The US Federal Reserve has a new Chair, but Janet Yellen gave every indication in her first Congressional testimony that she will continue the policies of her predecessor, Ben Bernanke. That means interest rates should remain low for the rest of this year and for most of 2015. “Too many Americans remain unemployed, and inflation remains below our longer-run objective,” she said.
Rather than comment on why the Fed chose to taper quantitative easing late last year, given these concerns over job growth and low inflation, Ms Yellen presented a simple, uncomplicated picture of the need to pursue an accommodative monetary policy. She revealed no doubts about the Fed’s capability of pursuing its goals.
The intent of policy will likely remain clear: it will be accommodative for an extended period, probably well into the second half of 2015
The cutback in quantitative easing means the Federal Open Market Committee (FOMC) is relying more on forward guidance for the federal funds rate. But here, Ms Yellen and the committee have a communication problem. In December 2012 it indicated that 6.5 per cent unemployment would be a threshold for considering a change in policy. With unemployment already down to 6.6 per cent when Ms Yellen took over, financial markets are naturally interested in whether the FOMC will start to reconsider its low interest-rate policy.
The simple answer to that question is no. Ms Yellen repeated the FOMC’s declaration that crossing the 6.5 per cent threshold will not automatically prompt an increase in the federal funds rate. Instead, given its assessment of labour market conditions, the current 0 per cent to 0.25 per cent target range for the federal funds rate will be maintained “well past the time that the unemployment rate declines below 6.5 per cent”, she said.
Another change in guidance is likely. In our view, the unemployment threshold may be eliminated in favour of less defined labour market indicators, along with a greater emphasis on inflation as a key determinant for policy. The intent of policy will likely remain clear: it will be accommodative for an extended period, probably well into the second half of 2015.
The general feeling of the FOMC is that inflation is unlikely to fall further and will not remain low for much longer. So while low inflation may provide the FOMC with a reason to keep the fed funds rate “lower for longer”, there is no consideration at present for an easier policy stance aimed at pushing up inflation towards its 2 per cent target.
This research was first published on 11 February 2014.