Yellen Should Answer Tough Questions Before Getting Fed Job

After the president, the chairman of the Federal Reserve is the most powerful office in the land.

But so far, Janet Yellen, the heir-apparent nominee to chair the Fed, has been slow-pitched and not asked the kind of direct questions in Senate Banking Committee hearings that reveal whether she is the right person to lead the Fed in the most challenging time since its inception in 1913.

The elephant in the living room is an unprecedented debt bubble that is manifest in not only the $17-trillion-plus of government debt, but also in the Fed’s debt holdings that have grown 400% to nearly $4 trillion since the beginning of 2008.

A zero percent Federal Funds rate and four rounds of long-term bond buying programs — collectively known as Quantitative Easing (QE) — have brought interest rates down to the lowest level since World War II.

And while benefiting Wall Street and wealthy investors by boosting stock prices, the Fed’s QE policies have utterly failed to create the kind of private sector job growth that has characterized every other post-recession recovery since the Great Depression.

The other beneficiary of QE has been the federal government, the cost of whose profligate spending and borrowing have been masked by the Fed’s artificial engineering of low interest rates through the QE bond buying.

QE is controversial because it is effectively a way to impose price controls on the entire yield curve.

Traditionally, central banks raise and lower short term interest rates, but QE is a totally unprecedented effort to suppress and keep the cost of long-term money at an artificially low level.

Since price controls are at the heart of the misallocation of resources that cause socialist economies to fail, Ms. Yellen needs to explain why and how the Fed’s price controls on the all-important price of money and credit can result in a good outcome for the American free enterprise system.

Five years of subpar employment and economic growth suggest that creating so much new money with artificially low interest rates fails in the same way that price controls bring malfunction to socialized economies everywhere.

Moreover, the QE-induced price controls have distorted national priorities, which will show up when the normalization of interest rates triples the cost of servicing the national debt.

If the $85 billion sequester was disruptive, what will Washington do when interest rates normalize around 6%, and the cost of servicing the national debt claims $500 billion more from the national budget?

The Fed has been able to circumvent concern about inflation that normally accompanies massive money printing of the scope pursued in the last five years, by pointing to the low inflation rates that have accompanied the Fed’s QE money printing and debt accumulation.

But inflationary pressure will surely come when the velocity of money increases from more economic activity.

Should the economy achieve this much-hoped-for critical mass, the Fed will have to move fast to take money out of circulation to thwart inflation by selling the bonds it has acquired through the four iterations of QE.

Since price stability is one of the two primary responsibilities and objectives of Federal Reserve policy, Ms. Yellen needs to explain how the Fed can unwind its $4 trillion portfolio in an orderly fashion without spooking the markets, cratering bond prices, driving up interest rates and unleashing inflationary psychology.

The record shows that Janet Yellen supported Ben Bernanke’s easy money policies and the unprecedented expansion of the Fed’s balance sheet through QE policies.

Insofar as unwinding and reversing these policies requires leadership of a different mindset, it is all the more important to know more about what she intends to do.

Let’s hope the full Senate confirmation hearings in December can be more rigorous than those of the Banking Committee’s, which proved to be more of a formality for her successful nomination.

Arguably, the more we continue on the same monetary path, the more difficult and disruptive it will be to achieve normalization.

But until the economy normalizes it can’t provide enough growth to cut unemployment and raise tax revenues to balance the budget and stabilize the federal debt.

Before the Senate votes on her confirmation next month, nominee Yellen needs to explain the new monetary policy options she would consider implementing to get the U.S. economy back on the right track.

Powell is an economist and senior fellow at Discovery Institute in Seattle.