Due to a stronger business cycle momentum in the second quarter, Janet Yellen’s answers on monetary policy were expected as important. It was her semi-annual testimony at the Congress (Senate) on July the 15. (see here her report)
An article in the Wall Street Journal yesterday mentioned that some FOMC members were expecting a more rapid increase of interest rate than what was said in the last minutes of the Fed’s meeting. (see here). What was then her position?
Janet Yellen has been cautious. The current recovery is not an incentive for her to change the agenda. She confirmed what has been said during the last FOMC meeting. The economy is stronger but the current scenario is not consistent with a too rapid hike in Fed’s interest rates. Interest rates will remain low for a long time period after the moment where the current program of asset purchases will stop (next October). Even if there is a perceived recovery, the Fed will keep interest rates low to be sure that the US economy trajectory is strong enough. The calendar mentioned at the last meeting was a first rise in 2015 with the fed funds rate close to 1% at the end of 2015. This is still her main scenario.
She also mentioned that if the recovery was stronger than expected, the first rise would be earlier. But at the same time she said that a weaker economic momentum would lead to low-interest rates for a longer period than in the central scenario.
In the Q&A session, she didn’t want to tie her hands with a specific date or a specific mechanism that could constrain her. At a question on a date, she said nothing more than what was said in the FOMC press release of the June meeting. She also mentioned that rules, like Taylor rules, were not appropriate as estimated parameters used in these rules could have changed dramatically during the crisis. She said that using such a rule would have implied higher rates now that what is currently observed. Yellen also mentioned that this would have had a negative impact on the economy. That’s why she is comfortable with her method. She will be able to hike interest rates when she will perceive that it is the good moment to do it.
The uncertainty on the economic scenario that Yellen referred to, can be seen on the chart below. This chart is just the number of new jobs every month in the USA (see more details here)
Since the beginning of the year, 230 000 jobs were created each month on average. It is stronger than what was seen in previous years. Nevertheless, we see that it is 190 000 during the first three months and 272 000 during spring.
The uncertainty is the following: is the rapid increase in spring the result of a new profile for the US economy and in that case it can be a reason for increasing interest rates, or is this rapid increase reflecting a rebound of the economic activity after the negative growth seen during the first quarter (-2.9% for GDP at annual rate (see here for more details))
In other words, if the pace of job creations is 230 000 then the Fed will probably have to change its scenario. But who is sure of that? Clearly not Janet Yellen and that’s why she doesn’t want to commit on the first increase. The economy is going well but it’s not going too rapidly. Jobs’ level in spring was just back to January 2008 level, meaning that the US economy is far from full employment (the labor force has increased by 1.6 million from January 2008 and there are not employed as jobs’ level is just back to January 2008). There are no strong pressures on the labor market, on wages or on capacities. That’s why Janet Yellen remains cautious, she is far from being convinced that the new normal is what was seen on the US labor market in spring.
She is probably right.