In her inaugural public appearance since becoming the central bank’s first chairwoman, Janet Yellen confirmed that her intention is to continue the policies of her predecessor (Ben Bernanke). According to the Wall Street Journal, “Her comments left little doubt that her plan – as was Mr. Bernanke’s – is to tiptoe away from those policies only gradually as the economy improves”. I agree that it is time to wind down the Fed’s unconventional monetary policy in which it conducts large-scale asset purchases. First, quantitative easing seems to have served its purpose of lowering long-term interest rates. Second, I still worry that we might face some undesirable consequences from quantitative easing down the road. Now that quantitative easing has fulfilled the intentions of its creators, it should be phased out sooner rather than later in order to reduce whatever unintentional effects might be looming in the future.
Although the continuation of the taper means a reduction in stimulus, financial markets responded well to the plan that Yellen outlined. Furthermore, I think financial markets were extremely pleased that Yellen appeared completely as advertised (meaning she performed as expected and without any surprises). According to the Wall Street Journal, “In two instances, she thanked lawmakers for calling her unexciting”. Yellen’s primary theme during her public appearance was predictability. Every detail of the presentation seemed to be planned perfectly. The financial markets are notably sensitive to everything, which includes what Yellen says and how she says it.
Yellen’s calm demeanor and clear rhetoric is exactly what everyone was hoping for and I think the financial markets were extremely pleased with the lack of surprises. According to the Wall Street Journal, “The markets, having anticipated a steady stance, greeted Ms. Yellen’s comments with approval”. As expected, Yellen will continue with the taper and not change the course of the Fed. Despite the two months of disappointing employment reports, the Fed will taper at the same pace ($10 billion reduction per month). Although financial markets rallied when the Fed surprisingly delayed the beginning of the taper last year, I do not believe the financial markets would handle such a surprise the same way today because tapering has already begun. Unless a significant problem develops in the economy, such a deviation from the plan set out only a month ago would signal a lack of confidence in the recovery. If the Fed was confident enough to announce the taper in December, then a departure from the taper only a month later would likely spook investors. Obviously, a major change for the worse would lead the Fed to dramatically change course. However, that event has not occurred yet and I hope it will never.
Yellen was so eloquent that she even managed to dodge the numerous questions she received regarding financial regulation. Although she did not provide any significant details, she seemed to defend and support the Dodd-Frank legislation. According to the Wall Street Journal, “[Yellen’s] comments suggest she’s likely to continue the Fed’s efforts to implement the 2010 Dodd-Frank financial overhaul in a way that places higher burdens on companies viewed as posing risks to the broader financial system. That could mean more capital and liquidity rules requiring the biggest banks to meet higher standards than smaller firms”. The implementation of Dodd-Frank has been a lengthy process with much scrutiny. On the one hand, some critics claim it is too tough and requires banks to hold too much capital. On the other hand, some critics claim it is too lenient and does not require banks to hold enough capital. In this situation, I am torn because I do not know the right amount of capital for banks to hold.
Currently, the additional amount of capital that banks are required to hold is already noticeable. For example, the return on equity for the largest financial institutions is down considerably. Although I understand that the intentions of Dodd-Frank is to avoid the next financial crisis, forcing banks to hold excess capital likely also restricts them from making loans and engaging in other activities that spur economic growth. I would imagine that Dodd-Frank will be shaped to keep American banks on the same page as European banks, which are subject to Basel III capital requirements. I think that it is in the best interest of the global economy to have similar global financial regulations. Otherwise the financial institutions of some countries will have a competitive advantage, but also be much riskier and be a potential danger to the global financial system. I look forward to how Dodd-Frank and other financial regulations are executed.