–Maybe ‘Wide Spectrum’ Maturities Buys if Econ Gets Worse
–Slow Growth Leaves Economy Vulnerable to Downside Shocks

WASHINGTON (MNI) – The following is the second section of excerpts
from the remarks of Federal Reserve Vice Chairman Janet Yellen prepared
Friday for the Annual Meeting of the Financial Management Association
International in Denver:

One potentially promising way to clarify the dependence of policy
on economic conditions would be for the FOMC to frame the forward
guidance in terms of specific numerical thresholds for unemployment and
inflation. Such an approach was discussed by my colleague Charles Evans,
president of the Federal Reserve Bank of Chicago, in a recent speech.5
Evans suggested that the FOMC could indicate its intention to continue
holding the federal funds rate close to zero as long as the unemployment
rate exceeds a given threshold, conditional on the medium-term inflation
outlook remaining at or below a specified level.6 Such an approach could
be helpful in facilitating public understanding of how various possible
shifts in the economic outlook would be likely to affect the anticipated
timing of policy firming. For example, if there were a further downward
revision of the economic outlook, investors would recognize that the
conditions for policy firming would not be reached until a later date
and hence would have a more concrete basis for extending the time period
during which they expect the federal funds rate to remain near zero.

The approach of numerically specifying the values of unemployment
and inflation that could prompt policy tightening is not without
potential pitfalls, however. For example, such thresholds could
potentially be misunderstood as conveying the Committees longer-run
objectives rather than the conditions surrounding the likely onset of
policy firming. Thus, in addition to giving careful consideration to
this particular approach, it seems sensible to explore other potential
enhancements to FOMC communications — a topic to which I will return
shortly.

—

Securities Holdings by the Federal Reserve

The FOMC has also provided monetary accommodation by modifying the
size and composition of the Federal Reserves securities holdings. In
particular, during 2009 and early 2010, the Federal Reserve purchased
about $1.4 trillion in agency mortgagebacked securities (MBS) and agency
debt securities and about $300 billion in longer-term Treasury
securities. Last November, the Committee initiated an additional $600
billion in purchases of longer-term Treasury securities, and those
transactions were completed at the end of June.

At our recent September meeting, the FOMC announced that we intend
to extend the average maturity of our securities holdings over coming
months by selling $400 billion of short-term Treasury securities and
purchasing an equivalent amount of long-term Treasury securities. This
maturity extension program should exert downward pressure on longer-term
interest rates and help make broader financial conditions more
accommodative, thereby supporting a stronger economic recovery. At that
meeting, we also decided that the principal payments from our holdings
of agency securities will now be reinvested in agency MBS rather than in
Treasury securities; this step was taken to support mortgage markets.

Both of these decisions will affect the composition of our
securities holdings without affecting the overall size of the Federal
Reserves balance sheet or the level of reserve balances of depository
institutions. Nonetheless, it is worth noting that the scale of the
maturity extension program is necessarily limited by the amount of our
holdings of shorter-term securities; furthermore, purchasing a very
large proportion of the outstanding stock of longer-term Treasury
securities could potentially have adverse effects on market functioning.
Thus, securities purchases across a wide spectrum of maturities might
become appropriate if evolving economic conditions called for
significantly greater monetary accommodation.

—

Fiscal Policy

It is crucial that the federal budget be put on a sustainable
long-run trajectory, and we should not postpone charting that course. A
failure to put in place a credible plan to address our long-run budget
imbalance would expose the United States to serious economic costs and
risks in the long term and possibly sooner. Timely enactment of a plan
to eliminate future unsustainable budget gaps will make it easier for
individuals and businesses to prepare for and adjust to the changes. In
addition, the sooner our longer- term budget problems are addressed, the
less wrenching the adjustment will have to be and the more control that
policymakers–rather than market forces or international creditors —
will have over the timing, size, and composition of the necessary
adjustments.

At the same time, it is important to recognize that too much fiscal
tightening in the near term could harm the economic recovery.
Significant near-term reductions in federal spending or large increases
in taxes would impose an additional drag on the economy at a time when
aggregate demand is already weak. We need, and I believe we have scope
for, an approach to fiscal policy that puts in place a well-timed and
credible plan to bring deficits down to sustainable levels over the
medium and long terms while also addressing the economys short-term
needs. I do not underestimate the difficulty of crafting a strategy for
our fiscal policy that appropriately balances short-run needs with
long-run considerations, but doing so would provide important benefits
to the U.S. economy.

Conclusion

In summary, the Federal Reserve has taken forceful actions to
promote its objectives of maximum employment and stable prices, and we
strive to communicate as clearly as possible our longer-run objectives
as well as our medium-term outlook and policy strategy. Although U.S.
economic growth was particularly slow during the first half of this
year, I expect that the pace of recovery will pick up over coming
quarters and that unemployment will resume a gradual decline toward its
longer-run sustainable rate; moreover, I anticipate that the medium-term
outlook for inflation will remain subdued. Nonetheless, there are
significant downside risks. Therefore, the FOMC will continue to assess
the economic outlook in light of incoming information, and we are
prepared to employ our tools as appropriate to foster a stronger
economic recovery in a context of price stability.

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** Market News International Washington Bureau: 202-371-2121 **

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