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It's a tricky time to be in charge of the nation's Central Bank. The Federal Reserve is winding down an unprecedented and potentially risky bond-buying strategy designed to set the economy back on course.
But every sign that the nation's prospects have finally turned the corner are offset by mitigating economic numbers. That was the backdrop for the Fed chair's semiannual trip to Capitol Hill today.
JANET YELLEN, Chair, Federal Reserve:
Although the economy continues to improve, the recovery is not yet complete.
After just five months on the job, Federal Reserve Chairwoman Janet Yellen was measured in her semiannual assessment.
Important progress has been made in restoring the economy to health and in strengthening the financial system. Yet too many Americans remain unemployed, inflation remains below our longer-run objective, and not all of the necessary financial reform initiatives have been completed.
Yellen told a Senate hearing the Fed remains on course to end a stimulus program of monthly bond purchases in October. But she gave no indication of when the Central Bank might begin raising a key short-term interest rate. It's been near zero since December of 2008.
We have in the past seen sort of false dawns, periods in which we thought growth would speed, pick up and the labor market would improve more quickly. And later events have proven those hopes to be — to be, unfortunately, overoptimistic. We need to be careful to make sure that the economy is on a solid trajectory before we consider raising interest rates.
Underscoring that point, the economy has been sending mixed signals lately. The National Association for Business Economics now estimates growth will be just 1.6 percent for 2014, down sharply from earlier estimates. On the other hand, unemployment dropped to 6.1 percent last month, beating expectations.
Yellen played down any fears of a surge in inflation today. And she said Fed leaders are watching for any bubbles in real estate or stock and bond prices. But she said, so far, prices remain in line with historic norms. Yellen is scheduled to testify to a House committee tomorrow.
We get a closer read now on Janet Yellen's remarks and the broader economic climate with from about Diane Swonk, senior managing director and chief economist for Mesirow Financial, a diversified financial services firm based in Chicago, and Greg Ip, U.S. economics editor of "The Economist."
Greg, what did you read into Janet Yellen's overall comments today?
GREG IP, The Economist:
Well, she is obviously somewhat optimistic about how the economy is making progress, but not so optimistic to think that the time is right to start raising interest rates.
She pointed out that the unemployment rate is still too high relative to what they think it should be, at around 6 percent. They would prefer it to be around 5 percent. And inflation, even though it's begun to move up, is still too low. They would like it to be around 2 percent. It's below 2 percent.
So, a she looks at the balance of forces out there, it seems that most of them still suggest that they should be keeping interest rates near zero. That said, things are getting better quickly enough that they can retire their more controversial program of stimulating the economy by buying bonds. That program, which we call quantitative easing, will be over by October.
Diane Swonk, did you hear the "yes, but" in Janet Yellen's remarks today?
DIANE SWONK, Mesirow Financial:
Absolutely. Good, but not good enough.
And you really saw what Chair Yellen does, unlike other Fed chairs have done, is really put — not does she appeal to financial markets and try to explain to them what she's doing, but also to the masses. And I think that's really important. She puts a human face on unemployment. She talks about the people she's talked to who are unemployed, people in her family.
She's talked about what it means to have the collateral damage of long-term unemployment and how the Fed has a long way to go and the economy has a long way to go to sort of heal enough to reengage those people, particularly what she calls the prime age earners, those 35-44-year-olds who have dropped out, to reengage in the labor force.
And I think those are very important things to her, that she really brings to this the reality that most Americans feel, and that is that, yes, economy has improved since the worst days of the great recession. Even over the last year, it has improved, but too many are still left behind. And it's improved a lot for a small number of people, but not enough for a large number of people.
Greg, here are the red flags I heard today. She worried a little bit about wage growth, wage stagnation. She talked about the first-quarter weakness of this year. At least a lot of people have talked about that.
And also concerns about inflation, which never go away.
