Yellen Impresses, but Fed’s Powers Are Finite

Doug Mills/The New York Times Janet L. Yellen, the president’s nominee to lead the Federal Reserve, before the Senate Banking Committee on Thursday.

Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities in Washington and a former chief economist to Vice President Joseph R. Biden Jr.

From what I’m reading, it sounds as if Janet Yellen was a very effective witness at her Senate confirmation hearing to head the Federal Reserve.  And it wasn’t because she avoided answering questions or equivocated.  She held forth about her views on monetary policy and the role of the Fed, and in the process disarmed some pretty hostile prosecutors.

No votes have been cast, and a few members of the Senate Banking Committee have already said they will oppose her, but I strongly suspect she’ll be confirmed.  In fact, I suspect that future nominees will carefully study her performance.  We may even need a new verb here: to “Yellen” someone, i.e., to turn a potentially hostile person who controls your fate into a fan.  As in:

“So, I met Beth’s parents last night.”

“How’d it go?”

“Well, I don’t mean to brag, but I’d say I Yellened ’em.”

There were some interesting, substantive moments.  I was particularly interested in an exchange with Senator Sherrod Brown, an Ohio Democrat, who characterized the Fed’s macro-management â€" low interest rates, supporting asset prices â€" as a form of trickle-down economics: “It’s not clear to me, and more importantly, it’s not clear to the many Americans who have not seen a raise in a number of years, that this policy increases wages and incomes for workers on Main Street. … Tell us how you will ensure that the Fed’s monetary policy directly benefits families on Main Street.”

As Annie Lowrey put it on Economix: “Many senators from both parties questioned her on whether the Fed was adding to income inequality and helping Wall Street without reaching Main Street. Her answer - that the Fed was focused on helping Main Street, but its tools allow it to reach Main Street in part through Wall Street - did not always seem to convince.”

Ms. Yellen elaborated on this point, noting that the Fed’s tools “tend to affect interest-sensitive spending,” adding:

But the ripple effects go through the economy and bring benefits to, I would say, all Americans, both those who are unemployed and find it easier to get jobs as the recovery is stronger, and also to those who have jobs. You mentioned that wage growth has been weak or nonexistent in real terms over the last several years. As the economy recovers, my hope and expectation is that that would change and, if we can generate a more robust recovery in the context of price stability, that all Americans will see more meaningful increases in their well-being.

I actually think she could have been more precise here: as I’ve documented in many places, history shows that the growth and wages and incomes are simply much more likely to reach the poor and middle class in periods of low unemployment than in periods of slack job markets.  In our book “Getting Back to Full Employment,” being published this month, Dean Baker and I show that lower unemployment has economically large impacts on the hours of work and real wages at the low end of the pay scale, moderate impacts in the middle, and almost none at the top, precisely the opposite pattern generated by the factors driving up inequality.

The question then becomes whether the Fed can really tighten up the job market, especially with Congress pushing in the opposite direction.  The answer, given what we’ve seen in recent years, would appear to be: the Fed can help, and Ms. Yellen has been a smart, forceful advocate of that position, but it can’t do so alone.   It needs complementary fiscal policy to stimulate the missing demand that would be taking advantage of the low-interest-rate environment that the Fed has created and fostered.

What was so interesting about the exchanges at Thursday’s hearing was that it is widely believed, and rightly so, that the head  of the Federal Reserve is one of the most powerful people in the world.  So naturally, senators figure that the Fed chief can set the rates of inflation and unemployment - and could, if so inclined, reduce inequality, lower the still historically huge share of long-term unemployment, and get the labor force participation rate back up.  If they’re as powerful as everyone seems to think they are, then they can turn all those dials.  Right?

Nope.  Perhaps we need to talk a bit more about the limits of Fed policy.  The Fed can set the table (lower borrowing costs) but can’t get customers to come in to eat.

So why then does everyone think the Fed rules the world?  Because it can “print” money, which is in fact a big deal (it doesn’t print it as much as electronically credit it to banks’ balance sheets); because  it is independent, so it can actually, you know, do stuff; but mostly because the financial markets are the sector it can  move around on a regular basis, and we pay a lot of attention to financial markets.  (By the way, I liked her line on this â€" yes, we move markets, but they’re not our ultimate target: “I don’t think that the Fed ever can be or should be a prisoner of the markets.”)

This is kind of where Senator  Brown and others were coming from.  In essence, senators like Mr. Brown and Elizabeth Warren were saying to her: Your actions are intermediated through financial markets, through equities and bonds and currency values, but we’re here to look out for displaced manufacturing workers, a single mom trying to get more hours of work at a retail outlet, wage earners scraping by.  Is it really true that the all-powerful Fed can’t help them directly?  That you’ve got to go at this by tweaking borrowing rates, buying assets, providing “forward guidance?”

And the honest answer, which Ms. Yellen gave, is yes, that’s really true.  The Fed can’t create jobs.  It can’t invest in infrastructure.  It can only try to create the conditions for other people to do so.  And it has done some of that.  But its influence is more limited than a lot of people realize.  In fact, an irony of these exchanges is that at some level, members of Congress are asking the Fed to do the job that Congress itself hasn’t  been doing for a long while.  That’s not the fault of Senators Brown and Warren,  to be sure, but there it is.

Can’t the Fed at least stop bubbles from inflating?  Actually, both Alan Greenspan and Ben S. Bernanke demurred or worse on this, arguing that the Fed didn’t have the insight to spot bubbles nor the tools to deflate them.  Here, I thought Ms. Yellen was very strong, arguing that the Fed should in fact use its bank supervisory powers to identify and deal with bubbles before they get out of hand.

“As a first line of defense,” she said, “we have a variety of supervisory tools, micro- and macro-prudential, that we can use to attempt to limit the behavior that is giving rise to those asset price misalignments.”

Amen to that.

The reports are that she could be successfully voted out of the Senate Banking committee by next week and is then likely to get the filibuster-proof 60 votes needed to pass the full Senate.  She’ll then be the first woman to head the Federal Reserve,  and I have very high hopes for her tenure.  But even if she can “Yellen” a few cranky senators, she cannot singlehandedly repair the economy, nor can her institution.