Questions Yellen will likely face for Fed confirmation

By Alister Bull

WASHINGTON (Reuters) - U.S. lawmakers unhappy with the Federal Reserve will have a prime opportunity to vent their concerns when the Senate Banking Committee vets Janet Yellen as next chair of the Fed, which has become a lightning rod for criticism of policy activism.

Nominated by President Barack Obama on Wednesday, Yellen immediately reinforced views that she is a monetary "dove" by noting the central bank's duty to serve the needs of all Americans in remarks at a White House ceremony.

Obama picked Yellen to replace Fed Chairman Ben Bernanke, whose term expires on January 31. But she must first be vetted by the banking panel, where Democrats occupy 12 of the 20 seats.

While the math is in her favor - Democrats control the U.S. Senate and need to pick up only six Republican votes to clear any procedural roadblocks and secure her nomination - that doesn't mean she will not have to endure some tough questions.

Here is a sample of what to expect:

ARE YOU, OR HAVE YOU EVER BEEN, A KEYNESIAN?

Senate Republicans, deeply skeptical of an unprecedented five years of ultra-easy monetary policy, will be eager to ask about an end to the Fed's bond buying, which has roughly quadrupled its balance sheet to around $3.7 trillion.

They will also want to know how soon she thinks the Fed might raise interest rates, held near zero since late 2008, and how high inflation can go before it does harm.

"I would like to hear Vice Chairman Yellen's plan for exiting the Fed from the multi-trillion trade it has put on, and I hope she will outline in detail what she sees as the limits of what monetary policy and zero interest rates can achieve in our economy," said Senator Bob Corker, Republican from Tennessee.

Alabama Senator Richard Shelby, another Republican who sits with Corker on the banking panel, said during her 2010 confirmation hearing for the vice chair's role that Yellen was known to be a Keynesian, code for someone who backs official intervention to spur growth and hiring. Shelby will likely want to drive home his disapproval of that way of thinking this time around.

INFLATION VERSUS UNEMPLOYMENT

Critics view Yellen as potentially soft on inflation, based on her frequent remarks emphasizing the damage done by high unemployment. This implicitly diminishes the weight she would place on maintaining price stability, the other half of the Fed's dual mandate from Congress.

In addition, Yellen has published research laying out an "optimal policy path" that would tolerate inflation temporarily above the Fed's 2 percent target, in order to drive high unemployment down faster.

That said, Yellen will know what senators want to hear, and the importance of saying the right things.

"I might ask her about long-run inflation and how she feels what would happen if inflation starts rising above 3 percent," said Martin Feldstein, a Harvard professor and former senior adviser to President Ronald Reagan.

"I would hope she would give the answer that that would be a bad thing ... that would be a good message for the television cameras," he said during a telephone conference with reporters.

QUANTITATIVE EASING

If not the first question, then almost definitely the second, Yellen will be asked if she thinks it would be appropriate to begin scaling back the Fed's bond buying later this year from its current $85 billon monthly pace.

The Fed badly confused financial markets when it delayed tapering this so-called quantitative easing program in September, after announcing in June that it thought it would begin slowing purchases sometime this year.

Echoing an argument Bernanke made last month, Yellen will likely say an uncertain economic outlook, which has been made cloudier by ongoing budget battles in Washington, continues to warrant caution in deciding when to scale back the buying.

She will not make the mistake of providing any further guidance. Bernanke is chairman until the end of January and the question is one only he should answer.

"She's an excellent and likeable communicator, so she should be able to handle the tough questions," said political strategist Greg Valliere at the Potomac Research group.

BANK REGULATION

Democrats are clearly supporters and several campaigned hard on her behalf when it looked like Obama favored his former adviser Lawrence Summers as a successor to Bernanke.

But Yellen should not bet on an easy ride from progressives worried about the failure of rules to curb the threat of banks considered too big to fail, or who back reinstatement of a law that once split commercial and investment banking activities.

That is certainly the position of Senator Elizabeth Warren, who was a strong advocate for Yellen behind the scenes, but who will not miss the opportunity to explore her views. Yellen served in President Bill Clinton's White House, which oversaw an aggressive period of financial industry deregulation.

Adam Posen, a former member of the Bank of England's Monetary Policy Committee who now runs the influential Peterson Institute for International Economics in Washington, said the senators must pin down her views on financial stability.

"What are the macro prudential tools that you need to do this job ... because at the moment the Fed doesn't have any," he told reporters on the conference call with Feldstein. (Editing by Eric Walsh)

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