Fed chair Janet Yellen told lawmakers this week she was studying
ways to "be prepared" in the event the current slide in world stock
markets, concern about financial sector stress, and slowing economic
growth all translate into a recession or another financial crisis.
But Yellen said the policy tool of negative interest rates, now
favored by some foreign central banks offers no sure bet for the
"We need to consider the U.S. institutional context. They are not
automatic...We previously studied them and decided they would not
work well," Yellen told the U.S. Senate Banking Committee on
Thursday, when asked whether the Fed was "out of ammunition" to
fight a new downturn.
After mistakenly raising interest rates briefly in 2011, the
European Central Bank turned to negative interest rates last year as
a policy tool, and the Bank of Japan followed suit in January in
another bid to avoid deflation and promote economic growth.
Yellen's two days of testimony to the U.S. Congress this week, a
semi-annual appearance mandated by law, brought home the dilemma the
The plan to return to "normal" policy was one Yellen engineered
slowly during her first two years in office, but was delayed until
December last year partly because Fed officials recognized they had
little maneuvering room to fight any fresh downturn.
So far this year U.S. economic data points to continued recovery,
with steady job growth and domestic consumption giving the Fed
reason to stick to the plan for "gradual" interest rate rises this
year, announced on Dec. 16 last year.
Given market concern about slowing Chinese economic growth, slumping
slumping commodity and stock prices recently, Yellen did acknowledge
though that U.S. financial conditions are now much tighter than the
Fed expected when it enacted an almost symbolic quarter point
interest rate hike last year.
The Fed's perceived miscalculation about the length of the oil price
slump, the strength of the U.S. dollar, and the impact of weakening
Chinese economic growth have led markets to doubt that inflation
will return to the Fed's 2.0 percent target.
NO EASY OPTIONS
A return to quantitative easing or bond buying to counter another
recession would face doubts though also. The initial round of U.S.
quantitative easing is thought to have helped battle the financial
crisis when it was launched in Dec. 2008, but even sympathetic
policymakers have questioned how much impact two subsequent rounds
of bond buying had on jobs, investment and economic growth.
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Beyond those tested tools, "the policy options for the Fed are not
great," said Jon Faust, a Johns Hopkins University economics
professor and former adviser to the Fed's Washington-based Board of
Quantitative easing "made a lot of sense" as an effort to prime a
nascent economic recovery, Faust said, "but that is not the same as
turning an economy that is heading down."
With short term U.S. interest rates still so near zero, the standard
monetary policy tool of lowering rates is also unlikely to work.
Other options, such as the direct lending programs used during the
2008 crisis, might stretch the Fed's legal authority.
"There are limits to what monetary policy can do," said John
Cochrane, a senior fellow at the Hoover Institution at Stanford
University. "There is a world market pushing for lower interest
rates that is very hard for the Fed to fight."
It is still too early for the Fed to declare defeat though, said
David Stockton, the Fed's former research director and now a fellow
at the Peterson Institute for International Economics.
The Fed's next monetary policy meeting will be held on March 15-16
when policymakers issue fresh economic forecasts and Yellen holds a
Given the perceived limits on what central banks can now do, and the
political limits on any likely fiscal response to a recession, "we
are going to be in a situation where you are pricing in greater
concern about negative outcomes than the benefits of positive
outcomes," Stockton said.
"We would be entering a much more perilous situation if we suffer an
outright downturn at this point."
(Reporting by Howard Schneider; editing by Clive McKeef)
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