Tags: Fed | Yellen | monetary | policy

Fed Chair Yellen Speaks at IMF — Part I

By    |   Tuesday, 08 July 2014 07:38 AM

Federal Reserve Chair Janet Yellen appeared at the International Monetary Fund (IMF) in Washington July 2 and made remarks on monetary policy and financial stability in the form of the inaugural Michel Camdessus Central Banking Lecture, named for the former governor of the Bank of France who later served 13 years as managing director of the IMF. Afterward she sat for an interview with IMF Managing Director Christine Lagarde, covered in the next article.

The financial press identified this as a significant speech, and it deserves attention so that readers can attempt to discern its meaning as of the current time and perhaps reconsider it in light of subsequent events, such as another episode in the ongoing, permanent financial crisis.

As this is written, Wall Street is celebrating a "strong" jobs number of 288,000 new jobs created and the headline unemployment rate is down to 6.1 percent, although many commentators prefer other indicators of the condition of the job market, and Yellen herself has said previously that she plans to look at an array of indicators, especially as the Fed gets closer to deciding when to increase the federal funds rate, which Yellen has said will remain near zero even after the Fed presumably finishes the gradual withdrawal of quantitative easing. Traders seemed unconcerned about holding positions with the markets closed for the long holiday weekend, secure in the knowledge that Yellen and Treasury Secretary Jack Lew have their backs.

Yellen declared that the Fed has "devoted substantially increased resources to monitoring financial stability and refocused our regulatory and supervisory efforts to limit the buildup of systemic risk." This begs the questions of whether the Fed has the ability to conduct these efforts effectively and whether the Fed's own actions, such as the flooding of financial markets with liquidity over an extended period of time, don't themselves contribute to systemic risk.

The theme of the speech was that monetary policy's effects on financial stability are not well understood, and Yellen believes that adjustments in interest rates can increase the volatility of interest rates and employment indicators. Therefore, "macroprudential supervision and regulation needs to play the primary role." Macroprudential is a fancy word the Fed seems to have developed in the wake of the 2008 crisis to explain that they didn't pay enough attention to the condition of the financial system as a whole, in addition to the fact that the banking regulators didn't pay enough attention to the supervision of "too big to fail" banks and holding companies.

She proposed to distinguish between tools designed to improve the resilience of the financial system, such as capital, and those that are supposed to curb excesses in financial markets.

Yellen candidly recognized that low interest rates create an incentive for market participants to take more risk by reaching for yield. She might have added that this is especially true when those speculators come to believe that what was formerly the "Greenspan put," then the "Bernanke put," is now referred to as the "Yellen put," shorthand for the assumption that the Fed stands behind the traders, who have shown relatively little interest in buying actual puts as protection.

According to Yellen, three principles should guide the interaction between monetary policy and macroprudential regulation and supervision: 1) completing the implementation of Basel III and domestic capital requirements; 2) careful monitoring of conditions in the financial markets and sometimes employing monetary tools to curb excesses; and 3) clear and consistent communication on how the Fed's assessment of financial conditions is influencing its monetary policy.

She concluded that despite some evidence that lenders are "reaching for yield," there is no need for the Fed to use monetary policy to counteract this potentially risky behavior.

(Archived video and an official transcript can be found here.)

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Federal Reserve Chair Janet Yellen appeared at the International Monetary Fund (IMF) in Washington July 2 and made remarks on monetary policy and financial stability in the form of the inaugural Michel Camdessus Central Banking Lecture.
Fed, Yellen, monetary, policy
Tuesday, 08 July 2014 07:38 AM
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