Yellen roped into tax debate, backs case to lift growth potential

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Outgoing Federal Reserve Chair Janet Yellen said the central bank would welcome and support a faster expansion of the economy stemming from changes in the tax code, provided it was the right kind of growth.

“The Fed is not trying to stifle growth,” she told the Joint Economic Committee on Wednesday in what may be her final testimony to Congress as head of the central bank. But “we’re worried about trends that could push inflation above our 2 percent objective.”

With the economy close to full employment, any acceleration in economic growth needs to be a sustained one that comes from productivity gains or an expansion of the labor force, she said. By implication, she was cautioning against tax cuts that simply create a short-term boost in demand that could stoke inflation.

Yellen’s hearing came during a week of frenzied bargaining among Republicans over how to shape a tax overhaul that could end up adding fiscal juice to gross domestic product just the central bank is withdrawing monetary stimulus to prevent what Yellen called a boom-bust economy.

President Donald Trump is pressing lawmakers to pass a tax overhaul by Dec. 25 that would sharply cut the corporate rate and provide relief to the middle class. Three Fed officials including Yellen this week expressed concern about rising national debt but stopped short of offering any clear endorsement or criticism of the measures lawmakers are considering.

Senate Debate

The House of Representatives has already passed its version, which would increase federal budget deficits by $1.4 trillion over 10 years, according to Congress’s Joint Committee on Taxation. The Senate tax bill is headed for a marathon debate this week as Republican leaders plan to hold a final vote as early as Thursday.

Yellen called the roughly 2 percent growth rate since June 2009 “extremely disappointing” and called for policies that boost business investment, increase infrastructure spending and improve the education system.

Fed Governor Jerome Powell, who has been nominated by Trump to take over from Yellen when her term expires in February, repeatedly ducked questions about the economic impact of the tax cuts in a congressional appearance on Tuesday.

“It remains unclear exactly what will pass,” he told the Senate Banking Committee during his confirmation hearing for the Fed’s top post. So “it’s been very difficult or impossible for us to start to incorporate” any tax package into the central bank’s economic forecasts.

December Meeting

Fed officials should have a clearer idea of what changes, if any, are coming in the code when they get together on Dec. 12-13 for their final policy making meeting of the year.

Powell signaled on Tuesday that the Federal Open Market Committee is likely to decide to raise interest rates at the meeting—a comment that came as no surprise to investors who already saw a December hike as a virtual certainty.

Instead, what they will be focusing on are policy makers’ projections for the path of rates next year. In September, officials penciled in three increases for 2018, based on their median outlook back then.

“If the tax cut is passed before the meeting, there’s no doubt they’ll go to four hikes for next year,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.

Investment Boost

White House chief economist Kevin Hassett argues that the planned reduction in business taxes will prompt companies to significantly increase capital investment, boosting productivity and allowing the economy to expand at a faster clip on a prolonged basis without stoking inflation.

While that’s the kind of growth Yellen appears open to, she sounded much less sure than Hassett on Wednesday about the beneficial impact of corporate tax cuts on business investment. While theoretically that made sense, “empirically the linkages are not clear,” she told lawmakers.

“And then of course the entire set of tax changes that are under consideration matter, so I think this is a complicated question,” she added.

New York Fed President William Dudley discussed some of those complications on Monday in New York at an event organized by the University of California, Berkeley.

“We don’t really need fiscal stimulus from an economic perspective," he said. “On the other hand if that’s the price to pay to get tax reform, then maybe that price is worth paying.”

What Dudley, Yellen and Powell all seem to share is concern about the long-term outlook for the federal government’s finances as more workers retire and begin to draw pension and medical benefits.

“Without commenting on any particular bill, like all of us, I’m concerned about the sustainability of our fiscal path in the long run,” Powell said.

—With assistance from Matthew Boesler and Christopher Condon

Bloomberg News
Tax reform Trump tax plan Economy Interest rates Janet Yellen Donald Trump Jerome Powell Federal Reserve