On Tuesday, Janet Yellen set course for steady bond-buy cuts. The Federal Reserve plans to keep winding down bond buying unless the economy takes another decline. Ms. Yellen believes that some recent economic data has been soft, in that she thinks the drop in labor-force participation is more structural than cyclical. Her reasoning behind this is that many baby-boomers have reached their time to retire, so we can expect a large proportion of Americans to be retiring at the same time.
Ms. Yellen served on the committee that helped formulate the current bond buying/tapering strategy, so she strongly supports this strategy. Before being sworn in last week, she had been the Fed’s vice chairwoman for more than three years. In her position as vice chairwoman, she pushed aggressively for the Fed to adopt easy-money policies and encouraged borrowing, spending, investment, and hiring. However, she suggested through her comments that she plans to gradually move away from these policies as the economy improves.
Later in her speech, Yellen articulated that she anticipates economic activity and employment to expand at a moderate rate this year and next. She anticipates the unemployment rate to continue to decline toward its longer run sustainable level and inflation will move back toward 2 percent over the coming years. Touching again on the drop in labor force, Ms. Yellen suggested that we use more than the unemployment rate when evaluating the current state of the United States labor market because those out of a job for more than the past six months make up an unusually large fraction of the unemployed. More factors contributing to the current unemployment rate are the high rate of adults working part time who want full-time jobs and also the number of Americans who lack the confidence to leave their jobs. (see below)
Moreover, Yellen also spoke about the Fed’s internal debate over how much weight to put on the unemployment rate as it drops. In December, they said they wouldn’t raise short-term interest rates from near zero until unemployment fell to 6.5%. It fell to 6.6% in January…
In my opinion, I believe that the slowdown in bond purchasing is great. However, I do believe that we will face problems once inflation levels fall short of the Fed’s 2% target. This scenario relates back to the discussion that we had last class, where some inflation is always necessary in order to get leeway on the zero lower bound. With the unemployment rate quickly approaching the 6.5% threshold, it will be interesting to see how the Fed will react.