During the hearing on monetary policy, which was required by law, Yellen addressed questions about her plans for the Fed and the central bank's ongoing effort to slow its massive bond purchases.
Apart from a few minor stumbles on topics other than monetary policy, Yellen appeared fairly comfortable fielding sometimes tough questions from both Republicans and Democrats on a number of topics.
Some of the main takeaways from the hearing:
1.) The Fed isn’t likely to stop tapering
Yellen said she was “surprised” by the weak December and January job reports, but that the unwelcome news about employment won't be enough to call off the taper for future Fed meetings. The purpose of the bond-buying program launched in late 2012 was to prevent the labor market from “stalling,” and employment growth has substantially picked up since then, Yellen said. It would take a “notable change in the outlook,” in terms of jobs numbers, economic growth, and inflation, for the Fed to halt the taper - although she still didn't rule that out.
2.) She’s not sure what’s behind the shrinking labor force
Rep. Spencer Bachus, the Alabama Republican and former Financial Services Committee chair, asked Yellen for her assessment of the rapidly-declining labor force participation rate.
At 63 percent, the rate is now lower than it has been since the late 1970s, raising the question of whether the falling unemployment rate is a product of Americans giving up on the search for work rather than improvement in labor markets.
Yellen said that there is no “clear scientific way” to tell how much of the decline in the labor force is due to cyclical factors rather than structural factors, such as the aging of the population and mass retirements of the Baby Boom generation. She cited the decline in participation among prime-age workers as a hint that at least part of the trend toward a smaller workforce is caused by workers getting discouraged – a cyclical problem that can be addressed by monetary policy, in theory.
But “there’s no doubt in my mind that an important portion of this labor force participation decline is structural,” Yellen clarified.
3.) The Fed isn’t going to worry about instability in emerging markets
It’s not the Fed’s job to worry about how slowing down its large-scale bond purchases might hurt emerging-market economics, Yellen warned.
Recent turmoil in countries including Brazil and Turkey has caused some investors to ask if the Fed will consider instability in such markets when making decisions about the its quantitative easing program.
Yellen said the answer is "no."
“We’ve been very clear at the outset that we initiated our program of asset purchases to pursue the goals that Congress has assigned to the Federal Reserve,” she explained.
Those goals include promoting maximum employment and price stability in the U.S., not financial health in emerging markets. Yellen added that “we’ve tried to be as clear as we possibly can” that the Fed would slow the asset purchases as U.S. growth and inflation picked up.
4.) Yellen provided no further details about plans for interest rates
Yellen avoided going into any further detail about the Fed’s plans for short-term interest rates, which now have been near zero for over five years.
Currently, the Fed's forward guidance about rates, which it sees as its main tool for stimulating the economy, is that it will keep them near zero “until well past the time” when the unemployment rate hits 6.5 percent. With unemployment falling to 6.6 percent in January, there have been questions about what the Yellen Fed will do to further clarify what “well past” means for the short-term.
Committee Chairman Jeb Hensarling, R-Texas, asked if the 6.5 percent threshold was “illusory,” but Yellen avoided spelling out any further details to the Fed’s guidance, just as she did in her prepared testimony.
5.) Questions remain about how quantitative easing works
Despite the fact that the Fed has committed trillions of dollars to quantitative easing, Fed members are not certain how exactly bond purchases boost the economy.
In an interview before he left office, Bernanke quipped that “the problem with QE is that it works in practice, but not in theory,” acknowledging that quantitative easing isn’t as well understood as he would like.
Yellen stated her view of how QE improves the economy on Tuesday: “The objective has been to push down longer-term interest rates,” she explained. “The purpose is to spur spending in the economy and achieve more rapid economic growth.”
As examples of how lower interest rates boost spending, Yellen cited rising home sales and prices and increased spending in other interest-rate sensitive sectors, such as automotive sales.
Increased spending from those parts of the economy, according to Yellen, has been key to the unemployment rate falling by 1.5 percentage points since the start of the latest round of quantitative easing in late 2012.
That’s the clearest answer that Yellen has given yet to a question about how large-scale bond purchases aid the economy, and one that’s fairly digestible in the media. It also accords with the motivation Bernanke first provided for the $600 billion round of QE he launched in 2010.
Yet it raises the question of how long-term interest rates are supposed to respond to an improvement in the economic outlook. Elsewhere in the question-and-answer session, Yellen said that interest rates are low for the “fundamental reason” that “there is excess savings relative to investment demand” for those savings.
In a stronger economy, Yellen added, savers would be able to realize a greater return because interest rates would be higher – introducing some tension between the stated purpose of the quantitative easing program – lowered interest rates – and its goal, a stronger economy with higher interest rates.