Here’s How the Federal Reserve Is Defending Its Monetary Policies

Speaking at the Federal Reserve’s “A Trans-Atlantic Agenda for Shared Prosperity” conference, vice-chair Janet Yellen explained why she thinks America has found it difficult to recover from the so-called Great Recession and addressed whether the persistence of long-term unemployment is due to structural problems in the labor markets or simply cyclical shortfalls in demand.

She also stated that the Federal Reserve would likely keep the benchmark lending rate near zero, defending the central bank’s aggressive monetary policy. The Federal Open Market Committee announced in December that it would keep the rate near zero as long as inflation was not forecast to increase more than 2.5 percent in one to two quarters and unemployment stays above 6.5 percent.

However, Yellen said in her speech on Monday that those objectives were merely “thresholds for possible action, not triggers that will necessarily prompt an immediate increase” in the FOMC’s target rate. “When one of these thresholds is crossed, action is possible but not assured,” she added…
In its fiscal policy, Federal Reserve bankers have emphasized reviving growth and reducing the 7.9 percent unemployment rate using near-zero interest rates and a bond buyback plan known as quantitative easing.

“With so many people today unable to find work, it might seem odd to highlight such an ambitious and distant goal for employment,” said Yellen. “I do so because the gulf between maximum employment and the very difficult conditions workers face today helps explain the urgency behind the Federal Reserve’s ongoing efforts to strengthen the recovery.”

To explain the central bank’s action, she asserted that the government’s fiscal policy has been more of a headwind than a tailwind in the economic recovery, an argument that highlighted how different this recovery has been compared to those following the 10 recessions the United States has experienced since the end of the Great Depression. Yellen cited the government’s inability to determine a long-term plan to reduce deficits along with its declining stimulus-related spending as detrimental to the country’s return to economic strength…
But while it has been argued that the persistence of long-term unemployment in this recovery is the result of structural problems, Yellen argued that it was due to a cyclical shortfall in aggregate demand. This differentiation has important ramifications for the Fed’s monetary policy; if the current, elevated level of unemployment is indeed cyclical, than the appropriate solution is to “take action to raise aggregate demand.” But if the problem was structural, the current policy could have little impact on unemployment and it would only stoke inflation.

“It is entirely appropriate for progress in attaining maximum employment to take center stage in determining the committee’s policy stance,” Yellen said. The Fed’s asset purchasing and other unconventional policies are meant to shore “up aggregate demand” that will, in turn, boost employment.

The U.S. central bank has a mandate to promote “maximum employment” that dates back to a law passed in 1946. A 1977 law added an additional task for Federal Reserve: to stabilize prices. But this has been a tough job, as the bursting of the housing bubble and the following financial crisis created the deepest and longest-lasting recession since the end of the Second World War.

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