Fed Chair Yellen July 2017 Testimony Notes

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“the Committee continues to anticipate that the longer-run neutral level of the federal funds rate is likely to remain below levels that prevailed in previous decades.”

“The Committee continues to expect that the evolution of the economy will warrant gradual increases in the federal funds rate over time to achieve and maintain maximum employment and stable prices. That expectation is based on our view that the federal funds rate remains somewhat below its neutral level–that is, the level of the federal funds rate that is neither expansionary nor contractionary and keeps the economy operating on an even keel. Because the neutral rate is currently quite low by historical standards, the federal funds rate would not have to rise all that much further to get to a neutral policy stance. But because we also anticipate that the factors that are currently holding down the neutral rate will diminish somewhat over time, additional gradual rate hikes are likely to be appropriate over the next few years to sustain the economic expansion and return inflation to our 2 percent goal. Even so, the Committee continues to anticipate that the longer-run neutral level of the federal funds rate is likely to remain below levels that prevailed in previous decades.”

Can’t just operate by rules

“In evaluating the stance of monetary policy, the FOMC routinely consults monetary policy rules that connect prescriptions for the policy rate with variables associated with our mandated objectives. However, such prescriptions cannot be applied in a mechanical way; their use requires careful judgments about the choice and measurement of the inputs into these rules, as well as the implications of the many considerations these rules do not take into account. I would like to note the discussion of simple monetary policy rules and their role in the Federal Reserve’s policy process that appears in our current Monetary Policy Report.”

Committee expects to begin reducing the balance sheet this year

“The Committee intends to gradually reduce the Federal Reserve’s securities holdings by decreasing its reinvestment of the principal payments it receives from the securities held in the System Open Market Account. Specifically, such payments will be reinvested only to the extent that they exceed gradually rising caps. Initially, these caps will be set at relatively low levels to limit the volume of securities that private investors will have to absorb. The Committee currently expects that, provided the economy evolves broadly as anticipated, it will likely begin to implement the program this year.”

The Fed stands ready to use all tools if the economic picture deteriorates

“Finally, the Committee affirmed in June that changing the target range for the federal funds rate is our primary means of adjusting the stance of monetary policy. In other words, we do not intend to use the balance sheet as an active tool for monetary policy in normal times. However, the Committee would be prepared to resume reinvestments if a material deterioration in the economic outlook were to warrant a sizable reduction in the federal funds rate. More generally, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.”

Do intend to return to a treasury only portfolio

“CONGRESSIONAL MANDATE? CHAIRMAN YELLEN: THE FOMC, IN ITS PRINCIPLES FOR NORMALIZATION OF MONETARY POLICY HAS CLEARLY INDICATED THAT IT INTENDS TO RETURN, OVER TIME, TO A PRIMARILY TREASURY-ONLY PORTFOLIO AND THAT’S IN ORDER NOT TO INFLUENCE THE ALLOCATION OF CREDIT IN THE ECONOMY.”

Believe that special factors are contributing to weak inflation

“CLOSE TO 2%. WE HAVE SEEN INCREASING STRENGTH IN THE LABOR MARKET. THAT CONTINUES, AND ALTHOUGH THERE ARE LAGS IN THIS PROCESS, I BELIEVE THAT’S SOMETHING THAT OVER TIME WILL PUT UPWARD PRESSURE ON BOTH WAGES AND PRICES. FOR SEVERAL MONTHS RUNNING, WE HAVE SEEN UNUSUALLY LOW INFLATION READINGS. AS I MENTIONED, THERE APPEAR TO BE SOME SPECIAL FACTORS THAT PARTLY ACCOUNT FOR THAT. FOR EXAMPLE, QUALITY ADJUSTED PRICES OF CELL PHONE PLANS PLUNGED SEVERAL MONTHS AGO AND PRESCRIPTION DRUG PRICES ALSO PLUNGED. SO SOME TEMPORARY FACTORS APPEAR TO BE AT WORK. NEVERTHELESS, SO OUR 12-MONTH INFLATION RATES WILL REMAIN LOW UNTIL THOSE FACTORS DROP OUT. BUT I WOULD SAY IT’S PREMATURE TO REACH THE JUDGMENT THAT WE’RE NOT ON THE PATH TO 2% INFLATION OVER THE NEXT COUPLE OF YEARS. AS WE INDICATE IN OUR STATEMENT, IT’S SOMETHING THAT WE’RE WATCHING VERY CLOSELY, CONSIDERING RISKS AROUND THE INFLATION OUTLOOK.”

