A More Confident Yellen

At her press conference, Yellen mirrored the greater confidence reflected in the Committee’s statement.  After all, at the press conference, she is principally speaking for the Committee. The FOMC’s greater confidence has reinforced their view that a process of gradual withdrawal of accommodation is now appropriate, and this move should be interpreted in that context. Nothing else stood out at the press event.  Still, we set out some of the more relevant questions and the Chair’s responses. When the narrative reflects my views, I put it in italics. 

But first, the opening statement. Most importantly, she clarified the discussion on inflation in the statement.  She noted that the 12-month inflation rate for headline PCE rose to nearly 2% in January, up from 1% last summer. But that rise was largely driven by higher energy prices. On the other hand, core inflation, which is a better indicator of future inflation, has been little changed in recent months at 1¾%. But core inflation is expected to move up and overall inflation to stabilize at 2% over the next couple of years. So, in effect, the core will catch up to the headline over this period. 

Now on to the Q&A. 

What’s the message today? Yellen thanked the questioner for serving this one up! 

The message from the rate hike is that the economy is doing well. Although the economy has been doing well for the last couple of years, it is now close to full employment, and there is greater confidence that inflation will move to and stabilize at 2%. Furthermore, growth is projected to remain above trend, so it is time for a gradual withdrawal of accommodation. OK, she didn’t say all of this in her response, but this is what she meant! She did say: “The simple message is the economy’s doing well. We have confidence in  the robustness of the economy and its resilience to shocks.” Put the emphasis on “confidence.” 

What does gradual mean and why is a gradual withdrawal of accommodation called for? 

The three hikes implied by the median dots for this year fit the meaning of gradual, but so would one less or one more. But you can bet that if the Committee gets to the point where it projects five hikes this year,  the word gradual will no longer apply and not be used in FOMC communications. 

Yellen said that the withdrawal of accommodation will be gradual because the neutral rate has declined and remains low—perhaps about 2% in nominal terms. As a consequence, the path from the current range of ¾  to 1 percent to a 2% neutral rate is almost bound to be gradual. The path also will be gradual because the  Committee wants to remain somewhat accommodative to support growth above trend, promoting further improvement in the labor market.

She also noted, however, that she and her colleagues thought that over time the neutral rate will move higher, back toward the Committee’s median estimate of the fund’s rate, in the long run, 3%. That provides a further reason to move in the direction of 2% over the next year or so. She linked the projected rise in the neutral rate to the gradual dissipation of the headwinds that have lowered the neutral rate — which she attributed largely to the increased caution and risk aversion that followed in the wake of the Great  Recession. She noted that sentiment was turning more optimistic. Some have described this as a transition from headwinds to animal spirits. 

Are participants taking prospective fiscal stimulus into account in their macro and funds rate projections?  Furthermore, would the rising interest rates anticipated by participants put the Committee on a collision course with Trump

She said there was no reassessment of the prospects for fiscal stimulus at this meeting, although some members did make an assumption about a fiscal program. In general, Committee members did not have a  firm view about the timing, size, and composition of any fiscal stimulus. There has, as a result, been no discussion of how the Committee would respond. You can be certain that, in the background, the staff is providing the FOMC with plenty of alternative scenarios that incorporate a range of possible fiscal outcomes. She stressed that there was certainly no effort to preemptively respond to speculation about a  fiscal stimulus package. 

She also said she did not see the FOMC as being on a collision course with Trump. He wants faster growth.  She said Committee members would be delighted with faster growth and that of course, the Committee would accommodate that growth—as long as it was faster growth of potential output. But she also noted that the response of monetary policy would depend on the mix of supply and demand-side effects expected from a fiscal package. A carefully constructed response! And she also noted that policy remains accommodative (which Trump should appreciate), which should support continuous improvement in the labor market, a Trump objective. 

What is the message implied by referring to the inflation objective as symmetric? 

The message is that the Committee views an inflation rate below the objective by a given amount equivalently to an inflation rate above the objective by the same amount. More specifically, once inflation returns to 2%, it will, of course, sometimes be above and sometimes below 2%. If the undershoot or overshoot proves to be persistent, then policy would have to move inflation back to its objective. 

Market expectations of a rate hike increased over the course of the last two weeks. What happened over the course of those two weeks to make participants more confident in signaling that there would likely be a  rate hike at today’s meeting? 

In effect, she disputed that something had happened that had caused participants to signal that there would be a rate hike at this meeting. That’s certainly correct: Neither the incoming data nor the updated forecasts issued by the Committee were instrumental to the March hike. Instead, she noted that the sequence of  communications since the December meeting had been “reasonably consistent.” She said. It’s true that the  message was consistent that if developments turned out as the Committee expected, a gradual  withdrawal of accommodation would be warranted, and “fairly soon.” OK, but the markets did not expect a  March hike a couple of weeks ago. Of course, there was a concerted effort to raise market expectations of a rate hike at this meeting. That’s appropriate, as FOMC communications should work to align market expectations with policy intentions. Well done. You should take credit for the success! 

What would be the effect of a border adjustment tax? 

She was ready for this one: “I would say [the effect] is very uncertain, exactly what would happen to the dollar…I think it’s complicated and uncertain.”

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