Prescient Yellen saw limits of zero Fed interest rates back in 2009

March 4, 2015

yellen.jpgDespite the Federal Reserve’s trillions of dollars in newly printed money, workers’ wages and overall U.S. inflation have failed to take off since the recession. Longer-term borrowing costs, from 10-year Treasury yields to 30-year home mortgages, have also compressed without any real signs of reversing. While this has perplexed many economists, transcripts of the U.S. central bank’s crisis-fighting meetings in 2009 show that Janet Yellen, then the head of the San Francisco Fed, was prescient in warning colleagues of these very problems.

“The bottom line is that we are faced with a situation in which inflation is undesirably low, and, even with large monthly employment gains, the level of resource slack will remain high for an extended period,” she said at a meeting in December of that year, when unemployment was nearly 10 percent and inflation was near zero. “In my forecast, the zero bound (for the Fed’s key interest rate) and the limits on unconventional policy constrain us from pursuing a more desirable and more expansionary policy for some time to come.”

Yellen, now the Fed Chair, said at the time that monetary theory and the central bank’s own models recommended pushing the federal funds rate into negative territory, rather than the 0-0.25 percent range at which it was and at which it has remained to this day. “We need to remind ourselves of this fact to counteract the very natural instinct to tighten policy as the economy recovers,” she said.

The Fed would end up unleashing not one but three rounds of bond purchases (or QE) in the years ahead, depressing borrowing costs across the economy. In 2013, when then Fed Chairman Ben Bernanke hinted that QE3 could start to be scaled back, market rates jumped – threatening the economy, and forcing the Fed to walk back the comments and delay its plan. According to the 2009 transcripts, New York Fed President William Dudley was already expressing some of the confusion that would haunt the Fed for years:

“Given the large amount of federal borrowing and the imminent wind-up of our large-scale asset-purchase program, I am, frankly, quite surprised that long-term rates have not climbed more sharply,” Dudley said at that December meeting.

And in a comment that foreshadowed the 2013 “taper tantrum,” Yellen said:

“Many market participants expect rates to spike up considerably. And if that happens when the economy is still very weak, and the housing markets remain fragile, I think we may need to resume purchases.”

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