Yellen Backs Making Fed Policy Hinge on Economic Goals
Federal Reserve Vice Chairman Janet Yellen threw her support behind proposals to tie the central bank’s low-rate outlook to economic goals, raising the odds the Fed will replace its current commitment to a calendar date.
“The Committee might eliminate the calendar date entirely and replace it with guidance on the economic conditions that would need to prevail before liftoff of the federal funds rate might be judged appropriate,” Yellen said yesterday in a speech in Berkeley, California. She is “strongly supportive” of such a change, she said.
Yellen joined three other Fed officials who have endorsed tying zero interest rates with progress on fighting unemployment as a way to provide more clarity on the central bank’s outlook for monetary policy. The policy-setting Federal Open Market Committee said last month it expects to keep its benchmark rate near zero through at least mid-2015.
“Under such an approach, liftoff would not be automatic once a threshold is reached,” Yellen said at the University of California at Berkeley, where she is a professor emeritus. “That decision would require further Committee deliberation and judgment.”
The Fed, which is required by Congress to pursue the twin goals of full employment and price stability, may adopt the strategy as soon as its next meeting Dec. 11-12, said Ward McCarthy, chief financial economist at Jefferies Group Inc. in New York and a former Richmond Fed economist.
“They’ve been kicking around the idea of changing the communications policy for a while, and she pretty much summed it up,” McCarthy said. “They want to put rate guidance in the context of the dual-mandate objectives. That was probably the main discussion at the most recent FOMC meeting.”
Policy makers may need more time to reach agreement on details of a new framework, said Roberto Perli, a managing director at International Strategy and Investment Group Inc. in Washington.
Still, Yellen “wouldn’t have supported those ideas if the committee didn’t have consensus about moving in that direction,” said Perli, a former economist for the Fed’s Division of Monetary Affairs.
Since June 2011, Yellen has led a committee created by Fed Chairman Ben S. Bernanke to shed light on Fed decision-making and minimize public confusion over its goals. Fed officials say that greater transparency makes their actions more potent because the economy is affected by public expectations about the future policy.
The central bank in January took one of its biggest steps ever toward greater openness by publishing a mission statement, an inflation target and anonymous forecasts by each FOMC participant for the benchmark interest rate.
“We’ve made progress, but much work remains to be done,” Yellen, 66, said yesterday. She said tying the outlook for low interest rates to economic thresholds, rather than a date, “would enable the public to immediately adjust its expectations concerning the timing of liftoff in response to new information affecting the economic outlook.”
Stocks fell as investors watched for progress on Europe’s debt crisis and Washington’s budget debate. The Standard & Poor’s 500 Index slid 0.4 percent to 1,374.53. Treasury 10-year note yields fell two basis points to 1.59 percent after earlier falling to 1.57 percent, the lowest level since Sept. 5.
Last year, Chicago Fed President Charles Evans first called for the central bank to tie policy to specific numerical thresholds, saying it should keep rates near zero until unemployment falls below 7 percent or inflation rises above 3 percent.
In September, Minneapolis Fed President Narayana Kocherlakota endorsed a variation of the pledge, calling for low rates until joblessness falls to 5.5 percent as long as inflation remains below 2.25 percent.
Boston Fed President Eric Rosengren said on Nov. 1 the central bank should buy mortgage bonds until the jobless rate falls to 7.25 percent and hold the target interest rate near zero until hitting 6.5 percent unemployment.
Yellen also said yesterday the Fed’s 2 percent inflation goal set in January should not be viewed as a ceiling, arguing that such an interpretation would lead to inflation that’s more frequently below the target than above.
“To balance the chances that inflation will sometimes deviate a bit above and a bit below the goal, 2 percent must be treated as a central tendency around which inflation fluctuates,” she said.
The FOMC’s 19 participants are also considering changes to the Fed’s quarterly publication known as the Summary of Economic Projections, which includes their individual forecasts for gross domestic product, inflation, unemployment and interest rates, according to their meeting minutes. One possibility would be to provide a consensus forecast by the FOMC’s 12 voting members for the economy and interest rates. Yellen, 66, said changes are under “active consideration.”
“The Committee could provide the public with its projections for inflation and the unemployment rate together with what it views as appropriate paths both for the federal funds rate and its asset holdings, conditional on its current outlook for the economy,” she said.
The FOMC could also “try to build on the individual projections of macroeconomic variables and policy already included in its quarterly SEP to provide at least some further information about how these individual projections inform the Committee’s collective policy judgment,” she said.
The central bank is “thinking carefully” about the potential adverse effects of a prolonged period of low interest rates, Yellen said in response to a question from the audience. These effects include reducing yields for savers, insurance companies and pension funds, in addition to possibly stoking excessive risk-taking in financial markets, she said.
Still, “we do not have any evidence yet of any increase in risk-taking that would be a major financial-stability concern,” she said.
Fed officials next meet shortly before a measure to extend the average maturity of bonds on the central bank’s balance sheet is scheduled to expire. Fed presidents, including John Williams of San Francisco, have said policy makers may need to expand their latest round of quantitative easing to include Treasuries to offset the end of the so-called Operation Twist program.
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