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Whoever's chosen, Fed chair stays a hot seat

With productivity gains weak and another Washington fight looming over the debt limit and the budget, front-runner Janet Yellen is looking at a very uncertain economy.

September 16, 2013|By Don Lee and Jim Puzzanghera
  • Investors believe Janet Yellen would be likely to extend the U.S. easy-money policy.
Investors believe Janet Yellen would be likely to extend the U.S. easy-money… (FRANCK ROBICHON, EPA )

WASHINGTON — To many investors and economists, the prospects for a new Federal Reserve chief became clearer — and brighter — after former Treasury Secretary Lawrence H. Summers dropped out of contention for the post.

The same can't be said for the lackluster U.S. economy.

Even if former UC Berkeley economist Janet L. Yellen, now the Fed's vice chair, gets the nod as the next leader of the central bank, she will inherit a job that is getting only more difficult.

With productivity gains weak, the housing market showing signs of cooling and another nasty Washington fight looming over the debt limit and the budget, Yellen and her colleagues are looking at a very uncertain economy as they head into an important two-day policy-setting meeting Tuesday.

Since the recovery from the Great Recession began more than four years ago, the central bank has consistently overestimated the pace of economic growth in the nation. And the economy is again underperforming the Fed's projections for this year.

"It's not an easy time, and it's not going to get any easier" for the next Fed chair, said Diane Swonk, chief economist at Mesirow Financial. "I wouldn't wish it on my biggest enemy."

The persistently weak economy has prompted the Fed under Chairman Ben S. Bernanke to inject an unprecedented amount of cash into the financial system. Policymakers on Wednesday are expected to announce just a small reduction in the central bank's $85-billion-a-month bond-buying stimulus program.

Fed officials are likely to try to offset what some may perceive as monetary tightening by signaling that it will keep short-term interest rates near zero even longer than mid-2015, the current projection.

Still, any cut in the Fed's stimulus efforts is a bet that the recovery — and the employment market in particular — will strengthen in the coming quarters. But the Fed's own projections cast doubt on that bet.

The economy grew at a disappointing annual rate of less than 2% in the first half, and the current quarter isn't looking any better — making it likely that the Fed on Wednesday will revise down its previous forecast of a 2.3%-to-2.6% expansion for this year.

Such moderate growth doesn't bode well for an acceleration in job growth, which has been modest.

Summers was President Obama's chief economic advisor in 2009-10 and a key figure in the administration's response to the financial crisis.

Known as brilliant but combative, he was Obama's top choice for the Fed. But Summers withdrew his name Sunday in the face of sharp criticism from many Democrats and strong doubts that he could win confirmation in the Senate.

Many analysts believe Yellen is now in the driver's seat for the nomination. But senior administration officials said Obama was upset about the unprecedented public lobbying by Yellen supporters that helped trigger Summers' decision, and he could turn to a third candidate.

In speeches, Yellen, a former president of the Federal Reserve Bank of San Francisco, has expressed strong concerns about the weak labor market.

Investors believe she would be more prone to prolonging the Fed's easy-money policies than Summers, whose views on monetary policy are less known but who is nonetheless seen as more concerned about inflation risks.

That perception helped boost the stock markets worldwide Monday. The Dow Jones industrial average rose nearly 119 points, but analysts saw the market bounce as short-lived.

The stock market rally also may reflect "some relief among investors that the nomination process is likely to be a smoother one," said Jessica Hinds, an economist at Capital Economics.

Economists point out that whoever gets the top Fed job will face tough challenges, especially if the economy doesn't pick up.

One difficulty is that the Fed has to engineer the tapering of its bond-buying and the eventual disposal of about $2 trillion in U.S. Treasury bonds it has purchased.

That tapering also could be hampered by the economy's failure to live up to the Fed's expectations.

The Fed's latest projection in June has growth accelerating next year to as much as 3.5%.

The U.S. economy could get a boost from a reviving Europe and a Chinese economy that seems to be stabilizing. Domestically, American corporations are raking in large profits, and U.S. households are in much better financial shape, having cut back debts and recovered a large part of the wealth lost in the Great Recession.

Yet most Americans haven't felt real income gains, and government spending cuts have hurt the economy.

Particularly disconcerting for the Fed is the recent slowing in the housing market recovery as mortgage rates rose sharply in recent months from near all-time lows.

Anticipating the end of the Fed's easy-money policies, which have kept interest rates low, investors have driven up rates for a 30-year mortgage by more than 1 percentage point since May, to 4.57% last week.

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