By Steven K. Beckner

LOS ANGELES (MNI) – Janet Yellen, the probable future vice
chairman of the Federal Reserve Board of Governors, sought Tuesday to
counter her reputation as one of the Fed’s leading inflation “doves,”
even while downplaying inflation risks and suggesting there is no urgent
need for the Fed to raise interest rates.

San Francisco Federal Reserve Bank President Yellen, who the White
House has called a leading candidate to succeed retiring Fed Vice
Chairman Donald Kohn, is commonly regarded as a leading “dove” among Fed
policymakers — one who is inclined to err on the side of promoting
economic growth and jobs rather than on the side of curbing inflation.

But she told reporters she is as committed to price stability as
anyone and is prepared to raise rates — or “take away the punch bowl”
as she put it — when the time comes.

But earlier, in a speech to Town Hall Los Angeles, Yellen suggested
that time is far off. She said the Fed should only raise rates when
“recovery takes firm root” and growth “moves toward its potential.” But
while projecting moderate growth of 3 1/2 percent this year, she
predicted the economy will operate “well below its potential for several
years.”

And Yellen said unemployment is apt to “stay high for years.” In
that climate, she said inflation will likely fall, not rise.

She described as “appropriate” the Federal Open Market Committee’s
decision last Tuesday to leave the federal funds rate near zero and to
repeat that it is likely to stay “exceptionally low … for an extended
period.”

Yellen left no doubt she is interested in taking over from Kohn
when he leaves the Fed June 23. She said she is providing the White
House with information it has requested as part of the nomination
process and said she is “open to serving if asked to do so.” She said
she did not know how long the vetting process would take or “whether
that’s realistic” to think she will be able to step in to the job in
late June.

Asked about her “dovish” reputation, Yellen protested good
naturedly.

“I think I am as committed to price stability and the attainment of
price stability as any member of the FOMC,” she said, adding that since
she became a Fed policymaker in 1994, consumer prices have risen 2.0% on
average and that this is “pretty darned close” to the Fed’s implicit
inflation target.

Yellen also noted that she has supported Fed rate hikes on 20
occasions and has never dissented against raising rates. “I haven’t
dissented on monetary policy decisions and have always supported
increases that have occurred,” she said.

If she has a dovish reputation, perhaps it is because she may “seem
less concerned that inflation is about to take off.” But she said her
inflation forecasts have been borne out.

“While I’ve gotten the label of being a dove, I don’t think I’ve
been wrong about my forecast of inflation,” she said. “I hold the view
that slack is important in driving inflation.”

“And I feel that since the mid-’80s the Fed has attained a great
deal of credibility along with other central banks” of caring about
keeping inflation low,” she continued, adding that this “has led to much
(lower) inflation expectations than we had in the 1970s.”

As a result, “the process of inflation has changed in a way that
has made inflation more stable,” she said.

But Yellen said she is “fully aware that to continue to have
inflation expectations stable … we have to be ready to take away the
punch bowl when necessary.”

Asking rhetorically whether she is prepared to support raising
rates and “take the punch bowl away,” she said, “You bet.” She said she
may want to raise rates a few months later than some of her colleagues,
but said that shouldn’t matter a great deal.

Yellen was probed about the meaning of “extended period.” She said
it “absolutely” does not mean that the Fed will wait until the output
gap closes completely before beginning to tighten — unless the country
were to go into deflation, which she said is “not something I expect.”

“If inflation stays subdued, it is not appropriate to wait until
we’re at full employment,” she said. “That would be a recipe to
overshoot full employment and end up with inflation.”

Yellen said she sees the FOMC statement as “not being one that’s in
any way unconditional about time … . It has no particular time
commitment … . It’s conditioned on the prevalence of certain
conditions that were listed and possibly others,” such as low rates
of resource utilization.

“Extended period is not something unconditional,” she said, but is
“deemed to be appropriate based on current economic conditions … and
the conditions we anticipate.”

Asked whether the FOMC’s more upbeat characterization of economic
conditions is a forerunner of a change in the “extended period”
language, Yellen replied that the statement simply reflected that “we do
have an economic recovery … a recovery that’s taking hold.”

The FOMC’s March 16 statement observed that “the labor market is
stabilizing” and that “business spending on equipment and software has
risen significantly.”

Yellen said “those phrases are meant to be descriptive. The labor
market does seem to be stabilizing … . And I have been surprised
personally by some of the strength we’ve seen in spending on equipment
and software.”

At the same time, she said, the statement supports her view that
low rates of resource utilization will keep inflation low and, indeed,
that the inflation trend “may be downward rather than upward … . We
may be moving to lower rates of inflation.”

In her speech, Yellen had said she does not see the need for the
Fed to sell assets when it starts tightening. Echoing that view in her
meeting with reporters, she said there are other ways the Fed can reduce
its balance sheet. Namely, she said, “we’re redeeming maturing mortgage
backed securities” instead of rolling them over.

While the Fed is “currently reinvesting proceeds from Treasuries,”
she said the Fed “could also redeem Treasuries that roll off” and
“could redeem everything in our portfolio rather than roll them over.”

“Given the fragility of the economy and the fact that we’re trying
to pump as much stimulus as we can into the economy, I would not like
that (asset sales) to happen in the near future,” she said, but said
asset sales could be done “eventually” “if we wanted to see some
tightening of monetary policy.”

Yellen emphasized that any asset sales, when they are done, would
likely be “something predictable and gradual at a time when it was
appropriate to see a tightening of monetary policy.”

Yellen noted that the federal funds rate has been trading below the
interest rate on excess reserves (IOER), because the large quantity of
reserves is preventing the IOER from setting a floor under the funds
rate. But she said that when the Fed starts raising the IOER “all rates
will go up.”

“Even if a slightly larger gap develops between the federal funds
rate and the (IOER) develops, that doesn’t mean we haven’t tightened
monetary policy,” she said, adding that the dominant role played by
Fannie Mae and Freddie Mac in the federal funds market and their
inability to earn interest on reserves is causing the funds rate to
trade below target.

Yellen said she and her fellow policymakers are “discussing
potential means to drain reserves, not to shrink our balance sheet, to
help tighten up the relationship between the funds rate and the (IOER).”
She said the Fed will “undoubtedly do more testing” of reverse
repurchase agreements and term deposits.

“It might be better to have a closer relationship” between the
funds rate and the IOER, she said, but she said the IOER may not be able
to set a floor under the funds rate “until we get to a much lower level
of reserves.”

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