Janet Yellen may be done with her two-day testimony before Congress, but she remains very much in the hot seat. As the Fed winds down its bond-buying stimulus program, set to end in October, and with inflation edging higher, economists, investors and other Fed watchers will focus ever more intently on just when and how the central bank will begin to raise interest rates.
Yellen, in her testimony, burnished her dovish credentials by suggesting the Fed still has more work to do before it turns to tightening. Yellen sounded notes of cautious optimism about the economy, and she acknowledged that inflation had climbed toward the Fed’s 2 percent target rate. But she also argued that the economic recovery still has a way to go and that “significant slack remains in labor markets,” as evidenced by stagnant growth in wages. “Too many Americans remain unemployed, inflation remains below our longer-run objective, and not all of the necessary financial reform initiatives have been completed,” she said in her prepared remarks.
At the same time, Yellen sought to assure lawmakers, and the markets, that the Fed is prepared to respond as needed "if the labor market continues to improve more quickly than anticipated." And she noted that Federal Open Market Committee members see the risks to their forecasts as "nearly balanced" — but warranting monitoring in the months ahead. Ian Shepherdson, chief economist at Pantheon Macroeconomics, wrote that those fairly trivial statements might have been included in Yellen's remarks as hints that the Fed may be starting to look closely at the the risks of rising inflation. Critics worried about the those risks and the disruptive market effects of the Fed’s ultra-low interest rates, including some of Yellen’s fellow Federal Reserve officials, have been arguing that the Fed should act sooner rather than later. Otherwise, the Fed could be inflating bubbles that could threaten to again destroy the economic stability and improvement the monetary policy-makers want to achieve.
It’s a debate that has been going on for many months, and is likely to continue for many more. But here’s a good way to think about the issues, via Jack Ablin, chief investment officer of BMO Private Bank in Chicago. In a note to clients of Thursday, Ablin neatly encapsulated — and vividly dramatized — the predicament Yellen and her central bank colleagues now face in trying to stoke the economy and the job market:
“Picture yourself alone in the wintry woods and the weather is touch-and-go. You have two matches, a pile of semi-dry kindling, some firewood and a canteen of water. There you are, deep in the forest, trying to build a fire in a bad situation, with a clear dilemma: If the fire grows too large, you run the risk of an uncontainable blaze. Then again, if the fire dies, so do you. What would you do? If the fire doesn’t start, freezing to death is the result. So you go with the big blaze, hoping the canteen of water will help you contain any errant flames.”
The risks may now be somewhat more balanced than they had been, but Yellen and those who agree with her still see far more reason to be patient and wait for further gains in the labor market — and for proof that the recent economic gains are not just another “false dawn.” “If it tightens monetary policy too soon and the economy falters, the central bank has very little experience and few tools to prevent a deep freeze,” Ablin wrote.
Yellen, already on the hot seat, wants to make sure the flames don’t die down.
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