I think one of the things that she and her staff are puzzling over is the fact that the economy, as you said, looked quite weak in the first quarter. It actually contracted. And yet the job market seems to be doing quite well. In June, we had the best job growth in quite a while. The unemployment rate is down at 6 percent, which is a six-year low. And we have seen job vacancies go up.
What could explain the fact that we have a lousy economy and good job growth? Well, it might be that the productivity of our workers isn't what it used to be. It may be that unemployment is coming down quickly because the economy is running out of spare workers. A lot of people who have lost their jobs are gone forever. They have retired, they have gone on disability benefits.
If this is true, then one thing she has to be careful about is the possibility that the economy has less slack in it than she thought, which might mean inflation could be a problem before she had expected.
But the reason she brought up the issue of wages is that she thinks that if there really were a problem with economy running out of workers, to the extent that it was an inflation problem, we ought to see wages being bid up. And that is just not happening. Between those rather conflicting signals, for now, she is siding with the weaker wage growth and saying that is reason enough not to raise rates now.
And would it be fair to expect interest rates at some point to begin to be allowed to rise again, Diane?
Yes, exactly, is what she would like to actually be is in a strong enough economy to allow interest rates to rise again.
I think it's important to point out this productive issue as well, because she also brought it up in another context. And that was that lower productivity rates means actually lower long-term interest rates as well, and lower interest rates for longer. And that's something else she stressed out there, is that when the Fed does begin raising interest rates, if we don't see a real pickup in productivity growth, which we really need out there, that the Fed won't be raising rates as quickly and to as high a level as we once were used to.
So, there's been a lot of multiple messages, that, one, the Fed will be very cautious before they raise rates. They would love to be able to do it because the economy is too strong. We would all love that. They can raise rates. When they do raise them, though, they are going to go very gradually and they're going to be very cautious how quickly they do it, because they don't know where we are in that spectrum that Greg noted between stagnant wage growth, stagnant productivity growth.
And is too much money accumulating to capital? And she actually brought that issue up. She brought up the secular stagnation argument that Larry Summers has brought up, which is kind of ironic that Larry Summers, who was once considered as a contender for chair of the Federal Reserve, is now having so much influence over the debate within the Federal Reserve as well.
I was struck, Greg, by a term I heard her use in her testimony. She talked about false dawns. Explain what she was talking about with that.
Well, one of the things, this has been a disappointing recovery, Gwen.
It's been growing around 2 percent per year for the last four or five years. Every year, we will think it will accelerate to around 3 percent. It never happens. And each — at the start of each year, we will often get a burst of strong job growth and then, for some strange reason, it peters out.
And I think what you hear from her is kind of the experience of those disappointments. It's very important for the Fed not to overreact to a few months of very good news, because it could fade away. And, in fact, I think that one of the strategies the Fed will pursue in the coming year is to essentially take a risk of moving too late to raise interest rates, rather than moving too early.
If they move too early, the risk is that they push the economy back into recession, and they don't have any tools to get us back out, whereas if they move too late, they might have an inflation problem, but they know how to deal with that. They have seen it before. They know how to deal with inflation.
Diane, does the Fed have a different role now than it did pre-recession?
It does have some different roles.
The financial stability role is always a role the Fed has had. That's one of its jobs. That's one of the reasons it was created. That said, the emphasis on financial stability is very important, because it is now very much a part of the fed's job and overseeing the overall financial markets, financial stability board that the Fed is on.
So, the Fed is in a very different place than it once was in the size of its balance sheet alone, which will be well over $4 trillion by the time they're done with this current asset purchase program. It puts them in a very different position than they once were.
And I agree 10 percent with Greg that they are more willing to err on not knocking the economy back into recession than allowing the economy to overheat a little bit. A little bit of heat is a lot easier to deal with than a frigid cold. And after the winter we had here in Chicago, I can tell you that is absolutely the case.
Nobody wants winter again.
Diane Swonk of Mesirow Financial and Greg Ip of "The Economist," thank you both very much.
Thank you, Gwen.
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