Federal Reserve Chairwoman Janet Yellen will begin answering questions about her plans to keep the nation’s monetary policy tied to the economy’s performance in the post-zero interest rate world when she appears on Capitol Hill Tuesday and Wednesday as part of her semiannual monetary policy report.
Lawmakers, especially Republicans skeptical of Yellen’s loose-money policies, are likely to ask what happens after the Fed decides to raise short-term interest rates from zero, where they have been since the financial crisis in 2008.
The Fed’s target for short-term interest rates influences all other interest rates throughout the economy, including those on mortgages, business loans and savings accounts.
Although the timing of the rate hikes has preoccupied investors and lawmakers in recent months, Yellen and company have clearly signaled that the decision is coming this year, whether it’s in June or later. The more important question then becomes how quickly rates could increase to historical levels.
“Watch for signs of an effort to shift the focus to the expected gradual pace of rate hikes,” University of Oregon economist Tim Duy wrote in his preview of this week’s testimony.
It’s been almost a decade since the Fed’s last rate-increasing cycle, which started in 2004 under Chairman Alan Greenspan. And the monetary policy committee has seen near-complete turnover since then. Only Yellen, then president of the Federal Reserve Bank of San Francisco, and Richmond Fed President Jeffrey Lacker are among the top officials in the Federal Reserve System today.
For her part, Yellen is sticking to the idea that the Fed’s decisions will react to the performance of the economy and inflation.
“Although there is a great deal of market focus on the timing of liftoff, what ought to matter in thinking about the stance of policy is what the entire path of interest rates will look like,” Yellen acknowledged in her last public appearance in December. “And I really don’t have much for you other than to say that they will be data dependent,” she told reporters then.
Whether that answer will be sufficient remains to be seen. At the moment, there is a significant gap between market perceptions and Fed officials’ forecasts for interest rates.
The majority of Fed officials see short-term interest rates rising to above 2 percent by the end of 2016 and to near 4 percent by the end of 2017, according to their projections released in December. Bond market prices, however, suggest that investors don’t believe short-term interest rates will hit 2 percent until late 2017 or early 2018, or that they will rise to 4 percent this decade.
In other words, the market doesn’t believe the Fed plans for the speed at which it will tighten monetary policy.
Neither does Yellen, necessarily. In her year-long tenure as chairwoman, she has cautioned against reading too much into Fed members’ projections for interest rates. Her track record shows that she is acutely aware that different Fed members have different ideas about the strength of the economy and knows that that officials’ projections can be rendered meaningless by future economic data.
Yellen led an effort to turn the Greenspan Fed away from committing to any pre-set plans and toward communicating to investors that it would react to changes in inflation or unemployment.
Yellen rejoined the Fed in 1994 as it began tightening monetary policy as the economy crawled out of the recession of 2001-2002. She had previously been a member of the Fed’s Board of Governors, each of whom has a vote on the committee, in the 1990s.
Greenspan’s Fed had said in official announcements that it would raise rates at a “measured” pace. As it turned out, that would mean that it would raise rates by a quarter of a percentage point for 17 consecutive meetings, until mid-2006.
During that time, Yellen led an effort to remove the “measured” language from monetary policy statements, transcripts from the meetings reveal. She worried that it locked the Fed into rate increases at each meeting, which would undercut the Fed’s ability to respond to economic data that could show things getting better or worse. “It is very important that we continue to communicate our views and what we know about future policy,” she said in March 2005, citing a need to react to economic news in a “less formulaic way.”
Eventually, the “measured” language was dropped in January 2006.
Yellen addressed that episode in December: “We’d probably not like to repeat a sequence in which there was a ‘measured pace’ and 25 basis point moves at every meeting.” Many Fed members, she added, think that “policy should be based on the actual evolution of economic activity and inflation.”
The Fed’s current statement reflects that Yellen and company are contemplating raising rates slowly after the initial hike to provide added support to an economy still struggling with low labor force participation, small wage gains and a tepid housing market.
But she is already worrying about how to make that process dependent on the data, rather than on any specific timeline — especially when each of the 10 voting members of the monetary policy committee might have different ideas on what the timeline might be.
Minutes from the Fed’s January meeting show that Yellen held a special planning meeting to discuss raising rates and what comes after. The Fed’s next meeting is schedule for March 17 and 18.
