WASHINGTON - As Janet Yellen prepares to deliver her first testimony to Congress as Federal Reserve chairman, the central bank’s tactics for guiding the recently more turbulent financial markets need reworking, economists say.
Even as unemployment nears the 6.5 percent marker the Fed had set for starting discussions on raising interest rates, the central bank is continuing its policy of buying bonds, albeit at a reduced rate.
“She needs to provide more clarity about what forward guidance is going to look like,” said Russ Koesterich, chief investment strategist at New York-based BlackRock, which manages $4.3 trillion in assets. “There is some uncertainty about how the Fed is going to approach monetary policy.”
Yellen, scheduled to appear today before the HouseFinancial Services Committee, isn’t the only central banker facing questions. Bank of England Gov. Mark Carney has signaled that he’ll update his guidance on Wednesday now that Britain’s joblessness is brushing up against the Bank of England’s 7 percent threshold to consider raising interest rates.
The success of their communication strategies has economic ramifications. If doubts surface about their intentions, confused investors, companies and consumers may hunker down, undermining the very expansions that Carney and Yellen are trying to spur.
While the Fed has signaled that monetary policy will stay easy for a long while, investors want it to spell out the conditions that would prompt it to shift its stance and begin raising interest rates, Koesterich said.
The recent financial tumult raises the stakes. Led by Reserve Bank of India Gov. Raghuram Rajan, policymakers in emerging markets have complained that the Fed and other major central banks helped fan the turmoil by failing to account for the effects their policies have on other countries.
Investors in emerging markets and elsewhere had taken comfort in recent years from the belief that the Fed would aid the U.S. economy with quantitative easing at any sign of weakness.
With the central bank starting to moderate its monthly bond purchases, “the market knows it is not going to get that any longer,” Koesterich said. Now, “what the market is looking for are the metrics that will be influencing the Fed’s thinking” on when it will increase interest rates.
Federal Reserve Bank of Atlanta President Dennis Lockhart suggested Wednesday that investors may not have long to wait to get a new message.
“When we get close to or even beyond the 6.5 percent, I think it is reasonable to expect the Federal Open Market Committee will revise forward guidance,” Lockhart told reporters in Birmingham, Ala.
The increasing length of the Fed’s policy statements illustrates how difficult it has become for the central bank to get its message across, said Torsten Slok, chief international economist in New York for Deutsche Bank AG.
When Yellen, 67, first joined the Fed board in 1994, the statement was 179 words long. When she returned to the central bank in 2004 after a stint in academia, it amounted to 278 words. The announcements grew longer after Ben Bernanke became chairman in 2006, as he sought to make the Fed more open. The Jan. 29 statement came to 830 words.
“It’s always been important to be clear about monetary policy,” said former Fed Vice Chairman Alice Rivlin, now a senior fellow at the Brookings Institution in Washington. “And the Fed has certainly come around to realize how important that is.”
The Fed and Bank of England are being forced to revise their forward guidance language because unemployment has fallen faster than they expected. When U.S. policymakers first introduced the 6.5 percent threshold in December 2012, they didn’t anticipate joblessness would reach that level until 2015. At 6.6 percent in January, it is set to break that benchmark this year, Slok said. Much of that drop has been driven by Americans leaving the workforce, rather than by companies hiring.
The unemployment rate “is giving a seriously misleading reading of how strong the economy is” because of the contraction in the labor force, said former Fed Vice Chairman Alan Blinder, now a professor at Princeton University in New Jersey.
Business, Pages 19 on 02/11/2014