Yellen: Farther To Go

Janet Yellen gave a balanced assessment of how monetary policy will be conducted during her tenure as Fed chair. However, the financial markets perceived a “dovish” tilt. She stressed that conditions in the labor market are still far from normal and noted that inflation has been running below the Fed’s goal of 2% “and is expected to do so for some time.” However, Yellen noted that there were risks of removing support too late as well as too soon. QE3 can’t go on forever.

Yellen: “Today the economy is significantly stronger and continues to improve. The private sector has created 7.8 million jobs since the post-crisis low for employment in 2010. Housing, which was at the center of the crisis, seems to have turned a corner – construction, home prices, and sales are up significantly. The auto industry has made an impressive comeback, with production and sales back to near their pre-crisis levels.”

“We have made good progress, but we have farther to go to regain the ground lost in the crisis and the recession. Unemployment is down from a peak of 10 percent, but at 7.3 percent in October, it is still too high, reflecting a labor market and economy performing far short of their potential.”

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In past speeches, Yellen has spoken emphatically about the need for improvement in the labor market. She was a major proponent of QE3 (which was meant to last until there was “substantial improvement” in labor market conditions). Labor market weakness has a significant impact on peoples’ lives, but is not just a problem for the individuals (and families) involved. The slackness in the labor market represents a loss of economic output and, if prolonged, will lead to lower potential growth.

As Chairman Bernanke noted, fiscal policy has been the main economic headwind this year. Yellen expressed encouragement that the economy has done as well as it has, noting that momentum would be building if not for the fiscal drag.

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The Fed has a dual mandate: low, steady inflation and maximum sustainable employment. Yellen would not sacrifice one goal for the other. She is fully committed to Fed’s goal of 2% inflation. In fact, at the request of Chairman Bernanke, Yellen led the effort to adopt astatement of the Fed’s long-term objectives. The formal statement of the 2% inflation goal has helped to anchor inflation expectations.

It’s no secret that Yellen has also had a strong hand in both the asset purchase program (QE3) and the forward guidance (on short-term interest rates). In her testimony, Yellen said “I consider it imperative that we do what we can to promote a very strong recovery,” adding that the Fed is doing that through the continuation of its asset purchase program. The Fed needs to be aware of the risks, but Yellen said that “at this point, I think the benefits exceed the costs.” She added that there has been some reach for yields, but “we don’t see a broad build-up of leverage that, at this stage, poses a risk to financial stability.”

She said “it’s important not to remove support, especially when the recovery is fragile and the tools available to monetary policy, should the economy falter, are limited given that short-term interest rates are at zero.” It could be “costly” to remove accommodation too soon. “On the other hand,” she noted, “it will be important for us, as the recovery proceeds, to make sure that we do withdraw accommodation when the time has come.”

She declined to give specific guidance on what constituted “substantial improvement” in the labor market, adding that the asset purchase program is “not on a set course” and will remain data dependent. However, she also agreed that “this program cannot continue forever” and the longer it continues, the more the Fed will need to worry about the risks.

© Raymond James

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