3 challenges awaiting Yellen as next Fed chairmanBy The Associated Press , Associated Press
Jan. 7, 2014 12:03 AM ET
Janet Yellen, confirmed Monday evening to succeed Ben Bernanke as chairman of the Federal Reserve, will confront numerous challenges when she begins the job Feb. 1. Here is a look at three of them.
The Fed announced in December that the job market had strengthened enough for the central bank to reduce the extraordinary stimulus it's given the economy since the Great Recession. The Fed said it would trim its bond purchases from $85 billion a month to $75 billion starting in January. The bond purchases have been intended to keep long-term borrowing costs low to stimulate borrowing and spending.
Economists expect further modest reductions of around $10 billion a month. The bond purchases could be phased out altogether by year's end if the economy keeps improving.
Despite paring its new purchases, the Fed said in December that it would keep reinvesting its bond holdings. The bond purchases have raised its investment portfolio above $4 trillion — four times its size before the financial crisis.
The Fed will need to be careful in navigating the wind-down of its bond purchases. If it moves too fast, it could spook financial markets, sending stock prices plunging and interest rates rising. If it acts too slowly, it could run the risk of creating asset bubbles in areas of the economy from stocks to real estate.
GUIDANCE ON SHORT-TERM RATES
Investors will carefully watch Yellen for any signal that the Fed is preparing to raise its key short-term interest rate, which affects many consumer loans.
The rate has been near zero since December 2008. Last month, the Fed revised its guidance to say it plans to keep that rate ultra-low "well past" the time when the unemployment rate hits 6.5 percent. The rate reached a five-year low of 7 percent in November.
The Fed foresees unemployment falling as low as 6.3 percent this year. Many economists think the first increase in the Fed's short-term rate won't occur before late 2015. But if unemployment falls faster or more slowly than that, Yellen might feel the need to modify the Fed's guidance.
The Fed's efforts to rescue the U.S. economy from the recession and financial crisis have made it a target for criticism. Some Republicans argue that the central bank isn't accountable enough to Congress.
Jeb Hensarling, the Republican chairman of the House Financial Services Committee, plans to examine whether changes should be made to the Fed's operations. Fed supporters worry that Congress could end up weakening the Fed's independence. They argue that its independence is critical to assuring markets that the Fed's actions aren't being swayed by political interests.
Last week, Bernanke criticized legislation that would give the Government Accountability Office the power to expand its audits of the Fed to review decisions on interest rates. The GAO, the auditing arm of Congress, can currently conduct audits of the Fed. But it's barred from investigating interest rate decisions.