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Janet Yellen's Very Bad Week

Irwin M. Stelzer

It was a bad week for the president of the United States and might prove to have been a career-ending week for the chair of the Federal Reserve Board. Special counsel Robert S. Mueller III is investigating whether Trump obstructed justice in connection with the FBI probe into Russian activities during the presidential election campaign. Mueller, a longtime colleague and close friend of James Comey, the FBI director fired by Trump, will be deciding whether to believe Comey’s charge that Trump obstructed justice, or the president’s denial. Mueller will have the help of a staff that includes lawyers who have contributed to the Democratic party. Trump has been around casinos long enough to know a stacked deck when he sees one, but cannot exercise his right to have Mueller fired lest he be accused of, er, obstructing justice.

Janet Yellen, the Fed chair, announced that the Fed believes the economy is in fine shape, good enough to withstand another quarter-point rise in the key fed funds rate and a gradual sell-off of the mortgages and bonds the Fed bought in an effort to end the recession. She feels compelled to do this even though there are few signs that the economy is overheating. It seems to have grown at the measly annual rate of 1.2 percent in the first quarter of this year, and inflation is well below the Fed target of 2 percent. Although the unemployment rate is a low 4.3 percent, there is no sign that wages are rising at a rate that will drive costs and prices up, if indeed there is such a thing as cost-push inflation, which many economists doubt.

Last week’s rate increase took the fed funds rate to between 1 precent and 1.25 percent. That brings the increases in the past two years to a full percentage point after seven years at approximately zero. Yet that rate is still below the current inflation rate of around 1.7 percent. Which means that the real interest rate—after correcting for inflation—remains below zero.

Given the still-low level of interest rates, and the Fed’s rosy outlook, it would certainly make sense for it to begin getting interest rates back to a more normal level, which most economists believe to be around 3 percnet for the fed funds rate. And to sell off some of the paper on its $4.5 trillion balance sheet. When the economy needed a boost the Fed wanted to keep interest rates low to stimulate investment and discourage saving, and so bought mortgages and bonds to raise their prices—which move inversely with interest rates. Now, it plans to sell those securities off at a rate starting at $10 billionn a month, rising over 12 months to $50 billion per month. That should add to upward pressure on interest rates.

Good idea—unless the economy is not as strong as Yellen believes. Her cheery view of the economy is not shared by everyone, and the Fed’s forecasting record leaves something to be desired. Auto sales have slowed considerably, and General Motors is extending its summer maintenance shutdowns to whittle down dealers’ inventories. The retail sector, with the exception of Zara and a few others, is in retreat. Skills shortages are holding back growth in the housing and other sectors. Productivity continues to lag. Hopes for tax cuts and health care reform are fading.

In the great British television series Yes, Minister, Sir Humphrey, the prototypical civil servant, frightened his minister into abandoning any scheme of which the bureaucracy disapproved by complimenting him with, “How very courageous, minister.” Most ministers not being profiles in courage, they dropped the potentially career-ending plan without further discussion. Courage was not for them. Yellen is different. She believes that the Fed policies she pursued prevented the Great Recession from becoming a rival of the Great Depression, and that now is the time for the Fed to wind down its stimulus programs and move rates to a neutral level, neither stimulating nor slowing the economy.

Not good enough for the president, who needs an annual growth rate of at least 3 percent to make his budget proposals plausible. Because of complicated rules, he must submit a budget that does not increase the deficit if he is to avoid a Senate filibuster by Democrats, and pass his budget with the backing of the slim 52-48 majority Republicans have in the Senate. Trump is counting on faster economic growth to generate the revenues the Treasury will need to offset the tax cuts Trump deems necessary to get the economy out of what he sees as a rut—except on those days when he takes credit for its robust growth, job creation, and booming share prices. His current position varies between praising Yellen for keeping interest rates low, and nominating board members who have criticised her for not raising them fast enough.

Yellen’s four-year term as Fed chair ends on Feb 3, 2018, only a bit more than seven month from now. (Her term as governor expires in 2024.) She is well aware that any slim chance she had of being reappointed, as were her three predecessors, Paul Volcker, Alan Greenspan and Ben Bernanke, disappeared when she announced plans to move the policy from stimulative to normal. Or perhaps when Trump let it be known that he prefers a non-economist as Fed chair, a businessman like, for example, Gary Cohn, the former Goldman Sachs president who now heads Trump’s National Economic Council—and the informal group tasked with finding a successor for Yellen. It would surprise no one if Cohn believes he sees the new Fed chairman in the mirror when he shaves in the morning. After all, there is precedent for such a recommendation. Dick Cheney headed George W. Bush’s search committee for a vice president, and look how that turned out.

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