposite: that the Fed s forecast is, once
again, too optimistic, as it was every year from 2008 to 2012. Mr Bernanke,
though upbeat at a speech on January 3rd, warned: If the experience of the
past few years teaches us anything, it is that we should be cautious in our
forecasts. There have already been scattered signs of weakness in December:
car sales, for example, were modest.
The past few years disappointments are commonly blamed on bad luck: Europe s
crisis, fiscal discord or natural disasters. Larry Summers, once a contender to
succeed Mr Bernanke, wonders if in fact America has entered a period of secular
stagnation, in which chronically weak demand is the rule, not the exception. Or
perhaps slowing growth in the workforce and productivity have hobbled the pace
at which the economy can grow. There is little Ms Yellen can do about that;
which is the most worrying prospect of all.
From the print edition: United States