Do not believe that we should mechanically follow any single simple rule

“THE APPROPRIATE APPLICATION. CHAIRMAN YELLEN: I DO NOT BELIEVE THAT THEY SHOULD MECHANICALLY FOLLOW ANY SINGLE, SIMPLE RULE. POLICY RULES DO EMBODY SOME PRINCIPLES THAT SHOULD INFORM OUR POLICY DECISIONS. WE HAVE, FOR SEVERAL DECADES NOW, LOOK THAT THE RECOMMENDATIONS OF THE TAYLOR RULE AND A NUMBER OF DIFFERENT RULES IN DECIDING ON THE APPROPRIATE STANCE OF POLICY. AS WE TRY TO POINT OUT IN THE REPORT, THERE ARE MANY DIFFERENT RULES. THERE IS NO CLEAR WAY TO DECIDE WHICH ONE IS BETTER THAN OTHERS. THERE IS NO SINGLE RECOMMENDATION THAT COMES OUT OF A RULES-BASED APPROACH AND THE REQUIRED JUDGMENT IN ORDER TO IMPLEMENT MEASURING THINGS LIKE GDP OR OUTPUT GAP, PARTICULARLY THE NEUTRAL LEVEL OF INTEREST RATE, SOMETHING WE HAVE BEEN STRUGGLING WITH, AS HAS THE PROFESSIONAL ECONOMICS COMMUNITY FOR MANY YEARS. >>”

I would say we should begin to normalize the balance sheet relatively soon

“NORMALIZATION UNCHANGED? CHAIRMAN YELLEN: WE HAVE BEEN TRYING TO VERY CAREFULLY LAY OUT OUR PLANS TO NORMALIZE OUR BALANCE SHEET IN A GRADUALLY PRODUCTIVE AWAY. MY COLLEAGUES MADE THE JUDGMENT IN JUNE, WHEN WE LAID OUT THE FINAL DETAILS THAT IF THE ECONOMY CONTINUES TO EVOLVE IN LINE WITH OUR EXPECTATIONS, IT IS SOMETHING WE SHOULD BEGIN TO DO THIS YEAR. TO MY MIND, I WOULD SAY RELATIVELY SOON. THE EXACT TIMING OF THIS, I DO NOT THINK MATTERS A GREAT DEAL. IT IS SOMETHING WE HAVE LONG BEEN PREPARING TO UNDERTAKE. AS I MENTIONED EARLIER, WE ARE WATCHING INFLATION VERY CAREFULLY. I DO BELIEVE THAT PART OF THE WEAKNESSES AND INFLATION REPRESENTS TRANSITORY FACTORS. INFLATION HAS BEEN RUNNING UNDER OUR 2% OBJECTIVE. THERE COULD BE MORE GOING ON THERE. IT IS SOMETHING WE WILL WATCH VERY CAREFULLY. ”

We haven’t seen a large increase in the borrowing base on higher asset prices so we’re all good

“STABILITY? CHAIRMAN YELLEN: IN LOOKING AT ASSET PRICES AND EVALUATIONS, WE TRY NOT TO — ON WHETHER THEY ARE CORRECT OR NOT CORRECT. AS YOU ASKED WHAT THE POTENTIAL SPILLOVERS OR IMPACTS ON FINANCIAL STABILITY COULD BE OF ASSET PRICE WE EVALUATIONS — A VALUATION’S, AS ASSET PRICES HAVE MOVED UP, WE HAVE NOT SEEN A SUBSTANTIAL INCREASE IN BORROWING BASE ON ASSET PRICE MOVEMENTS. WE HAVE A FINANCIAL SYSTEM, A BANKING SYSTEM THAT IS WELL-CAPITALIZED AND STRONG. I BELIEVE IT IS RESILIENT.”

