Assuming Janet Yellen is the next Fed chair, sometime in her tenure she will need to wind down the historic quantitative-easing policy that has been in effect since November 2008. The stimulus — which has entailed the Federal Reserve’s buying hundreds of billions of dollars of Treasury securities — was put in place to keep the economy from tanking during the Great Recession and then to try to help it recover. How adroitly Yellen winds down, or tapers, will surely be a defining act of her time as Fed chief. No pressure, Janet: The fate of the biggest economy in the world depends on you.
Let’s walk through just how tricky it is. First of all, we really have no idea whether quantitative easing has worked. The inability to measure cause and effect leads some to argue that we should end the program. They say all that easy money hasn’t done anything — GDP growth is still anemic in the mid-2% range, and the unemployment rate is still above 7%. Of course, folks at the Fed say that without the stimulus we’d be in much worse shape.
There’s no control to the experiment, so we’ll never know, but my feeling is that early on the Fed’s policy did mitigate a financial catastrophe and engender a recovery, if only because it showed that our government would step up and act. In conversations with the likes of Hank Paulson, Ben Bernanke, and Tim Geithner, I was told that if the government failed in preventing the worst-case scenario, it wouldn’t be because of “underdoing,” which they believed was what occurred in the 1930s. Fair enough. Lately, though, I think the Fed has been tap dancing, or extending the show unnecessarily.
Look at the stock market, one sector where there is almost certainly a cause-and-effect dynamic playing out. Stock prices have run up strongly over the past few years and have responded directly and perversely to economic news because of the stimulus. When Bernanke suggested that the recovery was strong enough to consider tapering in June, stocks tanked. When the Fed indicated at the end of the summer that no taper was in sight because of weakness, stocks soared.
You can find both Democrats and Republicans on either side of the issue. Some liberals favor big government stimulus, while others are wary that Wall Street is making out. Some small-government conservatives believe the Fed is successfully priming the economy, while others, like Fed historian Allan Meltzer, say the stimulus is a bust because most of the reserves “are sitting idly on balance sheets,” not creating investment in jobs or money lending.
Yellen has toed a dovish line, indicating she would continue the same course of easing that Bernanke has laid out. I’m not sure that’s the right thing to do. The unemployment rate peaked at 10% in October 2009 and has dropped over a percentage point every two years since. Yes, the labor participation rate is down, but that trend began in 2000. GDP growth is sluggish, but you have to wonder how responsive that metric would be to continued easing. What’s truly repugnant to me, though, is the suggestion that we may need more stimulus because of government dysfunction. That kind of enabling always ends badly, be it with kids, alcoholics, or rotten politicians.
At some point Yellen will need to flip the switch. My vote is for sooner rather than later. I think the case can be made that easing is no longer needed and that the economy needs to walk on its own. It’s time to move from tap dancing to tapering.
This story is from the December 09, 2013 issue of Fortune.