Fed’s Yellen comments on Taylor interest rate rule
WASHINGTON: Federal Reserve chief Janet Yellen expressed doubts about using a rigid formula to set interest rates, then had to defend her position to the author of that formula.
Speaking on the eve of the inauguration of President-elect Donald Trump, Yellen also repeated her opposition to a Congressional proposal that would audit the central bank any time it deviates from the strict rule, a move she said threatens the Fed’s independence.
The Fed chair, who has been the target of criticism by Trump for her handling of monetary policy, once again argued against using formulaic and rigid rules for adjusting interest rates, including the well-known Taylor rule.
The Taylor rule, originally published in 1993, calls for systematic adjustments in interest rates by the central bank based on just three economic variables, two of which are subject to interpretation.
While they can be “useful benchmarks” for the Fed, “the rules should not be followed mechanically, since doing so could have adverse consequences for the economy,” she told the Stanford Institute for Economic Policy Research in California.
The Taylor rule, for example, would have called for much higher interest rates during the slow US recovery, she said.
But when it came time to answer questions from the audience, Stanford economics professor John Taylor, the author of the rule, rose to challenge Yellen’s stance.
He argued – politely – that Yellen’s own graphs showed the Fed may have contributed to the financial crisis by keeping rates too low for too long.
Yellen disagreed, saying the problems in the housing market began before there was any indication interest rates were too low.
“To say that was responsible for the financial crisis, I guess I wouldn’t agree with that,” she told Taylor.
Taylor also wondered if Yellen’s presentation wasn’t just the sort of explanation of policy that Congress is asking for, but she said the House’s Fed Oversight and Modernization Act goes much further.
“We are and should be accountable to Congress,” she said, but noted that the FORM act calls for government audits of Fed decisions any time it fails to follow a strict rule.
“I’m very opposed,” because it is “essentially bringing shortterm political influence into the determination of policy.”
In her lengthy speech explaining the calculations that go into decisions about the benchmark interest rate, Yellen said potential “surprises” in the world economy and the still- undetermined spending policies of the Trump administration could impact the course of monetary policy.
Trump has promised massive spending on infrastructure as well as corporate tax cuts and deregulation.
“At this point, however, the size, timing, and composition of such changes remain uncertain,” she said.
This echoed a similar statement in her speech in San Francisco on Wednesday, when she said central bankers would “closely follow” the economic policy changes under consideration in the Trump administration.
Yellen said “the strength of global growth will also have an important bearing” on the path of interest rates.
She cautioned that “the scope for surprises is considerable,” but did not provide any details on the global outlook.
Officials in the Federal Reserve’s policy-setting Federal Open Market Committee (FOMC) last month indicated they expect three rate increases this year, and Yellen repeated that the best option is to adjust “monetary policy gradually over time – a strategy that should improve the prospects that the economy will achieve sustainable growth.”
After a long, sluggish recovery from the 2008 financial crisis, inflation finally is starting to move upwards towards the Fed’s two percent target as the job market improves and wages rise, but Yellen rejected the notion of allowing the economy to get too hot, calling the idea “risky and unwise.”
She warned that “waiting too long to tighten policy could require the FOMC to eventually raise interest rates rapidly, which could risk disrupting financial markets and pushing the economy into recession.” — AFP