Federal Reserve Chair nominee Janet Yellen sat before the Senate Banking Committee on Thursday morning. The session, which Yellen kicked off with a short testimony, covered a lot of ground. Committee members generally asked direct but mild questions about the Fed, its monetary strategy, and how Yellen intends to posture herself following her (technically tentative but widely presumed to be in the bag) confirmation.
Here are a few key takeaways from the hearing.
1. Transparency, openness, and the Fed’s relationship with Congress
Chaired by Sen. Tim Johnson (D-S.D.), the Senate Banking Committee traces its roots back to 1913, the same year that the Federal Reserve System was established by the Federal Reserve Act. The committee oversees a wide range of issues but has historically served as the primary interface between the Senate and the Fed. This is relevant because the nature of the relationship between Congress and the Fed is an increasingly important topic of conversation among policymakers, and the subject was breached at Thursday’s hearing.
Specifically, it is the evolving issue of transparency and openness with regard to Fed decision-making that has become a centerpiece of the conversation. The issue is perhaps best represented by a piece of legislation championed by Sen. Rand Paul (R-Ky.). The legislation would require that the Fed’s decision-making on monetary issues be audited, a step that is above and beyond the financial audits that currently take place.
The idea behind the bill — that the Fed needs to be more open and more transparent — has been a thread throughout much of the conversation surrounding Yellen’s confirmation. Broadly, this thread has been called the “audit-the-Fed movement,” and the cause has gained support from conservative lawmakers. Paul does not sit on the Senate Banking Committee, but he has proposed that Yellen’s confirmation be delayed until there is a vote on the audit bill.
Sen. David Vitter (R-La.) raised the issue during the hearing, asking Yellen if she would support the idea of the Government Accountability Office reviewing Fed decision-making. Yellen responded with some of the same boilerplate language that current Fed Chair Ben Bernanke used in the past to respond to similar questions: “We’re one of the most transparent central bank in the world.”
Yellen said that she would oppose any measure that would conflate the independence of Fed decision-making with “short-term political pressures.” For the past 50 years, Congress has recognized that the Fed should be exempt from GAO auditing specifically for that reason. At arm’s length, this appears the necessary policy — in order for the Fed to be effective, it must operate independently.
But ongoing asset purchases are expected to grow the Fed’s balance sheet to nearly one quarter of the size of U.S. gross domestic product in coming years, and this prospect is rightly concerning.
2. The effectiveness of quantitative easing and a timeline for tapering
“It seems to me that there’s a disconnect between what the Fed intended to accomplish and the results,” said Sen. Mike Crapo (R-Idaho), the ranking Republican on the Senate Banking Committee. “How do you respond to concerns that quantitative easing has limited impact on economic growth and has contributed to risks in our financial markets?”
For some context, the Fed is currently engaged in a monetary strategy called quantitative easing. Under this program, the Fed is purchasing agency mortgage-backed securities and longer-term Treasury securities from the open market at a rate of $85 billion per month.
“The purpose of these purchases was to push down longer-term interest rates, and we have seen interest rates fall very substantially,” Yellen said in response. “Lower interest rates, lower mortgage rates particularly, have been instrumental … in generating the recovery of the housing sector.”
She added: “I would agree that this program cannot go on forever. There are costs and risks to financial stability … and those are risks we take very seriously.”
When asked if she had any estimate of when the taper would begin, she repeated the standard language about the ongoing evaluation of incoming data. The Fed has set an inflation expectation threshold of 2.5 percent and a headline unemployment target of 6.5 percent as conditions for a change in policy. Fed economists have reiterated time and again that the timeline for a tapering of asset purchases will depend primarily on what the incoming data are saying.
3. Financial stability and the Fed’s role as a regulator
One of the great concerns regarding quantitative easing is that cheap credit will encourage risk-taking on Wall Street, which will ultimately lead to financial instability. Yellen was asked on several occasions if she believes there are bubbles forming in various asset classes, to which she said no.
Whether the Fed should — or even has the power — to fight asset bubbles is a hot topic of conversation, and the subject invariably came up during the hearing. Sen. Bob Menendez (D-N.J.): “Some commentators have suggested that in addition to managing inflation and promoting full employment, the Fed should also monitor and attempt to fight asset bubbles. Do you think it’s a feasible job and something that the Fed should be doing? And if so, how would you go about it?”
Yellen replied: “I think it’s important for the Fed, hard as it is, to attempt to detect asset bubbles when they’re forming. We devote a good deal of time and attention to monitoring asset prices in different sectors … to try to see if there is evidence of price misalignments that are developing. An environment of low interest rates can induce risky behavior, and I would not rule out monetary policy conceivably having to play a role” to curb that risky behavior.”
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