Tags: Fed | Yellen | Low-Rate | 2016

Yellen: Fed May Need to Keep Rates Low Until 2016

Tuesday, 13 Nov 2012 04:01 PM

 

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Federal Reserve Vice Chair Janet Yellen said that U.S. interest rates may need to stay near zero until early 2016 to forcefully lift employment, and she strongly backed adopting inflation and unemployment thresholds to guide policy.

Yellen, viewed as a front-runner to succeed Fed Chairman Ben Bernanke when his term expires in January 2014, argued that an optimal path for U.S. monetary policy would keep rates on hold for longer than expected, at the cost of a bit more inflation.

"This highly accommodative policy path generates a faster reduction in unemployment than in the baseline, while inflation overshoots the (Fed policy) committee's two percent objective for several years," she told students at the Haas School of Business at the University of California, Berkeley.

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

Yellen is generally regarded as one of the more dovish members of the Fed's policy-setting committee in her willingness to pursue an aggressive policy to spur job growth.

The Fed cut the overnight federal funds rate to near zero in December 2008 and has bought around $2.3 trillion in securities to drive other borrowing costs down and spur a stronger recovery.

While there are signs the economy is gaining a bit of speed, the unemployment rate remains stubbornly high at 7.9 percent and the economy faces the risks of a new recession if Congress fails to temper a $600 billion "cliff" of higher taxes and lower government spending set to take hold early next year.

To offer a contrast to her "optimal" path for overnight rates, the Fed vice chair used as a baseline the early September consensus estimates for unemployment, inflation and the federal funds rate from the Wall Street firms that deal directly with the central bank in the markets.

In January, the Fed adopted what it termed a "balanced approach" to its mandated goals of full employment and stable prices, suggesting it would temporarily tolerate a bit more inflation to move the jobless rate lower. On prices, it normally targets 2 percent inflation and policymakers' current estimates suggest they view an unemployment rate of between 5.2 percent and 6 percent as consistent with maximum employment.

"The optimal policy to implement this 'balanced approach' to minimize deviations from the inflation and unemployment goals involves keeping the federal funds rate close to zero until early 2016, about two quarters longer than in the ... baseline," Yellen said. She added that rates would stay under the baseline through 2018.

Yellen argued that in order for the Fed to keep its balanced commitment, it might be necessary to allow inflation to drift above target for a while.

"Provided that long-term inflation expectations are firmly anchored, the federal funds rate is set to balance the benefits from a faster reduction of unemployment against the losses from a temporary and modest increase of inflation above 2 percent," she said.

COMMUNICATING ON COMMUNICATIONS

After their last policy-setting meeting in October, Fed officials reiterated that they expected to hold near zero until at least mid-2015. They also said it would likely be appropriate to keep an ultra-easy monetary policy in place for a considerable time after the recovery strengthened.

Yellen stressed that communicating Fed intentions clearly was vital to the success of its policies, and emphatically endorsed adopting numerical thresholds for unemployment and inflation to guide expectations on when rates would go back up.

"Several of my ... colleagues have advocated such an approach and I am also strongly supportive," she said.

Chicago Federal Reserve Bank President Charles Evans has suggested holding rates steady until unemployment is under 7 percent, provided inflation remains below 3 percent. Minneapolis Fed chief Narayana Kocherlakota outlined thresholds of 5.5 percent unemployment and 2.25 percent inflation.

"The idea is to define a zone of combinations of the unemployment rate and inflation within which the (Fed) would continue to hold the federal funds rate in its current, near-zero range," Yellen said.

She said that would help shape expectations of the Fed's likely response to incoming data. Even so, she said the thresholds would not trigger a rate hike decision. That, she said, would require "further committee deliberation and judgment."

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

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