Federal Reserve Vice Chairman Janet Yellen said the central bank could use communications to make policy more accommodative, lower unemployment and raise the rate of inflation if financial markets expected a tightening of policy before the Fed intended.
If policy makers expected the Fed’s target rate to stay lower for longer “and market participants came to share that view, then financial conditions would become significantly more accommodative, even in the absence of any change in the current level of the funds rate,” Yellen said, according to prepared text of a speech today in New York.
“Such a shift in policy expectations would be associated with a lower trajectory for the unemployment rate,” Yellen said at the University of Chicago Booth School of Business’s annual U.S. Monetary Policy Forum. The shift would also cause “a somewhat higher path of core inflation,” Yellen said.
Yellen is leading a committee of policy makers to evaluate the effectiveness of the central bank’s communications strategy as it carries out a plan to purchase $600 billion of Treasuries by the end of June to boost the recovery.
Yellen also said the policy making Federal Open Market Committee is “regularly reviewing the asset purchase program in light of incoming information,” echoing the language of its statements. She said the panel “will adjust the program as needed” to fulfill its congressional mandate to deliver full employment and stable prices.
The Fed vice chair presented a scenario in which the Fed persuaded investors that it would postpone a policy tightening by one year from current expectations. Charts accompanying her presentation showed unemployment falling by 0.5 percentage point by 2013 from this action, and core inflation rising by 0.3 point.
She said that “it is not my intention to provide new information about the outlook for the U.S. economy or monetary policy,” and that she only wanted to “highlight the role of central bank communications in bolstering the effectiveness of unconventional monetary policy.”
The Fed first lowered its target interest rate to a range of zero to 0.25 percent in December 2008. In March 2009, it began saying it would keep rates low “for an extended period.”
In November 2009, the Fed said it would maintain its policy so long as the economy had “low rates of resource utilization, subdued inflation trends, and stable inflation expectations.”
Yellen said that “down the road, once the recovery is well established and the appropriate time for beginning to firm the stance of policy appears to be drawing near, the FOMC will naturally need to adjust its ‘extended period’ guidance and develop an alternative communications strategy to shape market expectations about the policy outlook.”
She said that in the case the economy faltered, current communications might cause markets to expect a later tightening of policy. “The forward guidance now in place might well be sufficient to facilitate an outward shift in the expected path of the funds rate, just as we saw over the course of last year,” she said.
Yellen also elaborated on a defense of the Fed’s large-scale asset purchases that she gave in Denver last month, saying that without the purchases, unemployment would have “remained persistently above 10 percent, and core inflation would have fallen below zero this year.”
Yellen, 64, became vice chair of the Fed in October after serving six years as president of the San Francisco Fed. She also served as a Fed governor from 1994 to 1997 and as chairman of President Bill Clinton’s Council of Economic Advisers from 1997 to 1999.
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