Bloomberg News

Yellen Signals Fed Would Maintain Easing After Halting QE

February 12, 2013

Federal Reserve Vice Chairman Janet Yellen signaled stimulus may outlast the Fed’s bond purchases, saying the central bank has the option to hold interest rates near zero even after reaching near-term targets for inflation or unemployment.

Yellen’s comments yesterday coincide with a Federal Open Market Committee debate over when to bring bond buying to an end, a shift that may prompt expectations of an interest-rate increase. The FOMC said in December it will hold the main interest rate in a range of zero to 0.25 percent so long as inflation isn’t forecast to rise to more than 2.5 percent in one to two years and unemployment exceeds 6.5 percent.

The speech by the Fed vice chairman “reminds people that if they are successful and if they get to their unemployment objective that doesn’t automatically mean they are going to slam on the brakes,” said Dominic Konstam, head of interest rate research at Deutsche Bank AG in New York. As “better data come out, they want to make sure the market doesn’t want to get carried away” and anticipate a boost in interest rates.

Yellen, who leads a Fed committee created by Chairman Ben S. Bernanke on improving monetary policy communications, said the targets announced in December are “thresholds for possible action, not triggers that will necessarily prompt an immediate increase” in the main interest rate. “When one of these thresholds is crossed, action is possible but not assured,” she said in a speech to the AFL-CIO in Washington.

“Several” members of the FOMC “thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013,” minutes from the December meeting said.

‘Throttle Back’

St. Louis Fed President James Bullard, a voting member on the FOMC, said in an interview this month the Fed could begin to “throttle back” the purchases later this year.

Following the advice of Yellen’s committee, the central bank in January 2012 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.

Yellen’s comments show Fed officials will continue to use communications such as speeches to sustain expectations for low interest rates, said Julia Coronado, chief economist for North America at BNP Paribas in New York.

“They don’t want financial conditions to tighten,” Coronado said.

Full Force

U.S. central bankers are focusing the full force of monetary policy on reviving growth and reducing 7.9 percent unemployment. The economy contracted at a 0.1 percent annual rate in the fourth quarter of 2012, dragged down by the biggest plunge in government defense spending in four decades.

The outlook for fiscal policy, which could include further defense cuts, is clouded by disagreement in Washington over federal taxation and spending.

The Standard & Poor’s 500 Index was little changed yesterday at 1,517.01 in New York. The 10-year yield rose one basis point, or 0.01 percentage point, to 1.96 percent as of 5 p.m. in New York, according to Bloomberg Bond Trader prices. Yields have risen from 1.72 percent since the Fed announced new bond buying on Sept. 13.

Echoing Bernanke, Yellen warned against deep fiscal spending cuts at a time when unemployment is high and growth is weak. An economy that already has low interest rates and high unemployment may sustain larger negative effects from fiscal spending cuts, she said.

Negative Impact

“We’re seeing larger so-called fiscal multipliers, or namely, a more significant negative effect on the economy of austerity than many researchers had expected,” Yellen said. “To me the evidence, both in the United States and in Europe, is that fiscal austerity does raise unemployment.”

The Fed in September started a third round of asset purchases and expanded it in December to $85 billion per month, saying the quantitative easing will continue until the labor market is improving “substantially.”

“With employment so far from its maximum level and with inflation currently running, and expected to continue to run, at or below the Committee’s 2 percent longer-term objective, it is entirely appropriate for progress in attaining maximum employment to take center stage in determining the committee’s policy stance,” Yellen said in her speech.

Yellen noted that the FOMC maintains a longer-run goal for inflation of 2 percent while the FOMC estimates that labor resources are fully utilized at an unemployment rate of 5.2 percent to 6 percent.

‘Imperfect’ Control

“Our control over the economy is imperfect, and so temporary deviations from the FOMC’s specific longer-term goals will sometimes occur,” Yellen said. “Importantly, these quantitative goals are neither ceilings nor floors for inflation and unemployment, and the committee will take a balanced approach to returning both measures to their objectives over time.”

The Fed’s asset purchases and other unconventional policies have helped “shore up aggregate demand,” Yellen said.

“However, while this contribution has been significant, lower interest rates may be doing less to increase spending than in past recoveries because of some unusual features of the Great Recession and the current recovery,” she said.

Unemployment averaged 8.1 percent last year as the expansion which began in June 2009 was too weak to pull it lower.

The Fed under its congressional mandate seeks to promote “maximum employment” and “stable prices.” The personal consumption expenditures price index is below the central bank’s stated goal of 2 percent, rising just 1.3 percent last year.

Big Waste

Some 4.7 million people were unemployed six months or more in January, a condition that Bernanke called “an enormous waste of human and economic potential” at a press conference after a Dec. 11-12 meeting of policy makers.

The central bank’s asset purchases have pushed its balance sheet above a record $3 trillion. Yellen said that while the Fed may remit less cash to the Treasury as it begins to unwind the portfolio, the broader impact from its large balance sheet needs to be considered.

For example, higher levels of employment boost tax revenues, while lower Treasury bond rates help reduce interest payments for the U.S.

“This is a policy that is not only good for output and employment and American workers, but also for the federal finances overall,” she said.

To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net;

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net


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