WASHINGTON — Janet L. Yellen is taking over the leadership of the Federal Reserve on the cusp of a more challenging period for the central bank.
For the last several years, Fed officials largely agreed that more had to be done to reduce unemployment and revive inflation. As the economy recovers, however, there are signs that old differences are returning even as the Fed emphasizes clear communication as its primary policy tool.
“It’s a much tougher job to manage this committee than Bernanke had, because we’re at more of a transitional point,” said Julia Coronado, chief economist for North America at BNP Paribas, referring to Ben S. Bernanke, Ms. Yellen’s predecessor. “We’re not in a crisis, we’re kind of recovering to a degree — and then the question is, how much can monetary policy do?”
The immediate challenge confronting Ms. Yellen, who as Fed chairwoman will lead her first meeting of the Fed’s policy-making committee on Tuesday and Wednesday, is to overhaul the Fed’s forward guidance for short-term interest rates.
The Fed is gradually ending the expansion of its bond holdings, one aspect of its economic stimulus campaign. It is widely expected to announce Wednesday that it will add $55 billion in Treasury and mortgage-backed securities in April, down from $65 billion in March and $85 billion each month last year. Fed officials say they intend to end purchases in the fall unless the economic outlook changes sharply.
But officials have offered much less clarity about the policy they regard as the centerpiece of the stimulus campaign, the Fed’s effort to suppress borrowing costs for businesses and consumers not just by holding short-term interest rates near zero, but also by convincing investors that rates will remain low for some time.
In December 2012, the Fed said that it intended to keep short-term interest rates near zero at least as long as unemployment, which was 7.9 percent at the time, remained above 6.5 percent. Officials have since concluded that the rapid fall in the official unemployment rate – to 6.7 percent in February – overstates the labor market’s recovery. They agree that the Fed should tell investors that rates will remain low well past that threshold, but a small minority of officials are pushing for a clearly defined new threshold. Most officials instead want to provide a more general description of the economic objectives for the policy.
They argue that the task of calibrating monetary policy is inherently becoming more complicated as the economy recovers, like the difference between sailing quickly toward an island and then maneuvering slowly into the harbor.
John C. Williams, president of the Federal Reserve Bank of San Francisco, said that describing the Fed’s plans in terms of a broader set of economic indicators would be more vague, but also more accurate. “How to do that without going to dates and using numbers, that will be the art of crafting how we communicate,” he said.
The Bank of England last month made a similar shift, replacing a statement that it intended to keep interest rates at a low level at least as long as British unemployment remained above 7 percent with a long description of the factors it planned to consider before raising rates, emphasizing that the economy still had considerable “spare capacity.” Some Fed officials, including William C. Dudley, the influential president of the Federal Reserve Bank of New York, have cited that “qualitative rather than quantitative” approach as a useful model.
A shift toward descriptive guidance could diminish the potency of the Fed’s effort to suppress interest rates if investors find the goals less clear or more likely to shift. The Bank of England has struggled to dissuade investors who continue to bet that it will raise rates sooner than the timetable implied by its forecasts.
But the Fed is unlikely to face an immediate test of its credibility because the economy remains weak. “Their job is being made easier by the fact that the data is reinforcing their message of patience,” Ms. Coronado said. “In contrast to the Bank of England, which is fighting strong data and trying to convince the market that they’re going to be low for long, everyone believes the Fed right now.”
A shift toward looser guidance also reflects the reality that Fed officials do not agree about the end point for their campaign, because they have different views about how much of the damage wrought by the Great Recession, in particular the sharp drop in labor force participation, can still be fixed by encouraging borrowing and other forms of financial risk. As the debate moves, in effect, from picking a neighborhood to picking a house, disagreements are likely to intensify.
“When unemployment was so high and inflation was so low, it was just a debate about how much we should do, and eventually we’ll be in a situation where it won’t be so obvious what we should do,” Mr. Williams said.
He added that Ms. Yellen, who hired him as research director when she was president of the San Francisco Fed, was well suited to the challenge.
“She’s seen as and is a fair person, and she’ll be listening to counterarguments, she’ll be trying to find a consensus, but at the same time she has strong views and a very determined sense of what our purpose is at the Fed and how we can be set to achieve it,” he said. “Her willingness to entertain conflicting views, accept differences of opinion but at the same time say, ‘Here’s where we are coming out at the end of the day,’ that will be her strong suit.”
Adam S. Posen, president of the Peterson Institute for International Economics and a former member of the Bank of England’s monetary policy committee, said that growing divisions would also be a cause for celebration, because they would show the economy was returning to health.
“The only time it should be obvious and you should be seeing unanimous votes is when you’re far away from where you want to be,” Mr. Posen said. When the economy is closer to normal health, “You should expect lots of split votes, if people are really voting their conscience, because you should be close to the right policy and therefore there should be fine judgments.”
By Binyamin Appelbaum
\_/ Article taken from The New York Times, March 18, 2014