Yellen’s Mind-the-Gap Goals Rule Says Rates Stay Low
For Federal Reserve Chair Janet Yellen, monetary policy now is all about a simple rule familiar to any subway rider: Mind the gap.
In her first major speech on her policy framework as Fed chair, Yellen said U.S. central bankers must be mindful of how short the Fed is of its goals of full employment and price stability.
“The larger the shortfall of employment or inflation from their respective objectives, and the slower the projected progress toward those objectives, the longer the current target range for the federal funds rate is likely to be maintained,” Yellen said today to the Economic Club of New York.
The gap, in both cases, is large, with a jobless rate of 6.7 percent more than a percentage point higher than the top end of the Federal Open Market Committee’s estimate of full employment. Inflation, by the Fed’s preferred measure, is more than a percentage point below its 2 percent goal. It will take more than two years for the economy to close in on the Fed’s goals, she said, adding that the Fed’s forecasts in the past were disrupted by negative surprises, not positive ones.
“She clarified exactly what her views are and what the committee’s views are about what the Fed may do over the next six to 12 months or even the next three years,” said Brian Jacobsen, who helps oversee $241 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin. Her speech “better managed the messages she wanted to get out of the last policy statement.”
In her address, Yellen, 67, spoke of a “continuing commitment” to support the economy, which since December 2008 has taken the form of a policy rate held in a range of zero to 0.25 percent.
While Yellen used the word “expansion” to describe current economic conditions, her preferred word was “recovery,” which she used more than a dozen times, including it in the title of her remarks.
“Thus far in the recovery and to this day, there is little question that the economy has remained far from maximum employment,” she said.
Yellen, in her third month leading the U.S. central bank, gave more detail on her data-driven framework after the Fed dropped a link to a specific level of unemployment for raising the benchmark lending rate last month.
At 6.7 percent for March, she said the unemployment rate was more than a percentage point higher than policy makers’ estimate for full employment of 5.2 to 5.6 percent.
“This shortfall remains significant, and in our baseline outlook, it will take more than two years to close,” Yellen said.
Stocks extended gains after Yellen’s comments, with the Standard & Poor’s 500 Index climbing 1.1 percent to 1,862.31 at 4 p.m. in New York.
“The progress that they’ve made so far has been a result of the Fed continuing to provide even more accommodation than anyone anticipated,” said Laura Rosner, a U.S. economist at BNP Paribas SA in New York and former researcher at the Federal Reserve Bank of New York. “That’s important. She’s willing and ready to provide that in order to sustain progress.”
Yellen also underscored the risks to the Fed’s baseline outlook. She said wage gains are proceeding at a “historically slow pace,” and the chances of inflation rising above the Fed’s 2 percent goal were “significantly below the chances of inflation persisting below 2 percent.”
Harvard University economist Martin Feldstein asked Yellen whether short-term unemployment rates might provide an early indicator of inflation pressures. She replied it would be “premature” to conclude that wages would necessarily be pushed higher as people out of work less than six months find jobs.
“I think that the long-term unemployed are likely to move back more actively into the labor force and into the job market,” helping keep a lid on wages and prices, she said. “Clearly we will have to watch unfolding evidence.”
The Fed last month scrapped its pledge to keep the main interest rate low at least as long as unemployment exceeds 6.5 percent. Instead, the Fed said it will look at a “wide range of information” when considering the first increase since 2006.
Officials dropped the threshold after unemployment fell, even as other indicators showed the job market is still scarred by the deepest and longest recession since the Great Depression.
At the same meeting last month, the Fed released forecasts showing officials expect the federal funds rate to rise faster than they previously predicted. Treasuries declined in response, and selling continued when Yellen said the rate might start to climb “around six months” after the Fed ends its bond-purchase program.
In her remarks today, she emphasized the central bank is maintaining maximum flexibility on monetary policy and moving away from schedules for raising the cost of borrowing.
“We need to be alert to what is happening in the economy and to respond to what we see happening, and not a fixed idea that we perhaps held at some earlier time about what will come to pass,” she said.
The Fed is cutting back on bond buying at a rate that indicates purchases will end late this year. The Fed in March reduced the monthly pace by $10 billion, to $55 billion, and repeated it is likely to continue paring the program in “further measured steps.”
The reduction in quantitative easing comes as recent economic reports show the almost five-year expansion is gaining momentum after harsh winter weather depressed consumption and disrupted homebuilding and manufacturing in much of the country.
A Fed report today showed industrial production rose more than forecast in March after a February gain that was twice as big as previously estimated. Retail sales rose last month at the fastest pace since September 2012.
Private payrolls rose by 192,000 workers in March, following an 188,000 gain the month before. That brought the job count to 116.1 million, exceeding the pre-recession peak for the first time.
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