2014-01-14 08:08:00
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