Edited by Vani Rao
Fed on right path to reduce stimulus despite poor labor data
The Federal Reserve Chair Janet Yellen, in her first public meeting on Tuesday, 11 February 2014, sought to reassure investors that she would follow her predecessor’s approach towards the interest rate policy. In her first remarks delivered before the House Committee of Financial Services since becoming the Fed chief earlier this month, she made it clear that she will not make any abrupt changes to the monetary policy, stating that the Central bank was on the right path to keep reducing the stimulus even though recovery in the labor market was far from complete.
Moreover, Yellen said the central bank must keep its eye on the “unusually high” incidence of long-term unemployment and the “exceptionally high” proportion of Americans who are able to find only part time employment, while plotting the reversal of the accommodative policy stance. There were few key pointers from her comments.
Tapering not going to stop any time soon
Yellen said she was “surprised” by the weak December and January job reports .However, she mentioned that unwelcome news about employment would not be enough to stop the tapering in future Fed meetings. She also stated that the purpose of the monetary stimulus launched in 2012was to prevent the labor market from “stalling,” and that employment growth has substantially picked up since then .It would take a drastic change in terms of job numbers, economic growth, and inflation, for the Fed to halt the tapering, which she still didn’t rule out.
Reason for shrinking labor force not clear
When quizzed about her assessment of the rapidly-declining labor force participation rate which at 63%is now lower than it has been since the late 1970s, Yellen said that there is no “clear scientific way” to tell how much of the decline in the labor force is due to cyclical factors rather than structural factors, such as the aging of the population and mass retirements of the Baby Boom generation. She cited that the decline in participation among prime-age workers could be partly caused by workers getting discouraged, which is a cyclical problem that can be addressed by the monetary policy.
Fed will not worry about repercussions in emerging markets
The recent turmoil in countries such as Brazil and Turkey has caused some investors to ask if the Fed will consider instability in such markets when making decisions about the quantitative easing program. Yellen warned that it is not Fed’s job to worry about how the slowing down its large-scale bond purchases might hurt emerging market economics. “We’ve been very clear at the outset that we initiated our program of asset purchases to pursue the goals that the Congress has assigned to the Federal Reserve,” she explained.
A few of these goals include promoting maximum employment and price stability in the US, and not financial health in emerging markets. She also added that “We’ve tried to be as clear as we possibly can” that the Fed would slow the asset purchases as US growth and inflation picked up in the coming months.
No further details about plans for interest rates
Yellen avoided going into any further details about the Fed’s plans for short-term interest rates, which now have been near zero for over five years. Currently, the Fed’s forward guidance about rates, which it sees as its main tool for stimulating the economy, is that it will keep them near zero “until well past the time” when the unemployment rate hits 6.5%. Yellen also avoided spelling out further details to the Fed’s guidance.
Questions remain about how quantitative easing works
Yellen stated her view of how the quantitative easing improves the economy. She said, “The objective has been to push down longer-term interest rates,” she explained. “The purpose is to spur spending in the economy and achieve more rapid economic growth.”Yellen cited rising home sales and prices and increased spending in other interest-rate sensitive sectors such as automotive sales could boost spending.
She also stated that increased spending from in key sectors has been key to the unemployment rate falling by 1.5% since the start of the latest round of quantitative easing in late 2012.That’s the clearest answer that Yellen has given yet to a question about how large-scale bond purchases aid the economy, and one that’s fairly digestible in the media. It also accords with the motivation Bernanke first provided for the $600-billion round of quantitative easing that he launched in 2010.
However, the question arises as to how long-term interest rates are supposed to respond to an improvement in the economic outlook. Yellen said that interest rates are low for the “fundamental reason” that “there is excess savings relative to investment demand” for those savings. In a stronger economy, Yellen added, savers would be able to realize greater returns because interest rates would be higher. This could cause a tension between the stated purpose of the quantitative easing program, which is to lower interest rates, as opposed to the actual goal of achieving a stronger economy with higher interest rates.