If the Fed`s neutral rate is as low as they estimate or even lower, they will be glad to have their unconventional tools in their toolkit

President Trump will announce the next Fed Chair very soon. This is happening at a time were Mr Trump is planning a new tax reform. At a time were Mr Trump want to spend more money on infrastructure.

Mr Trump attacked Ms Yellen on the campaign trail and accused her for holding the rates too low, but he has halted any criticism of Yellen and the Fed since his inauguration. Now, Mr Trump say he like Ms Yellen and refuse to close down the possibility of reappointing her.

 

Ms Yellens term as a Fed Chair is about to end and the term is up for renewal early next year, but Yellens term as a governor on the Federal Reserve extends until January 2024.

So, if Mr Trump wants to “fire” Ms Yellen as a Fed Chair, she will still stay on the board even is Mr Trump dont want her to win the next term as a Fed Chair.

John Taylor and Jay Powell are among two of the other candidates on Mr Trumps shortlist. Anyway, whats interesting is their policy on interest rates.

Fed Chair Janet Yellen wrote an article about A Challenging Decade and a Question for the Future on the Fed`s own website. Her headline was a key question for the future. As the financial crisis and Great Recession fade into the past and the stance of monetary policy gradually returns to normal, a natural question concerns the possible future role of the unconventional policy tools we deployed after the onset of the crisis, Ms Yellen said.

My colleagues on the FOMC and I belive that, whenever possible, influencing short-term interest rates by targeting the federal funds rate should be our primary tool. As I have already noted, we have a long track record using this tool to pursue our statutory goals. In contrast, we have much more limited experience with using our securities holdings for that purpose.

Where does this assessment leave our unconventional policy tools? I belive their deployment should be considered again if our conventional tool reaches its limit, that is, when the federal funds rate has reached its effective lower bound and the U.S economy still needs further monetary policy accommodation.

Does this mean that it will take another Great Recession for our unconventional tools to be used again? Not necessarily. Recent studies suggest that the neutral level of the federal funds rate appears to be much lower than it was in previous decades.

Indeed, most FOMC participants now assess the longer-run value of the neutral Federal funds rate as only 2-3/4 percent or so, compared with around 4-1/4 percent just a few years ago. With a low neutral federal funds rate, there will typically be less scope for the FOMC to reduce short-term interest rates in response to an economic downturn, raising the possibility that we may need to resort again to enhanced forward rate guidance and asset purchases to provide needed accommodation.

Of course, substantial uncertainty surrounds any estimates of the neutral level of short-term interest rates. In this regard, there is an important asymmetry to consider. If the neutral rate turns out to be significantly higher than we currently estimate, it is less likely that we will have to deploy our unconventional tools again.

In contrast, if the neutral rate is as low as we estimate or even lower, we will be glad to have our unconventional tools in our toolkit.

The bottom line is that we must recognize that our unconventional tools might have to be used again.

If we are indeed living in a low-neutral-rate world, a significantly less severe economic downturn that the Great Recession might be sufficient to drive short-term interest rates back to their effective lower bound.

Ms Yellen concluded with this summary: As a result of the Great Recession, the Federal Reserve has confronted two key challenges over the past several years: One, the FOMC had to provide additional policy accommodation after short-term interest rates reached their effective lower bound; and two, subsequently, as we made progress toward the achievement of our mandate, we had to start scaling back that accommodation in the presence of a vastly expanded Federal Reserve balance sheet.

Ms Yellen highlighted two points about the FOMC`s experience with those challenges. First, the monetary policy tools that the Federal Reserve deployed in the immediate aftermath of the crisis – explicit forward rate guidance, large-scale asset purchases, and the payment of interest on excess reserves have helped us overcome these challenges.

Second, in light of evidence suggesting that the neutral level of short-term interest rates is significantly lower than it was in previous decades, the likelihood that future monetary policymakers will have to confront those two challenges again is uncomfortably high.

For this reason, we must keep our in conventional policy tools ready to be deployed again should short-term interest rates return to their effective lower bound.

things

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Shiny bull. The author has made every effort to ensure accuracy of information provided; however, neither Shiny bull nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Shiny bull and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.

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