Yellen says Fed might turn to QE in another downturn

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Janet Yellen, the Federal Reserve chair, has warned that there is an “uncomfortably high” risk that the central bank will have to deploy crisis-era stimulus tools again — even in the case of a less severe downturn than the Great Recession. Her comments come as President Donald Trump considers a sharp change of direction at the Fed which could see him install new leadership that is much more dubious about the Fed’s use of quantitative easing. Ms Yellen said in a speech that the US economy had made “great strides” but that policymakers may be unable to lift short-term rates very far as the recovery proceeds. This could leave the Fed once again leaning on quantitative easing and forward guidance on the future rate outlook when the economy hits a downturn, she suggested. “The probability that short-term interest rates may need to be reduced to their effective lower bound at some point is uncomfortably high, even in the absence of a major financial and economic crisis,” she said in a speech in Washington DC. Former Fed governor Kevin Warsh and John Taylor, a Stanford University economist, are among those who have criticised the US central bank’s decision to swell its balance sheet to $4.5tn as it battled the crisis. Both are candidates to take over from Ms Yellen if Mr Trump declines to give her a second term when her current one expires in February. Conservative lawmakers on Capitol Hill have also long been critical of the Fed’s unconventional monetary policy, and some have warned that the Fed was risking a major flare-up in inflation and asset bubbles because of its stimulus programmes. Some GOP lawmakers have been agitating for a new regime at the Fed, signalling support for both Mr Taylor and Mr Warsh.

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Mr Trump has signalled a decision on a new Fed chair could come soon, and in an interview with Fox Business to be broadcast this weekend the president suggested Ms Yellen remains in contention for a second term. Mr Trump also singled out Mr Taylor and Jay Powell, who is currently on the Fed board, and hinted that they are leading candidates. The president added that there are a couple of other contenders, whom he did not name. They are likely to be Mr Warsh and Gary Cohn, the director of the National Economic Council. In her speech, Ms Yellen pointed out that most Fed policymakers only expect to lift the federal funds rate to about 2.75 per cent in the coming years, well below previous norms, suggesting there will be little room to cut rates again when a new downturn strikes. This meant the Fed needed to remain prepared to deploy new rounds of asset purchases. She also defended the Fed’s payment of interest on excess reserves held by commercial banks — an unpopular mechanism with some lawmakers but one that has allowed it to set rates without being forced to dramatically cut the size of its balance sheet. Does this mean that it will take another Great Recession for our unconventional tools to be used again? Not necessarilyJanet YellenMs Yellen said unconventional policy should be used once again if the Fed has to cut its target range for the federal funds rate to near-zero levels, from about 1-1.25 per cent now. “Does this mean that it will take another Great Recession for our unconventional tools to be used again? Not necessarily. Recent studies suggest that the neutral level of the federal funds rate appears to be much lower than it was in previous decades,” Ms Yellen said. “The bottom line is that we must recognise that our unconventional tools might have to be used again. If we are indeed living in a low-neutral-rate world, a significantly less severe economic downturn than the Great Recession might be sufficient to drive short-term interest rates back to their effective lower bound.”

10/24/2017
FT