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Yellen fighting for job growth doesn't give ground on inflation

Craig Torres

Published: Wednesday, Oct. 9 2013 10:11 a.m. MDT

Price increases decelerated to a 1.2 percent 12-month pace in August from 1.3 percent the previous month and have been half a percentage point or more below the Fed's 2 percent goal since November. The August unemployment rate of 7.3 percent compares with the 5.2 percent to 5.8 percent rate that the Fed views as representing efficient labor resource use.

For now, Yellen is likely to continue using the same tools that Bernanke wielded — and she helped design — to achieve the dual mandate, possibly with a different view on how long to continue them, said Antulio Bomfim, senior managing director in Washington with Macroeconomic Advisers.

U.S. central bankers in December increased their bond purchases to an $85 billion monthly pace while tying changes in the benchmark lending rate to thresholds for unemployment and inflation. The Fed said it will keep the federal funds rate, the overnight lending rate between banks, in a range of zero to 0.25 percent so long as unemployment is above 6.5 percent and inflation is forecast to be no higher than 2.5 percent.

Yellen was involved in developing the thresholds, and pushed for having the Federal Open Market Committee commit to an inflation target before the panel adopted these as policy guidelines.

The FOMC in January 2012 said for the first time its target for prices was a 2 percent annual increase. Yellen led the subcommittee that built consensus around the goal and stood behind a phrase in the panel's policy goals document that said anchoring the public's views on inflation "enhances the committee's ability to promote maximum employment in the face of significant economic disturbances."

In Wall Street parlance, Yellen is viewed as a "dove," or a policymaker who is more permissive on inflation and tilted toward boosting employment. Michael Feroli, chief U.S. economist for JPMorgan Chase & Co., placed Yellen at that end of the FOMC's policy spectrum, along with Fed presidents Charles Evans of Chicago, Eric Rosengren of Boston, and Narayana Kocherlakota of Minnesota. Economists who have worked with her, though, say she would follow a balanced approach and would be an aggressive defender of the 2 percent goal.

She doesn't support Blanchard's suggestion, in a 2010 paper with two other IMF economists, that a 4 percent inflation target might provide a better buffer against deflation and give policy makers more flexibility to lower the federal funds rate. The rate typically is higher than the inflation rate. So, with 4 percent inflation, the benchmark might be 6 percent, giving policy makers more room to cut before hitting zero.

The idea hasn't died. Laurence Ball, an economist at Johns Hopkins University in Baltimore, wrote a paper in April titled "The Case for Four Percent Inflation."

At the same time, Yellen may be less worried than some of her fellow FOMC participants about the cost of further expanding the Fed's $3.75 trillion balance sheet. In a March speech, she listed four potential risks a rising balance sheet might entail: It could impair market functioning, create difficulty in removing stimulus, lead to balance-sheet losses when assets are sold, and pose risks to financial stability, such as inflating asset bubbles or driving investors into high-yield investments of lower credit quality. She dismissed all of them.

"She seems to have higher tolerance than Bernanke in terms of quantitative easing, likely seeing a more favorable cost- benefit tradeoff," said Bomfim, a former Fed Board economist. "But less concerned doesn't mean not concerned," he added.

Yellen did add an asterisk to one of the risks.

"Financial stability concerns, to my mind, are the most important potential cost associated with the current stance of monetary policy," she told the National Association for Business Economics in Washington March 4.

Yellen now has a staff designated to watch for financial risk. The Office of Financial Stability Policy and Research, which Bernanke established in 2010, reports to the vice chairman.

On the effectiveness of the asset purchases, Yellen said in the March 4 speech there is "considerable evidence" that the purchases, by keeping longer-term rates low, "have presumably increased interest-sensitive spending."

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