Why Janet Yellen Still Needs to Be Patient

In Today’s Global Economy, Even the Mighty Federal Reserve Isn’t in Charge

Sometimes my parenting slackens—say on vacation—and Sebastian gets accustomed to staying up late, taking too much screen time, and passing on his veggies. Pulling him back to normalcy from this brink of anarchy is never easy.

All of which is to say I don’t envy Janet Yellen.

As foreign goods become cheaper to Americans, U.S. goods become a lot more expensive to foreigners, hurting U.S. exports as well as the profits of U.S. companies doing business overseas.

The Federal Reserve has been a fantastically lax economic parent since 2008, letting us all binge on the financial equivalent of sugary treats like its quantitative easing and near-zero percent interest rates that basically begged financial institutions to take free money. When historians look back at Washington’s response to the crisis of 2008-2009, they will marvel at the Fed’s unprecedented, “whatever it takes” measures, and at how these dwarfed the stimulus provided by Congress and the Obama administration.

Trouble is, it’s proven awfully hard for the Fed to pull us back to normalcy. After much drama, the Fed has managed to phase out its quantitative easing program (which entailed the central bank pouring tens of billions into the economy a month by buying a range of assets to prop up their value). But it has kept its benchmark interest rate at essentially nada (that is the technical financial term) for an unprecedented period, as if the economy were still in need of life support. We can quibble over how strong the economic recovery has been, but we no longer have any business being in the intensive care ward. In the past couple of years, employment numbers have surged, consumer confidence has rebounded, the banking system has gotten itself back on solid footing and, by some measures, the stock market has tripled in value from its harrowing bottom in March 2009.

And so, the drama that unfolded last Wednesday in Washington was all too familiar to parents faced with the challenge of pulling their kids back to normalcy while trying to minimize the associated temper tantrums (in this case, by a stock market addicted to easy money and the safety blanket of a Fed willing to do whatever it takes to keep us out of trouble). This was Janet Yellen’s “just one more cookie” or “just 15 more minutes of TV and then it really is time for bed” moment.

She artfully minimized the temper tantrum. In the Byzantine and cultish Fed-watching realm, no ritual is more venerated than the parsing of the statement released by the central bank’s committee that meets to review interest rates every other month. For some time that statement has consistently included the soothing phrase that the Fed would be “patient” before hiking rates again, but investors have been fretting for months over when the Fed would drop that one word, realizing that it would amount to a last call or final warning.

The Fed had no alternative but to drop the word “patient” from its statement, lest it lose all parental credibility. But it confounded expectations by sending other conflicting signals, including on how low it thinks unemployment can go before it triggers inflation. And in the most memorable phrase of the day, cheered by the stock market but probably deplored by parenting experts worldwide, Yellen stated at her afternoon press conference: “Just because we removed the word ‘patient’ from the statement doesn’t mean we’re going to be impatient.” Which, to a kid, would sound a lot like, “Who knows what will happen—you might even score another cookie!”

Now, to fully understand Yellen’s apparent indecision, we have to acknowledge an inconvenient truth that is all too often overlooked: The Federal Reserve and its chairwoman—contrary to what conspiracy theorists, congressional critics, and plenty of investors would like to believe—aren’t fully in charge.

We often the mighty Fed’s actual mission: to oversee monetary policy with an eye toward maximizing employment and ensuring “stable prices” and “moderate long-term interest rates.” The statutory goal is to keep the economy humming so that the greatest possible number of us can find jobs, without things overheating to a point where inflation gets out of hand (the Fed has defined “stable prices” to mean a desirable inflation rate of 2 percent). The fear for a number of years now (among so-called “hawks” among Fed watchers) has been that all this cheap money sloshing around would trigger an inflationary spiral, especially once the economy started recovering on its own, a process that typically creates more demand for goods, services, and workers, thus driving up prices.

As any econ 101 student knows, balancing employment and inflation is not an exact science under the best of conditions. But the real problem facing Yellen and her colleagues at the Fed is that the world has shrunk and become too interdependent for their controlled domestic experiment to balance those two measures.

Yellen might feel its time to pull us back into normalcy, but in Europe, Japan, and other parts of the world, more feeble economies still require indulgent parenting of the type we are trying to move away from. Many central banks are cutting interest rates and adopting quantitative easing even as the Fed has been eyeing interest rate hikes.

The Fed isn’t supposed to be concerned about the value of the U.S. dollar, but it has to be in today’s world, whether it cares to admit it or not. Because the U.S. economy has been stronger than most over the past year (attracting investors from around the world), the value of the dollar has soared in recent months, and would likely soar even more if interest rates start rising in the U.S. while going down elsewhere (attracting even more investors looking for higher returns on Treasury bills and other bonds).

When the value of the dollar spikes compared to other currencies, a lot of the stuff we love to buy goes on sale—gas, your clothes made in China, German cars, foreign travel, you name it. If the dollar appreciates by 25 percent, as it has in the last half year, Americans are basically handed extra cash in the global shopping mall.

So the strong dollar and economic weakness elsewhere in the world threaten to derail Janet Yellen and the Fed’s careful parenting plans in a number of ways. For one thing, it tampers down the inflation (with everything on sale!) we’d normally see given our own economic rebound. More worrisome, a strengthening dollar can pose a threat to the very recovery the Fed is eager to certify as the rationale for its return to normalcy. That’s because just as foreign goods become cheaper to Americans, U.S. goods become a lot more expensive to foreigners, hurting U.S. exports as well as the profits of U.S. companies doing business overseas. And, lastly, the combination of Fed rate hikes, a surging dollar, and falling commodity prices threaten to wreak havoc on the public finances of many countries around the world, including plenty of U.S. allies.

All of which is to say I don’t envy Janet Yellen. And one way or another, she has no choice but to remain very patient.

Andrés Martinez is editorial director of Zocalo Public Square, for which he writes the Trade Winds column. He is a professor of journalism at Arizona State University.
Primary Editor: Joe Mathews. Secondary Editor: Sarah Rothbard.
*Photo courtesy of Images Money.


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