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Fed’s Yellen: QE3 May Be Warranted
Federal Reserve Vice Chairman Janet Yellen said a third round of large-scale securities purchases might become warranted if necessary to boost a U.S. economy challenged by unemployment and financial turmoil.
The central bank should also give “careful consideration” to Chicago Fed President Charles Evans’s proposal to tie the near-zero interest-rate pledge to specific levels of unemployment and inflation, Yellen said today in a speech in Denver.
The remarks signal Fed officials may be prepared to delve further into unprecedented monetary territory and take criticism inside and outside the central bank for expanding the balance sheet. Fed policy makers are struggling to lower unemployment that’s been stuck near 9 percent or higher for 30 months without boosting inflation that’s already close to the central bank’s long-run goal.
“Securities purchases across a wide spectrum of maturities might become appropriate if evolving economic conditions called for significantly greater monetary accommodation,” Yellen said in prepared comments to the annual meeting of the Financial Management Association International.
The U.S. recovery is “disappointingly slow,” which leaves the economy “vulnerable to downside shocks,” Yellen said. Job growth is likely to remain “tepid in the coming months,” and the chance that Europe’s sovereign-debt crisis may pressure U.S. financial companies is “particularly worrisome,” Yellen said.
“The potential for such adverse financial developments to derail the recovery creates, in my view, significant downside risks to the outlook,” said Yellen, 65, an economist who has been Chairman Ben S. Bernanke’s top lieutenant in Washington for one year. She previously served as president of the San Francisco Fed.
Stocks extended gains after the speech, with the Standard & Poor’s 500 Index rising 1.9 percent to 1,238.25 at 4 p.m. in New York. Yields on 10-year Treasuries rose 3 basis points, or 0.03 percent, to 2.22 percent from yesterday.
Responding to a question after the speech, Yellen said that the Fed is “certainly not targeting equity prices,” yet at the same time, “we would expect any action that we take that’s providing additional accommodation to show up in supporting the stock market.”
Fed officials are divided over whether and how to ease policy further after two decisions to lower borrowing costs with unconventional tools. Options include a third round of securities purchases and making the near-zero interest-rate pledge more specific. Dissenters including Philadelphia Fed Chief Charles Plosser say loosening policy harms the central bank’s credibility.
In August, the Fed pledged to hold interest rates near zero until at least mid-2013, and last month the central bank said it would swap $400 billion of short-term debt in its portfolio for longer-term securities in order to bring down interest rates, a strategy dubbed Operation Twist by economists and the “maturity extension program” by the Fed.
Yellen said the scale of Operation Twist “is necessarily limited by the amount of our holdings of shorter-term securities” and that buying such a large portion of long-term Treasuries “could potentially have adverse effects on market functioning.”
As a result, buying securities with varying maturities may eventually be warranted, she said without giving a timeframe or specifying the type of asset.
Yesterday, Fed Governor Daniel Tarullo, who’s backed all of Bernanke’s policy decisions for almost three years, said the central bank should consider resuming large-scale purchases of mortgage bonds to boost economic growth and help combat a “crisis” in employment.
Evans and Eric Rosengren of Boston have also urged the policy-setting Federal Open Market Committee to increase its record stimulus. Evans is calling for the Fed to keep the target for the benchmark U.S. interest rate near zero until either unemployment falls below 7 percent or the medium-term inflation outlook rises above 3 percent.
Evans’s plan is “potentially promising” and “could be helpful in facilitating public understanding of how various possible shifts in the economic outlook would be likely to affect the anticipated timing of policy firming,” Yellen said today.
At the same time, the approach has “potential pitfalls,” including the chance that “such thresholds could potentially be misunderstood as conveying the committee’s longer-run objectives rather than the conditions surrounding the likely onset of policy firming,” Yellen said.
More Asset Purchases
Rosengren said in an Oct. 19 interview with CNBC that “if the economy were to be weaker than most people are forecasting, that would certainly be cause for doing additional monetary policy,” and more asset purchases are “certainly a possibility.”
The August and September FOMC decisions provoked dissents from three policy makers, the most disagreement during Bernanke’s almost six years as chairman. One of those policy makers, Minneapolis Fed President Narayana Kocherlakota, said today that the Fed’s decision-making this year “has introduced a lack of clarity about its monetary policy mission.”
Additional asset purchases would constitute a third round of so-called quantitative easing after the Fed bought $2.3 trillion in housing and government debt in two rounds from December 2008 to June 2011.
Any decision to expand the Fed’s $2.86 trillion balance sheet may also spark a fresh wave of political criticism from Republicans. Most of the party’s presidential candidates have found fault with Bernanke or the Fed; Texas Governor Rick Perry said printing more money may be “treasonous.” Republican lawmakers, including House Speaker John Boehner of Ohio, sent a letter to Fed officials last month urging them to forgo additional easing.
Yellen said the view is “erroneous” that the Fed’s expansion of its balance sheet through additional bank reserves will fuel inflation because the central bank can raise the interest rate paid on reserves. The Fed eventually plans to shrink its assets once it judges inflation is a risk, Yellen said.
The economy expanded at a 1.3 percent annual pace in the second quarter after a 0.4 percent rate in the first three months of the year, according to the Commerce Department. Analysts surveyed by Bloomberg this month projected a 2 percent rate of growth in the third quarter, based on the median estimate; the government will release its first estimate on Oct. 27.
Economic growth, after an annual pace of less than 1 percent in the first half of 2011, is likely to be “noticeably stronger” in the second half, with inflation “more moderate,” Yellen said, citing lower commodity prices and increased auto production and sales.
“Unfortunately, however, a range of other, more persistent factors also appear to be restraining the recovery,” Yellen said. “Moreover, financial market conditions have deteriorated, on net, in recent months, intensifying some of the headwinds facing the economy.”
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