YELLEN'S CHALLENGE AT THE FED: SPEAKING PERSUASIVELY TO INVESTORS
c.2013 New York Times News Service
WASHINGTON — Janet L. Yellen, President Barack Obama’s choice to lead the Federal Reserve over the next four years, has championed the idea that the Fed can stimulate the economy simply by speaking clearly.
Her confirmation by the Senate is regarded by most Democrats and Republicans as all but inevitable.
But even before she takes over, the questions she will begin to confront on Thursday, as she appears before the Senate Banking Committee, are whether the Fed under her leadership can communicate more clearly than it has managed to do in recent months — and whether that is the best the Fed can do to lift the economy from its enduring malaise.
Yellen, the Fed’s vice chairwoman since 2010, has been a key architect of the push to more fully explain the Fed’s actions, its reasoning and its plans to the public. The theory is that the Fed can exert greater influence over investors, by enlisting them to hold down longer-term interest rates at a time when the Fed has cut short-term rates practically as low as they can go, by detailing an itinerary rather than sending occasional postcards.
She is widely expected to double down on this strategy, assuming she is confirmed as chairwoman.
The Fed has said that it will begin to taper its asset purchases in the coming months. To counter any negative effects from that move, the central bank is likely at the same time to reinforce its commitment to hold down interest rates until unemployment gets closer to normal levels.
Dennis P. Lockhart, president of the Federal Reserve Bank of Atlanta, told Bloomberg Radio on Tuesday that tapering “could very well take place” in December, when the Fed’s policy committee next meets. Other officials have also said that December remains on the table, provided that job growth and other economic indicators remain relatively strong.
“The right monetary policy for these circumstances is continued strong stimulus,” Lockhart said earlier in a speech in Montgomery, Ala. “That is not to say, however, that the mix of policy tools needs to or will stay the same.”
Since September 2012, the Fed has added $85 billion a month to its holdings of Treasury securities and mortgage bonds. As it pulls back, borrowing costs on things like home mortgages and consumer loans will tend to climb, resuming a rise that began in June when the Fed’s chairman, Ben S. Bernanke, first described plans for a retreat by the end of the year.
But Bernanke and Yellen, along with other Fed officials, have argued that the Fed can limit the increase in borrowing costs for businesses and consumers by persuading investors that short-term rates will remain near zero well into the future, because interest rates on longer-term loans are determined in large part by the expected level of short-term rates over the duration of the loan.
Long-term rates rose over the summer in part because investors saw the arrival of tapering as indicating that short-term rates also might start to rise sooner than they had expected. Yellen faces the challenge of convincing investors that is not the case.
Analysts see evidence of the Fed’s expected approach in a pair of papers published last week, each listing one of the Fed’s senior staff economists among the authors.
The Fed has said that it plans to hold short-term rates near zero at least as long as the unemployment rate remains above 6.5 percent. The first paper, with William B. English, the head of the Fed’s monetary affairs division, as one of the authors, presents evidence that the Fed should instead reduce that threshold to 5.5 percent.
The second paper, with David Wilcox, head of the division of research and statistics, as an author, suggests the threshold perhaps should be even lower.
“It is hard to overstate the importance” of the studies, Jan Hatzius, the chief economist at Goldman Sachs, wrote in a note to clients last week.
It is rare for any of the Fed’s senior staff members to publish work with such clear implications for current policy — their considerable influence is largely exercised privately. Moreover, the two papers are in harmony with past remarks by Yellen suggesting that the Fed might need to keep rates near zero for longer.
In light of the two papers, Hatzius wrote that he now expected the Fed to decide in March — at what is likely to be Yellen’s first full meeting as chairwoman — to reduce the unemployment threshold to 6 percent.
Such a step would represent a partial victory for Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis. He has campaigned in recent months for stronger action to reduce unemployment, delivering variants of the same speech at least four times, most recently on Tuesday, declaring that the Fed is facing a “time of testing” because the labor market remains “disturbingly weak.”
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But any effort to extend the Fed’s forward guidance about interest rates could be complicated by changes in the composition of the Fed’s policymaking committee.
Yellen, if confirmed, is likely to begin her term as one of only three voting members of the 12-seat committee who have expressed strong support for the stimulus campaign. The other two are Kocherlakota, who will have a vote next year, and William C. Dudley, president of the Federal Reserve Bank of New York. The other voting members of the committee all have registered reservations, particularly about the consequences of asset purchases.
Four of the 12 voters change each year as part of a regular rotation of the presidents of the regional reserve banks, a rotation that this year is ushering out several of the strongest supporters of stimulus and ushering in several critics.
Another three seats are empty because of departures from the Board of Governors. Obama is expected to avoid a fourth vacancy by nominating to a full term Republican financier Jerome H. Powell, who joined the board last year.
The White House has not indicated its plans for the other vacancies.
Some analysts see these shifts as relatively inconsequential. They argue that Yellen would retain the strongest hand in setting the Fed’s course, and that tapering asset purchases would be a sufficient concession to maintain a majority.
“The institutional momentum is there even as the people in the chairs change,” said Diane Swonk, chief economist at Mesirow Financial in Chicago.
Swonk said the new voices probably would cause some confusion, but “it increases uncertainty more than it changes the course of monetary policy.”
Michael Feroli, chief U.S. economist at JPMorgan Chase, is not so sure. He said that vocal opposition could undermine the efficacy of a lower unemployment threshold by gnawing at the confidence of investors that the Fed would do what it said.
“When it comes to thresholds, consensus seems to be pretty important,” he said. “When they’re talking about years into the future, you have to have the sense that all of the committee is behind whatever is being committed to.”