Politics & Money

Yellen holds fast to taper

QE policy and changing benchmarks questioned

Federal Reserve Chair Janet Yellen – showing a solid resolve – said Tuesday that she plans on keeping the central bank on a steady and consistent course, with less quantitative easing but a continued commitment to near-zero interest rates.

In her first official remarks since taking over for Ben Bernanke, Yellen told the House Financial Services Committee she is optimistic about the economy, unemployment and the prospect of inflation. Yellen is scheduled to appear similarly before the Senate Banking Committee.  (View her written remarks here.)

“The economic recovery gained greater traction in the second half of last year,” Yellen said.

Yellen said she expects the Federal Open Markets Committee will continue ahead with its plan to taper off the monthly pace of bond and Treasurys purchases.

The Fed announced in December it would start to reduce its monthly purchases of $85 billion in mortgage bonds and Treasurys. It cut $10 billion in December and another $10 billion in January.

The program of quantitative easing has added $4.1 trillion to the Fed’s balance sheet.

The Fed has said it will keep its outlook flexible, even though the labor market has “improved substantially.”

"The Committee's decisions about their pace will remain contingent on its outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases," she said.

Philadelphia Fed President Charles Plosser reflected Yellen’s commitment to the taper in his remarks Tuesday morning in Delaware.

"Reducing the pace of asset purchases to $65 billion a month is moving in the right direction, but that may prove to be insufficient if the economy continues to play out according to the FOMC forecasts," Plosser said.

But House Financial Services Committee Chair Jeb Hensarling, R-Texas, said it wasn’t appropriate that the Fed kept changing the benchmark they use to determine action.

"What good is forward guidance if when you reach a milepost you jettison it?" Hensarling asked Yellen. "There are exceptions to every rule, but at some point you have no rule. You're making it up as you go along. And I think that breeds greater fear and uncertainty in the capital markets."

The FOMC meets again March 18-19.

Yellen said she was committed to keeping the interest rate near zero “well past the time” unemployment falls below 6.5%. For January the rate was 6.6%.

Yellen recounted the cumulative progress made in the jobs market, but emphasized that "recovery in the labor market is far from complete."

Furthermore, she candidly noted that more should be considered than the unemployment rate when looking at the jobs market – presumably the record number of people who have dropped out of the workforce and the record highs of underemployed workers.

“Those out of a job for more than six months continue to make up an unusually large fraction of the unemployed, and the number of people who are working part time but would prefer a full-time job remains very high,” Yellen said. “These observations underscore the importance of considering more than the unemployment rate when evaluating the condition of the U.S. labor market.”

“I am committed to achieving both parts of our dual mandate – helping the economy return to full employment and returning inflation to 2% while ensuring that it does not run persistently above or below that level,” she said.

She also addressed volatility in emerging markets, some of which has been connected to American monetary policy.

“We have been watching closely the recent volatility in global financial market. Our sense is that at this stage these developments do not pose a substantial risk to the U.S. economic outlook,” she said.

A response to Yellen was offered in testimony to committee from John B. Taylor, Mary and Robert Raymond Professor of Economics at Stanford University. (Written testimony here.)

“Recently released data indicate that the U.S. economy continues to underperform, with the recovery from the deep 2007-09 recession looking as disappointing as ever,” Taylor said. “Real GDP growth has been too slow to close the gap between real GDP and its pre-recession trend, even incorporating the temporary pickup near the end of last year.

“Job growth has been too slow to raise employment relative the population, leaving the employment-to-population ratio below the recession low,” Taylor said. “While the unemployment rate has declined recently, much of the decline is due to an unusually large number of people dropping out of the labor force because of the weak recovery.”

Taylor said it is good news that the inflation rate has averaged very close to the Fed’s 2% goal during the past decade, but by any measure the performance of the real economy has deteriorated compared to the previous two decades.

Taylor argued that it’s the inconsistent nature of Fed policy that is hurting the economy.

“I have argued that the main cause of the poor performance is a significant shift in economic policy away from what worked reasonably well in the decades before,” he said. “Broadly speaking, monetary policy, regulatory policy, and fiscal policy each became more discretionary, more interventionist, and less predictable starting in the years leading up to the financial crisis and have largely remained in that mode.”

Most damningly, Taylor said the trillions spent on quantitative easing have had no real impact on the economy or on job creation.

“Though the intention of the majority of those at the Fed in favor of the policies was to stimulate the economy, there is little evidence that the policy has helped economic growth or job growth. Growth has been less with the unconventional policies than the Fed originally forecast,” Taylor said. “In the year since QE3 gained full steam at the end of 2012, interest rates on long-term Treasuries and mortgage backed securities have risen rather than fallen as was the intent of the policy. Before quantitative easing, from 2003 to 2008, the average spread between one year and ten year Treasury securities was 1.3%. During the three quantitative easing programs, from 2009 through 2013 the average spread was 2.4%. So it is very hard to establish that QE reduced spreads.”

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