Janet Yellen only takes questions from reporters four times per year, so her semi-annual testimony on monetary policy is a key window into the powerful Fed chair’s views on key issues ranging from interest rates to regulation.
Yellen will find herself caught in the usual partisan tug-of-war where politicians on both sides try to ask questions that affirm their worldviews, generally with limited success as she tends to give only broad answers to questions not directly related to her mandate.
She will also be asked whether she’s had any discussions with President Donald Trump about staying in the job. He is widely expected to replace her at the end of her term as chair early next year, and is reportedly considering Gary Cohn, former president of Goldman Sachs and head of Trump’s Nation Economic Council, for the post.
However, Yellen will probably demure and simply say she’s focused on the job at hand, as she did during her June press conference. This is Yellen’s last official testimony to Congress before the end of her term in February of 2018.
Yellen faces two days of hearings on Capitol Hill, the first before the House Financial Services Committee and the second in front of the Senate Banking Committee. Given political spin and her professional future are likely off limits, here are five questions lawmakers might consider asking her:
1. Why are you raising interest rates if inflation is falling?
Fed officials are having increasing trouble justifying their outlook for continued interest rate increases this year and next in the face of inflation data that is slipping despite a historically low unemployment rate. Nor is Wall Street all that convinced, with many traders barely pricing in another rate hike this year.
“A further retreat from the Committee’s longer-run objective will prove increasingly difficult to disregard, particularly with both the annual rate in headline and core consumer inflation at near two-year lows,” says Lindsey Piegza, chief economist at Stifel Nicolaus.
Given the room afforded by low inflation, why not leave interest rates steady and wait to see solid wage increases before tightening monetary conditions further?
Realistically, these are not questions Yellen will answer head on.
“Given the disagreement evident in the minutes of the last FOMC meeting, we don’t expect any definitive steer from Yellen on when the balance sheet run-down will begin or whether to expect a September rate hike,” writes Paul Ashworth of Capital Economics in a research note.
Still, her tone on the economy will offer insight into how high a bar the Fed currently has to divert from its rate hike path. It appears set pretty high.
2. What do you make of Republican efforts to dilute post-crisis financial rules?
As much as Yellen avoids talking politics, financial regulation is certainly part of her mandate, and she’s already had much to say about Trump and the Republican Congress’ efforts to reverse many of the post-crisis reforms intended to prevent another meltdown.
“We lived through a devastating financial crisis. Most members of Congress and the public came away from that experience feeling that it was important to take a set of steps that would result in a safer and stronger financial system,” she said during her last testimony in February. “I feel that we have done that.”
Yellen will likely get asked about the issue again, given many Republicans and Wall Street CEOs blame bank regulation for weak economic growth. Trump’s board nominee for financial regulation, Randall Quarles, is a creature of Wall Street, meaning Yellen must redouble her effort to push back against what is effectively an undoing of the work she and her colleagues have spent seven years undertaking.
3. What are you doing to boost financial stability and monitor market bubbles?
Fed officials have often cautioned against raising interest rates in order to tame asset market bubbles. But with inflation nowhere to be seen in the current economic horizon, it’s hard not to get the feeling that the Fed’s resolve to keep raising borrowing costs after a prolonged period of zero interest rates is in part due to its fears of an ever-rallying stock market.
Yet policymakers including Yellen have described such an approach — slowing down the entire economy just to soften a single market — as counterproductive. Instead, they have talked about using “other tools” to monitor and if needed restrain particular corners of finance. These policies are sometimes referred to as “macroprudential,” and could include things like loan-to-value restraints or curbs on leverage. But officials have never been specific about what they could do, or how? It’s time for Yellen to provide more clarity on this front.
Ethan Harris, economist at Bank of America-Merrill Lynch sheds some light on this internal debate in a note to clients.
“This year the Fed appears to have shifted to a ‘hawkish bias.’ This was evident when the Fed hiked rates and signalled balance shrinkage at its June meeting despite weak growth and inflation data. Why the change of feathers?”
Among other factors, he says, “the Fed is worried a bit about financial stability and overheating markets. However, we put a relatively low weight on this argument. Chair Yellen and her allies have repeatedly underscored the idea that macro prudential policy is the first line of defence against asset bubbles and monetary policy is a distant ‘Plan B.'”
4. Why are you tweaking the Fed’s balance sheet now and where do you see it headed?
The Fed has complicated the outlook for official interest rates by announcing potentially imminent changes to its balance sheet policy, which directly affects the amount of outstanding stimulus in the economy — at least according to standard monetary theory.
But it has left a number of unanswered questions about when and and to what extent it will reduce bond buys, by gradually easing up on reinvesting proceeds of maturing bonds in its $US4.5 trillion balance sheet back into the market.
Fed Governor Lael Brainard said this week she was pretty much ready to announce a start to balance sheet reduction, although she sounded more sceptical about continued interest rate hikes. “I believe it would be appropriate soon to commence the gradual and predictable process of allowing the balance sheet to run off,” Brainard said in a speech
Lawmakers should ask Yellen for further clarification as to why the Fed has decided to further muddy the interest rate outlook at a time when the political environment is itself a source of extreme uncertainty.
5. Any comments about your long-time colleague, ex-Richmond Fed President Jeffrey Lacker?
Lacker resigned in April after admitting to confirming confidential information to Medley Global Advisors, a consulting firm that then sold those details directly to clients in a private report. Yellen overlapped with Lacker at the Fed for over a decade, and yet she has never made a public statement about his resignation. Before becoming Fed Chair, she was vice chair and before that held a role parallel to Lacker’s, as president of the San Francisco Fed.
She and the Fed have also not addressed the main question arising from Lacker’s resignation letter. If he was merely confirming details Medley already had, who was the original leaker? This is especially relevant because the House Financial Services Committee says it still has an open investigation into the matter. At a time of heightened scrutiny over ethical scandals, the Fed would only help itself by boosting transparency on this issue, if only to put it to rest.