Yellen Says Economy Performing ‘Far Short’ of Potential

Janet Yellen, nominated to be the next chairman of the Federal Reserve, said the economy and labor market are performing “far short of their potential” and must improve before the Fed can begin reducing monetary stimulus.

“A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases,” Yellen, the Fed’s vice chairman, said in testimony prepared for her nomination hearing tomorrow before the Senate Banking Committee. “I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy.”

The remarks show Yellen is committed to the central bank’s strategy of attempting to boost the economy and lower 7.3 percent unemployment, more than four years after the economy began to recover from the longest and deepest recession since the Great Depression. She also signaled support for capital and liquidity rules to help reduce the perception that some banks are too big to fail.

“Her approach is let’s do more QE now to get the job done faster,” said Laura Rosner, a U.S. economist at BNP Paribas SA in New York and a former researcher at the New York Fed, referring to the quantitative easing bond purchase program. “Yellen is repeating her commitment to getting the job done.”

In three pages of prepared remarks, Yellen said unemployment is “still too high, reflecting a labor market and economy performing far short of their potential” and that inflation is “expected” to remain below the Fed’s 2 percent goal. She also highlighted areas where the economy has improved, saying housing “seems to have turned a corner” and the auto industry has made an “impressive comeback,” she said.

Bond Yields

Equity futures advanced and government bond yields decreased on Yellen’s comments, released after the close of U.S. exchanges. Standard & Poor’s 500 Index futures expiring in December climbed 0.1 percent to 1,779.6 at 5:08 p.m. in New York. The yield on the 10-year Treasury note fell 0.07 percentage point to 2.7 percent.

Yellen in her testimony publicly voiced her views for the first time in seven months on the unprecedented monetary stimulus that she’s supported and that some lawmakers have used to justify voting against her. The hearing is scheduled to start at 10 a.m. in Washington.

She also said that the Fed has “made progress in promoting a strong and stable financial system, but here, too, important work lies ahead.”

Liquidity Rules

Capital and liquidity rules, as well as “strong supervision,” are important tools to regulate the largest banks, Yellen said. “In writing new rules, however, the Fed should continue to limit the regulatory burden for community banks and smaller institutions, taking into account their distinct role and contributions.”

The U.S. central bank is imposing higher capital and liquidity standards on the biggest banks as required by the Dodd Frank Act, and examining how banks fare in a crisis through its annual stress test.

“It’s a note from their well-played songbook,” said Joseph Engelhard, senior vice president at Capital Alpha Partners LLC in Washington. “There is an implicit recognition that too-big-to-fail exists,” even though the Fed has “the tools to deal with it.”

Yellen, 67, was nominated last month by President Barack Obama to succeed Ben S. Bernanke, whose term at the central bank expires Jan. 31.

Dire Outcome

In her remarks, Yellen said “the past six years have been challenging for our nation and difficult for many Americans,” crediting Bernanke for averting an even more dire outcome.

“The effects were severe, but they could have been far worse,” Yellen said. “Under the wise and skillful leadership of Chairman Bernanke, the Fed helped stabilize the financial system, arrest the steep fall in the economy and restart growth.”

The banking committee, consisting of 12 Democrats and 10 Republicans, will vote at a later date on whether to advance Yellen’s nomination to the full Senate. She’ll need the support of at least 60 senators to win confirmation.

Tim Johnson, chairman of the banking committee and a Democrat from South Dakota, said he is “excited to cast my vote to confirm her as the first woman to serve as chair of the Federal Reserve, and when we vote on the nomination, I urge my colleagues to do the same,” he said in remarks prepared for the hearing.

Opposed Yellen

Four of the committee’s Republicans, including Idaho Senator Mike Crapo, the senior member, opposed Yellen when she was considered for Fed vice chairman in 2010.

“I still have concerns, which were the concerns behind my original vote on her original nomination, about her support of the quantitative easing and the entire direction the bank has been going for the last few years,” Crapo said in an interview last week. He has not committed to how he will vote this time.

The other banking committee Republicans who previously opposed Yellen are Alabama’s Richard Shelby, Louisiana’s David Vitter and Tennessee’s Bob Corker. She was supported in 2010 by Nebraska Senator Mike Johanns, a Republican. None of the panel’s Democrats have said they’ll oppose her nomination.

Yellen’s testimony comes at a critical moment for monetary policy. The Federal Open Market Committee, which she is poised to lead, is considering whether to begin slowing its $85 billion monthly bond purchase program, which is pushing the Fed’s assets toward a record $4 trillion.

Elevated Joblessness

The nation’s jobless rate has exceeded 7 percent for more than four years since the end of the longest recession since the Great Depression, even as the Fed presses on with an unprecedented program to keep interest rates low. The Fed’s target rate has been held near zero since December 2008.

Financial markets have closely followed the debate within the Fed over when to wind down its bond buying. Speculation that the Fed would begin to taper its bond buying helped push 30-year mortgage rates to a two-year high of 4.58 percent in August, while the yield on the 10-year Treasury rose to a two-year high of 3 percent in September. The average mortgage rate was 4.16 percent as of Nov. 7.

Yellen’s Speeches

Yellen has refrained from publicly engaging in the asset purchase debate. She stopped giving speeches once she was under consideration for the top job. Her last public address, on regulation, was delivered June 2. She has not given a speech on monetary policy since April 16.

Last month, when President Barack Obama announced her nomination, Yellen said more needs to be done to strengthen the nation’s economic recovery.

“While we have made progress, we have farther to go,” she said Oct. 9. “The mandate of the Federal Reserve is to serve all the American people, and too many Americans still can’t find a job and worry how they will pay their bills and provide for their families.”

If confirmed, Yellen will lead the Fed’s efforts to finish implementation of the most sweeping overhaul of financial regulation since the 1930s. Rules on proprietary trading and bank capital are pending.

U.S. financial regulators are also trying to ensure that a failure at one of the largest banks won’t threaten to trigger an economic collapse, requiring taxpayer support to prop up the bank. The Dodd-Frank Act requires banks to write plans on how they would wind operations down, and empowers the Federal Deposit Insurance Corp. to reorganize a failing bank while imposing losses on shareholders and creditors.

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