To markets hungry for direction from the US Federal Reserve, Fed Chair Janet Yellen offered a sobering dose of uncertainty for monetary policy and the global economy on Friday, suggesting interest rates could rise faster than expected in coming months or just as easily crater back to zero.
In keynote remarks to an annual policy conference in Jackson Hole, Wyoming, the Fed chief spoke of long term risks that could force the Fed into a new world of monetary policy including expanded bond purchases while also seeking to reinforce expectations of a near term rate hike.
More immediately she provided a probability chart of where the Fed funds rate may move in coming months. The chart, distributed with her speech, undercuts the Fed’s own “dot plot” of expected rates by showing the potentially broad range of possible outcomes, from the policy rate spiking above 3.0 percent by the end of 2017 or falling again to zero with a 70 percent probability.
The comments gave little clarity about where the Fed is heading, but instead sent markets a message: pay less attention to the Fed’s quarterly summary of economic projections, the so-called dot plot, as a guide to policy, and more to the flow of economic data.
The Fed has been debating the value of the dot plot, which some officials argue is too narrowly interpreted as a precise forecast of rates which markets then promptly second guess when conditions change.
The “fan chart” of likely interest rates, wide enough to encompass a range of outcomes and market rate predictions, is a change the Fed has discussed as a permanent addition to its quarterly summary of economic projections. Yellen said that level of uncertainty should be taken as a fact of life.
“Our ability to predict how the federal funds rate will evolve over time is quite limited,” Yellen said, explaining the chart that put the expected rate path released by the Fed in June in the middle of a broad set of likely outcomes.
“The reason for the wide range is that the economy is frequently buffeted by shocks and thus rarely evolves as predicted.”
Yellen’s remarks kicked off a three day conference that this year is exploring whether monetary policy needs a fundamental overhaul in light of the 2008 global financial crisis, with papers exploring ideas like how to make it easier for central banks to impose negative interest rates.
For the US, Yellen set aside many of the more adventurous ideas with a broad conclusion that the Fed could fight future crisis with the tools it has at hand, using bond purchases to pump money into the financial system and using forward guidance to commit to keeping rates low.
However she also sketched a future in which much will remain unsettled.
If productivity and economic growth remain low and world savings rates remain high, she said it is conceivable the Fed is never able to raise the policy rate beyond 2.0 percent, leaving the central bank anchored uncomfortably close to zero.
A recession at that point, she said, would mean that “asset purchases and forward guidance might have to be pushed to extremes to compensate.”
In a footnote she referred to recent Fed research indicating that a bad downturn that begins when rates are low could require the Fed to take on another $4 trillion in assets, doubling its current balance sheet.
“Future policymakers could find that they are not adequate to deal with deep and prolonged economic downturns,” Yellen said, and may need to look at some of the more adventurous ideas under discussion. “Future policymakers might choose to consider some additional tools.” (Reporting by Howard Schneider; editing by Clive McKeef)