What does Janet Yellen as Treasury secretary mean for the US economy?
- Given that Yellen has been chair of the Federal Reserve, US fiscal and monetary policy are likely to be much more in sync
- While Yellen is not an advocate of austerity policies, if the market appetite for risk skyrockets or the dollar weakens considerably, higher interest rates might come sooner than expected
Next year will be transformative for the global economy, policy perceptions and financial markets as the world finally transcends the Covid-19 pandemic. Interest rates are already bottoming out, and the US might be in the vanguard for rate rearmament a lot sooner than expected.
Irrational exuberance has done its job, risk-aversion is receding and a return to better times might tempt global policymakers to talk tough again in 2021. Premature tightening should be resisted at all costs.
It’s an exciting move since Yellen preceded current Fed chair Jerome Powell as central bank head, proving a unique opportunity for US fiscal and monetary policy to work much more closely to the economy’s advantage. There’s a better chance now that Biden’s recently unveiled US$7 trillion coronavirus recovery package can rescue the US economy from its deepest recession since the Great Depression.
The good news about Yellen is that she is not an advocate of austerity policies and has spoken about the need for the government to extend “extraordinary fiscal support” during the pandemic. The aim of Biden’s Build Back Better economic recovery package is sustainable recovery, funding new job creation, boosting consumer spending power with a doubling of the national minimum wage to US$15 an hour, while investing in new infrastructure initiatives to boost economic regeneration.
What this means will be bigger budget deficits and a mushrooming pile of US government debt in the next few years, which must be supported by the Fed’s ongoing asset-buying programme until stronger recovery is secured.
From the Fed’s perspective, it means the policy baton passes from monetary stimulus to fiscal reflation as the main driver of recovery going forwards. This should provide the Fed with a lot more room for manoeuvre on its future interest rate decisions.
In recent months, the Fed has hinted at a strong reluctance to let short-term interest rates drop into negative territory, implying that the target rate for Fed funds has reached a natural floor at the current range of 0 to 0.25 per cent. If the US economy is shifting into a quicker recovery phase, the key question is how long before the Fed eventually shifts from ultra-easing mode back towards a tightening bias?
There is a lot to take into consideration, not least juggling expectations about the future outlook for growth, jobs and inflation, especially while the Fed tries to rebuild its overstretched monetary credibility. Back in June, when the Fed was forecasting that US gross domestic product might bounce back to the tune of 5 per cent in 2021, the indications were that the Fed intended to keep rates steady at zero at least through 2023.
This prospect seems even more likely considering the Fed has downgraded its growth expectations for 2021 to 4 per cent according to September’s Federal Open Market Committee projections. Forward implied rates in the US money market curve seem well contained for now.
It might be the last thing on the market’s mind right now, but never say never again to an early interest rate hike from the Fed.
David Brown is the chief executive of New View Economics