Janet Yellen opened the festivities at this year’s Jackson Hole economic symposium by musing on what central bankers had learned since the crisis and how they can deal with future recessions in a world where interest rates are far lower than in the past.
Unsurprisingly, bond-buying and “forward guidance” featured prominently in Yellen’s narrative of successful new tools. (On the other hand, scholars have estimated the combined impact of these measures was an unemployment rate a mere 0.13 percentage points below where it would have been using purely conventional instruments.)
More importantly, Yellen argued no additional central bank innovation should be necessary to respond to future recessions, even though Fed policymakers expect the average level of short-term interest rates to be just 3 per cent. (Markets think it’s closer to 2 per cent.) Emphasis ours:
Would an average federal funds rate of about 3 percent impair the Fed’s ability to fight recessions? Based on the FOMC’s behavior in past recessions, one might think that such a low interest rate could substantially impair policy effectiveness…On average, the FOMC reduced rates by about 5-1/2 percentage points, which seems to suggest that the FOMC would face a shortfall of about 2-1/2 percentage points for dealing with an average-sized recession.
But this simple comparison exaggerates the limitations on policy created by the zero lower bound…A large portion of the rate cuts that subsequently occurred during these recessions represented the undoing of the earlier tight stance of monetary policy. Of course, this situation could occur again in the future. But if it did, the federal funds rate at the onset of the recession would be well above its normal level, and the FOMC would be able to cut short-term interest rates by substantially more than 3 percentage points.
A recent paper takes a different approach to assessing the FOMC’s ability to respond to future recessions by using simulations of the FRB/US model…The study concludes that, even if the average level of the federal funds rate in the future is only 3 percent, these new tools should be sufficient unless the recession were to be unusually severe and persistent.
Suppose, though, you lack the Fed’s confidence in its own abilities, or perhaps you’re worried about a recession that’s “unusually severe”. This is where things get interesting. Yellen acknowledged there are other tools available, some of which have been explored by foreign central banks. You might expect negative interest rates to get a brief mention, but the topic was studiously avoided.
Instead, we got a hint of “the possibility of purchasing a broader range of assets”. Whether she was thinking of corporate bonds, in emulation of the European Central Bank and the Bank of England, or equities and real estate investment trusts, à la the Bank of Japan, or foreign currency, in the manner of the Swiss National Bank and the Swedish Riksbank, was left unclear.
Just as listeners were starting to ponder which sorts of things the Fed might like to acquire next time around, Yellen transitioned to discussions of faster inflation targets, price-level targeting (where deviations today are offset by compensating deviations in the future), and the possibility of targeting nominal output rather than the price level. After that, she engaged in the well-worn tradition of central bankers commenting on fiscal policy, followed by even more speculative thoughts on what we could do to boost America’s meagre pace of productivity growth.
Yet negative interest rates, which, depending on your point of view, afflict or comfort about 500 million people, all of whom live in the rich world, didn’t merit a mention in this panoply of initiatives. One can only conclude the policy is considered so toxic by enough Fed officials they want to avoid even speaking its name.
Yellen speech: how the Fed plans to escape policy trap — Fast FT
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