A Faint Glimmer of Hope on Deficits

Former chairman of the Federal Reserve, Janet Yellen, has been picked to serve as Secretary of the Treasury in the Biden administration. While running the central bank, she ended the Bernanke-era monetary expansion called Quantitative Easing. President Trump was not entirely happy with this, but wanted a more accommodating approach from the Treasury. He placed Jerome Powell at the helm and pretty much got what he wanted.

Since Yellen left the Federal Reserve we have seen an unprecedented expansion in both fiscal and monetary policy. This expansion is slated to continue, with new stimulus packages being passed by Congress and put on the horizon by President Biden. It is now Janet Yellen’s job to carry out an excessively expansionary fiscal policy – and to do so knowing that the Federal Reserve is really the only source of funding she can rely on.

The big question, therefore, is how Yellen is going to respond, now that she is in the other seat asking her former colleagues over at the Federal Reserve to expand money supply – precisely what she tried to move away from. Judging from her comments while being questioned by the Senate during her confirmation hearing, there is a glimmer of hope on the horizon.

First, though, the bad news. Reports the Wall Street Journal (Jan. 20, print ed., p. A6):

Ms. Yellen would become the administration’s top economic-policy spokesperson responsible for selling Mr. Biden’s $1.9 trillion aid proposal, which includes more stimulus payments, extended jobless benefits, grants for small businesses and a nationwide vaccination program.

She also explained – contrary to both economic theory and experience – that if more stimulus money is delayed, it

could lead to a more-protracted economic recovery and cause long-term economic damage in the form of permanent job losses and business closures.

This is not the case, of course. In the third quarter of 2020 we saw precisely the V-shaped recovery that President Trump predicted back in May. Once states started rolling back the artificial economic shutdown, the economy recovered at predictably solid pace. Therefore, the best remedy for the economy is to remove remaining restrictions and let the private sector flourish.

So far, Yellen has echoed the Democrat desire for more government spending. She did, however, also allude to what could be seen as a coming shift in policy focus, from entitlement spending – as in the stimulus packages – to long-term investment spending on “infrastructure and workforce training”. This would be a less inflationary form of spending; it is still spending that requires deficit funding, but it funds productive, value-creating economic activity and is therefore less of a concern in terms of inflation than stimulus spending on entitlements.

Then Yellen actually provides a glimmer of hope that the Biden administration might see the dangers they are helping to create. The Wall Street Journal again:

Ms. Yellen acknowledged the government’s debt, which stands at $21.6 trillion. But she urged lawmakers to put those concerns aside for now. Interest rates are at historic lows and expected to remain there for some time, making borrowing more affordable.

While this sounds like a carte blanche to more deficit monetization, it is really a statement of what metrics she will be using in her evaluation of just how far it is advisable to push the current monetary expansion. Once interest rates start rising, there is an actual possibility that Yellen will sound the alarm and demand that Congress and the president roll back their dangerously expansionary fiscal policy.

The problem for Yellen is that once rates start climbing to where debt service costs make a serious dent in the federal budget, it will be too late for prudent, deficit-reducing measures. At that point, we are likely already going to be in a fiscal crisis where the only option for Congress is European-style, panic-driven austerity.

What would a crisis like that look like? This week’s issue of our Economic Newsletter will explain that scenario in detail. Sign up today – only $2.99/month – and get exclusive access to economic analysis and information that nobody else provides!

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