It will take years to determine whether Ben Bernanke’s 8-year tenure as chairman of the Federal Reserve was successful, but there’s one thing we already know about Bernanke: He was the Master Easer.
Bernanke began cutting interest rates in 2007, a year-and-a-half into his first term as chairman, and kept the easy money flowing until the very end of his time at the Fed. The official end of the super easy-money era came in December, when the Fed announced it would begin to wind down the huge bond-buying program knows as quantitative easing, which took effect at the end of 2008 and was renewed several times.
The Fed says it will still remain “highly accommodative,” keeping short-term rates near zero until at least 2015. But the Fed’s shifting stance is already unnerving markets, as the odds of rising rates in the United States and a whole new monetary policy regime reroute the global flow of money. And with Bernanke leaving the Fed, it’s now up to his successor, Janet Yellen, to deal with all the delayed consequences of the aggressive and controversial policies that dominated his tenure.
The most obvious concern all along has been the risk that the Fed’s “money printing” would lead to runaway inflation somewhere down the road. That could still happen, but every dire prediction of soaring prices has been wrong so far. And the Fed says that if necessary, it can create incentives for banks to keep their money parked at the Fed instead of lending it out and stoking an overheated economy.
Meanwhile, it’s often the problems nobody foresees that turn out to be the real bugaboos. Here are 4 such problems Yellen may have to grapple with:
Bubbles. They’re hard to spot when you’re in them, but there certainly is some risk that artificially low interest rates have pushed stock prices a lot higher than they’d be otherwise. Bernard Baumohl of the Economic Outlook Group points out that margin debt—which is basically borrowed money used to buy stocks--is at an all-time high of $445 billion, driven at least in part by bullish investors who felt Fed policies would continue to push up stock prices.
“A major pullback in the stock market could create serious financial strains for those borrowers,” Baumohl writes. Margin calls, when brokers call in the collateral that backs margin debt, are one of the things that could intensify a stock market correction, turning it into a bursting bubble.
It seems less likely there’s a bubble in house prices too. Double-digit increases during the past year may have been a bit frothy. Many investors anticipated some leveling of stock and real-estate prices once Fed policy pivoted. The real problem for Yellen would be a market overreaction that begins to depress confidence and activity in the real economy, perhaps even requiring a return to easier Fed policies.
Global aftershocks. The Fed is so powerful that its policies affect markets in many countries other than the United States. The latest shift in Fed policy, for instance, is partly responsible for the sudden outflow of money from emerging markets such as Turkey, Argentina and South Africa, as investors anticipate higher returns in the United States and take their money out of riskier investments. Emerging market turmoil, in turn, is pushing down stock prices in the United States and Europe.
It’s not the Fed’s job to worry about stock prices every day, but the Fed does bear responsibility for the consequences of its own policies. “While the Fed will claim to be focused on domestic policy concerns alone, the removal of QE may complicate its policy shift via knock-on effects from abroad,” says Rick Reider of investing firm BlackRock.
Scarce jobs. Part of the Fed’s mission is to pursue policies meant to foster maximum employment. The problem is that the Fed doesn’t seem to have the tools to do that. The unemployment rate, now 6.7%, has obviously come down since peaking at 10% in 2010, yet the pace of improvement seems glacial given that the Fed basically threw everything it had at the problem. The risk now is that the Fed may have to raise rates, as a bulwark against inflation, before the labor market is convincingly healed. “Catcalls will come from the left if Yellen determines that tighter monetary policy is needed to head off inflation, even while the unemployment rate remains high,” writes economist Phil Swagel of the American Enterprise Institute.
Political meddling. The Fed is supposed to be independent of the political process, and Bernanke generally had a free hand to do as he wished. That could change if Bernanke’s policies produce high inflation or other consequences that seem unusually harmful. Some Fed critics feel the central bank should focus only on inflation and forget about employment, while others feel Fed policy should be less subjective and more beholden to firm rules that would dictate policy, almost like an algorithm.
If the Fed starts to seem like an anchor pulling the economy down, Congress could change the Fed’s mandate or rein it in in other ways. Then again, it’s always possible that the economy will wean itself off the Fed’s super-easy money in a stable, measured way, making Bernanke and Yellen look like heroes. Here’s one way to tell: The less you hear of Janet Yellen during the next four years, the more likely that things will be going her way.
Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success . Follow him on Twitter: @rickjnewman.
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