Yellen Backs ‘Lower for Longer’ Fed Rate Policy Amid Risks

Federal Reserve Board Vice Chairman Janet Yellen said she favors holding the benchmark interest rate “lower for longer” while cautioning that some bond-market investors may be paying too much for higher yields.

The Fed vice chairman said the central bank’s low-rate policies are intended “to promote a return to prudent risk-taking” in credit markets. “Obviously, risk-taking can go too far,” Yellen said today at an International Monetary Fund panel discussion on monetary policy in Washington.

The Federal Open Market Committee in December pledged to keep the main interest rate near zero so long as the unemployment rate remains above 6.5 percent and the forecast for inflation doesn’t exceed 2.5 percent over one to two years. Last month the committee said it will continue buying $85 billion in bonds until the labor market “improves substantially.”

“I don’t see pervasive evidence of rapid credit growth, a marked buildup in leverage, or significant asset bubbles that would threaten financial stability,” Yellen said. “But there are signs that some parties are reaching for yield, and the Federal Reserve continues to carefully monitor this situation.”

In response to an audience question, Yellen said she didn’t expect financial stability concerns to grow so acute that they become “the dominant factor that should control our policy.”

Policy makers need to weigh the possibility that by raising interest rates they may create another set of threats to financial stability by weakening the economy and by undermining bank capital and profits, Yellen said.

Weak Demand

The Fed vice chairman said in her remarks that she was “persuaded” by Columbia University economist Michael Woodford’s theories that keeping interest rates “lower for longer” are suitable for times of high unemployment and weak demand. The FOMC’s decision to tie the benchmark interest rate to economic indicators aligns with the “lower for longer” approach, she said.

Yellen said the pace and composition of asset purchases are important questions for central bankers in deciding how much stimulus to provide.

“And how long should they be held once purchases cease?” Yellen said. “Each of these factors may affect the degree of accommodation delivered.”

The U.S. economy is in its fourth year of expansion after emerging from recession in June 2009. The unemployment rate stood at 7.6 percent in March, and the Fed’s preferred inflation measure rose just 1.3 percent in February.

Highest Level

Reports today showed that new-home construction climbed to the highest level in almost five years, while factory production cooled. At the same time, data showed that consumer prices unexpectedly dropped last month, indicating that the Fed has leeway to keep pumping money into the financial system.

Stocks rallied and Treasuries fell after the reports, while gold rebounded from its biggest slump in three decades. The Standard & Poor’s 500 Index gained 1.4 percent 1,574.57 in New York. The U.S. 10-year yield rose four basis points, or 0.04 percentage point, to 1.72 percent.

Minutes of the FOMC’s March 19-20 meeting show members of the panel discussing costs and benefits of continued bond purchases that have pushed the Fed’s balance sheet to $3.23 trillion in total assets.

Several members anticipated that it “would probably be appropriate to slow purchases later in the year and to stop them by year-end” if the outlook for the jobs market improved as they anticipated, the minutes said.

Yellen, 66, is a former San Francisco Federal Reserve Bank President.

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