Initial caps will start at $10 B per month in runoffs, ramping to $50 B over the course of a year

“MONTHLY RECEIPT OF PRINCIPLE EXCEEDS A CAP. THE CAP WILL INITIALLY START AT LOW LEVELS, $6 BILLION A MONTH FOR TREASURIES AND $4 BILLION A MONTH FOR MORTGAGE BACKED SECURITIES. AND OVER THE SPACE OF A YEAR WE WILL RAMP THAT UP TO $20 BILLION FOR MORTGAGE BACKED SECURITIES AND $30 BILLION FOR TREASURIES. SO, AFTER A YEAR OF THIS PROCESS RUNNING, THE CAPS WILL REMAIN IN PLACE, BUT ONLY INFREQUENTLY WHEN THEY ARE AND USUALLY LARGE, REDEMPTIONS OF PRINCIPLE THAT TAKE PLACE.”

This process could last through 2022

“WILL ENTAIL OUR SUPPLYING TO THE BANKING SYSTEM. WE EXPECT IT TO BE SUBSTANTIALLY LARGER THAN PRE-CRISIS, BUT SUBSTANTIALLY LESS THAN WE HAVE NOW. AND I WOULD SAY THIS PROCESS WILL PLAY OUT PROBABLY TO AROUND 2022, WHEN OUR BALANCE SHEET WILL PROBABLY BE SHRINKING TO NORMAL LEVELS. NOW, CURRENCY SINCE THE CRISIS, CURRENCY HAS MORE THAN DOUBLED IN QUANTITY FROM ABOUT $700 BILLION TO $1.5 TRILLION NOW. OUR BALANCE SHEET WILL END UP SUBSTANTIALLY LARGER THAN IT WAS BEFORE THE CRISIS, BUT APPRECIABLY LOWER THAN IT IS NOW. AND THEN OVER TIME WHEN THIS PROCESS IS COMPLETE, IF CURRENCY AND CIRCULATION CONTINUES TO GROW, A BALANCE SHEET WOULD LIKELY GROW IN LINE WITH THE OVERALL ECONOMY. >> YOU PROBABLY SAW THE”

Technological change is disruptive

“CHAIR YELLEN: TECHNOLOGICAL CHANGE HAS BEEN A GYM AND IS — HAS BEEN A CHAIRMAN TO SLEEP IMPORTANT SOURCE OF GROWTH OF LIVING STANDARDS IN THE UNITED STATES AND AROUND THE WORLD. IT IS SOMETHING THAT WE SHOULD WANT TO SEE AND FOSTER, BUT IT IS DISRUPTIVE, AND IT CAN CAUSE CONSIDERABLE HARM TO GROUPS OF LIVELIHOOD — WHOSE LIVELIHOOD IS DISRUPTED BY TECHNOLOGICAL CHANGE THAT RENDERS THEIR SKILLS LESS VALUABLE. I WOULD EXPECT THE KIND OF TECHNOLOGICAL CHANGES THAT YOU DESCRIBE WILL CONTINUE TO CHANGE THE NATURE OF WORK, THE KINDS OF JOBS THAT WILL BE AVAILABLE AND THE SKILLS THAT WILL BE NEEDED TO FILL THOSE JOBS. TO MY MIND, VERY IMPORTANT FOCUS FOR ALL OF US SHOULD BE — QUEST WHAT SHOULD BE THE THREE THINKS WE SHOULD — >> WAS TO BE THE THREE”

Even though valuations are towards the top end of their historical ranges, we view risks as moderate

“MACRO ECONOMY RIGHT NOW? CHAIR YELLEN: VALUATIONS GENERALLY ARE TOWARD THE TOP OF THEIR HISTORICAL RANGES. WHAT I TRIED TO THINK ABOUT IS IF THERE ARE ADJUSTMENTS IN ASSET PRICES, WHAT CONSEQUENCES WITH A HAVE ON OUR FINANCIAL SYSTEM? IN THAT CONTEXT, LOOK FOR EVIDENCE THAT SEARCHING ASSET PRICES MIGHT BE LEADING TO BORROWING BUILT UP IN LEVERAGING THE ECONOMY THAT WOULD BE DANGEROUS IF THE PRICES WERE TO UNWIND. WE ARE NOT SEEING THAT, SO WE JUDGE FINANCIAL STABILITY RISKS AT THIS POINT IS MODERATE”