When Janet Yellen was nominated to the position of Federal Reserve Chair, investors and policy analysts cheered the nomination of the first female head, and paid great attention to the future of quantitative easing.
Yu Xiang
In the past three years, the Fed has pivoted from normalizing markets to pursuing much more ambitious macroeconomic objectives. Talk of a taper by Fed officials, including Ben Bernanke, prompted a near-doubling in the benchmark 10-year Treasury yield to 3% over the summer. That pushed mortgage rates up for homeowners, weighed on the economy, and ultimately forced the Fed to step back from a widely expected taper in late September.
Ben Bernanke’s second term as Chairman ends on January 31, 2014, and markets are speculating on whether the successor will bring a significant policy adjustment. There are some important reasons to believe that the Fed may continue the current monetary policy.
First of all, Fed policymakers, including current chair Ben Bernanke and expected incoming chair Janet Yellen, share similar policy positions on the role of conventional and unconventional monetary policies. They all believe that robust growth is the best way to allow for the orderly normalization of monetary policy, and insist that they will only reduce their bond buys in the face of a sustainable recovery.
Yellen delivered a confident and comfortable performance to Congress during her confirmation hearing and told members of the Senate banking committee that it was “imperative to do what we can to promote a strong economic recovery.” Refuting doubts about the effectiveness of quantitative easing, Yellen argued that the benefits of the Fed’s unconventional asset purchase program exceeded its costs. She left no doubt that she is committed to maintaining the Fed’s current approach.
Usually, the Fed chairman’s personal preference has an important influence on the Fed’s monetary policy. On Nov. 21, the Senate banking committee approved Yellen’s nomination with 14 votes in favor to eight against. Eleven of the 12 Democrats on the 22-member committee voted for Yellen, who was also backed by three Republicans. Several Republicans in the full Senate are also expected to support her. It’s relatively safe to predict that Yellen will win a full Senate vote before the end of the year.
Secondly, the economy is picking up pace but is still weak. Business spending is slow, which means that businesses are cautious about their economic prospects. Consumer spending, which accounts for more than two-thirds of US economic activities, is also weak and expanded only 1.5 percent, the slowest pace since the second quarter of 2011. The New York manufacturing survey came in at negative 2.2 for November, below the forecast. Impacted by the shutdown, the unemployment rate rose slightly from 7.2 to 7.3 per cent. The Labor Department said on Nov. 22 that unemployment rates rose in 11 states and were also flat in 11. Employers cut jobs in 15 states. Although unemployment fell in 28 U.S. states last month, the number of employed people dropped by 735,000, but was matched by a drop in the workforce of 720,000 , as reported by the Financial Times. The pressure to reduce unemployment remains intense. Because of that, Yellen noted that the labor market had improved, but was still performing “far short” of its potential.
In addition, the economy may be impacted by dysfunction in Congress in the near future, as Tom Perez, the US secretary of Labor, told the Financial Times. There is a high probability that there will be a new round of US political polarization and Congressional dysfunction in early 2014. The latest challenge is a group of 22 Republicans in the House of Representatives, who said they would oppose President Barack Obama’s bid to secure “fast track” legislation to pass trade deals on Nov.12. Soon thereafter, about 150 members of the house Democratic Party also signaled their opposition to “fast track” legislation. The Obama administration wants Congress to quickly pass the Trade Promotion Authority to help it secure a trade pact with 11 other Pacific Rim nations, as it has always deemed TPA as an important platform to bolster economic growth and job creation across the US.
Markets and some Fed’s officials worried that a premature tightening of monetary policy would disrupt the fragile economic recovery. Policy makers want to keep the monetary spigot open as long as possible to ensure the economy can sustain itself on its own.
Furthermore, US CPI is still low, which provides policy space for quantitative easing. The US consumer price index dipped 0.1 per cent in October as petrol prices fell sharply, after rising 0.2 per cent in September. In the 12 months through October, the CPI increased 1.0 per cent, the smallest gain since 2009. Meanwhile, the core CPI, which excludes the volatile energy and food components, increased 0.1 per cent in October and 1.7 per cent over the previous 12 months. The Fed’ policy red line is targeting 2 per cent inflation. The absence of inflation provides space for policy, suggesting the Fed will probably stick to its monthly $85 billion bond-buying program as it tries to stimulate demand through low interest rates.
There are some reasonable reasons for the Fed to continue quantitative easing but, in running a serious risk of inflating asset bubbles and spurring emerging market countries to enhance monetary cooperation by accelerating the ending of the dollar hegemony, the longer they wait, the more difficult it will become later on. Therefore, tapering is inevitable in the future. In order to reduce the tapering risks, when a modest tapering of asset purchases is initiated, the Fed will reinforce the forward guidance and make up for weak policy functions. The minutes of the Fed’s Open Market Committee meeting set out two sets of tools: direct measures to expand guidance; and balance sheet actions to make its tapering guidance more credible. Elizabeth Warren, a Democrat from Massachusetts, has requested the Fed to make regulatory policing as important as monetary policy. The Fed’s lack of attention to regulation and supervision helped lead to the financial crisis of 2008. With the implementation of the Dodd-Frank Act, the Fed will need to play a greater regulatory function.
When the Fed signaled in May that it would end quantitative easing, emerging markets became the focus of financial distress. After that, policy makers in the emerging markets unveiled a succession of temporary policies to rein in capital outflows and defend currencies. Besides, exposed countries are moving fast to recover their balance to reassure markets of their long-term stability and are accelerating economic structure reforms to increase productivity growth. So the Fed’s modest tapering could have a negative impact on emerging markets, but the impact will be limited.
Yu Xiang is an Associate Fellow at the China Institutes of Contemporary International Relations.
