Yellen cautious, but says case for rate hike stronger

August 26, 2016 | Last updated on August 26, 2016
4 min read

The strengthening U.S. economy is near the Fed’s “statutory goals of maximum employment and price stability,” said Fed Chair Janet Yellen in her Jackson Hole, Wyoming speech this morning.

The line that most excited markets was Yellen’s hint at an upcoming rate rise: “In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months,” she notes.

Read: Fed vice-chair hints at 2016 rate hike

On the back of that statement, reports Associated Press, some economists now think conditions are ripe for the Fed to act at its next policy meeting in September. Still, AP adds, other economists say December remains a more likely time for a resumption of rate increases.

That’s because the Fed may need to further prepare investors. According to data from the CME Group on Friday morning, the market’s forecast of a rate hike in September was fluctuating between about 18% and 24% based on immediate reaction to Yellen’s speech—that was within yesterday’s reading of a 21% chance.

Yellen’s tone was cautious as she outlined good and bad economic news. In her speech, Yellen says: “U.S. economic activity continues to expand, led by solid growth in household spending. But business investment remains soft, and subdued foreign demand and the appreciation of the dollar since mid-2014 continue to restrain exports.”

Read: U.S. economy grew at tepid 1.1%

She adds that, “while economic growth has not been rapid, it has been sufficient to generate further improvement in the labor market. Smoothing through the monthly ups and downs, job gains averaged 190,000 per month over the past three months. Although the unemployment rate has remained fairly steady this year (near 5%), broader measures of labor utilization have improved.”

But, Yellen notes, inflation has continued to run below the FOMC’s objective of 2%, “reflecting in part the transitory effects of earlier declines in energy and import prices.”

The future of monetary policy

The focus of Yellen’s speech was on the current state of monetary policy and on how it could be improved. She wonders “whether our existing tools are adequate to respond to future economic downturns […] One lesson from the crisis is that our pre-crisis toolkit was inadequate to address the range of economic circumstances that we faced.”

Read: Yellen’s challenge: Quell fears about monetary policy limits

For example, she finds the Federal Reserve’s monetary policy toolkit was relatively simple prior to the financial crisis, which revealed shortcomings. “The first [issue] was an inability to control the federal funds rate once reserves were no longer relatively scarce. Starting in late 2007, faced with acute financial market distress, the Federal Reserve created programs to keep credit flowing to households and businesses. The loans extended under those programs helped stabilize the financial system. But the additional reserves created by these programs, if left unchecked, would have pushed down the federal funds rate, driving it well below the FOMC’s target.”

To prevent this, the Federal Reserve tried to “sterilize the effect of its liquidity and credit operations on reserves,” she adds. But, “by the fall of 2008, the reserve effects of our liquidity and credit programs threatened to become too large to sterilize via asset sales and other existing tools. [Thus], the quantity of reserves increased to a point that the Federal Reserve had difficulty maintaining effective control over the federal funds rate.”

Looking forward, says Yellen, “we will likely need to retain many of the monetary policy tools that were developed to promote recovery from the crisis. In addition, policymakers inside and outside the Fed may wish at some point to consider additional options to secure a strong and resilient economy.”


Yellen expects forward guidance and asset purchases will remain key components of the Fed’s policy toolkit. But, she says, “These tools are not a panacea,” which is why future policymakers may explore the possibility of purchasing a broader range of assets. Further, says Yellen, “some observers have suggested raising the FOMC’s 2% inflation objective or implementing policy through alternative monetary policy frameworks, such as price-level or nominal GDP targeting.”

Yellen notes the FOMC isn’t actively considering these additional tools and policy frameworks, but they’re being researched.

Additional news

In advance of Yellen’s speech today, Fed members Esther George and Stanley Fischer (and eight other Fed officials) met with about 120 activists from the Campaign for Popular Democracy’s Fed Up coalition, reports AP. The group of policy activists, labour unions and community groups has been lobbying the Fed to keep rates low to allow the economy to strengthen enough to benefit more Americans.

The coalition also wants the Fed and Congress to consider changes in the makeup of the boards of directors of the 12 regional banks to promote diversity.

Read: Higher diversity, higher returns