The Senate has confirmed Janet Yellen to be President Biden’s Treasury secretary. But her testimony before the Senate Finance Committee raises questions about her suitability for the job. Her testimony suggests that Yellen might be as keen to do her boss’s bidding as she was when she previously headed the Federal Reserve. She might be willing to do so even though, as a well-trained economist, she must know she’d risk mortgaging the country’s future.
Yellen’s last year at the Federal Reserve’s helm will long be remembered for her having kept interest rates too low for too long at a time when the U.S. was experiencing a satisfactory economic recovery. She did so seemingly to please President Trump in her unsuccessful bid to secure renomination as Fed chair. She also did so even though she had to know that those policies were contributing to unhealthy asset price bubbles and to a dangerously rapid increase in the U.S. highly leveraged loan market.
Now as Biden’s Treasury secretary, Yellen seems to have drunk the “deficits do not matter” Kool-Aid. At a time when the country’s public debt level is already over 100 percent of GDP, Yellen is proposing a $1.9 trillion budget stimulus package. That’s on top of a recently approved $900 billion stimulus package and at a time when the Federal Reserve continues to provide the economy with a massive amount of monetary policy support.
In justifying the size of her proposed budget spending, Yellen is arguing that the world has changed fundamentally in the wake of the COVID-19 pandemic. Not only are the immediate needs of households in distress unusually high, interest rates are also now at historically low levels and are likely to remain so indefinitely. With interest rates very low, Yellen is arguing that the smart thing to do is to act big on the budget, especially if we care about people who have been struggling for a very long time.
As a former distinguished economics professor, Yellen must know that with the amount of fiscal policy stimulus that she is proposing, interest rates are highly unlikely to stay at their currently historically low levels for very long. In particular, she must know that with all of the monetary and fiscal policy stimulus that the economy is now receiving, it is probable that we will get a very strong economic recovery once most of the population is vaccinated. That in turn risks giving rise to higher interest rates that will increase the size of the country’s debt service burden.
One way that interest rates could rise as a result of Yellen’s public spending largesse would be for the Federal Reserve to raise its policy rates to prevent the economy from overheating. But even if the Fed were not to raise rates, the bond vigilantes could force market interest rates higher out of fear that we could be on the road to higher inflation. Hopefully, it has not escaped Yellen’s notice that talk of more fiscal stimulus has already caused market inflationary expectations to rise to above 2 percent for the first time in more than two years. That in turn has caused long-term U.S. government bond rates to rise meaningfully from their recent historic lows.
Yellen must also know that an overly expansionary U.S. budget policy risks undermining the U.S. dollar’s privileged status as the world’s international reserve currency. It might do so as foreigners begin to worry that the U.S. will again suffer from a twin budget and external current account deficit problem, at the very time that a large U.S. public debt level will make it difficult for the Fed to raise interest rates to defend the dollar. Hopefully, Yellen has noticed that already over the past year the dollar has lost more than 10 percent of its value on such fears.
At a time of real economic challenges, the country needs a Treasury secretary who will remain true to the laws of economics and not bend with the political wind. Judging by her time at the Fed and her recent Senate testimony, it is far from clear that Yellen is the right person for the job.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.