Yellen Fails to Change Fed’s Tune in First Testimony

Earlier today, Janet Yellen gave her first Congressional testimony as chair of the Federal Reserve Board of Governors. Chair Yellen offered no surprises and implied the Fed will mostly remain on its current course of action in the coming months. Her first impression was continuity, not surprise.

With its new leadership, one wonders when the Fed will change its tune on monetary policy. Yellen is considered by many to be the first fiscal dove leading the Federal Reserve. She places primary emphasis on the Fed’s role in promoting job growth. Historically, the Fed’s primary focus has been to control inflation.

Since late 2012, the Fed has been using a 6.5 percent unemployment rate as a target for when it will finally raise short-term interest rates. Given the three most recent jobs reports, in which the unemployment rate fell from 7 percent to 6.6 percent mostly due to labor force dropouts, many wondered if the Fed would take additional criteria into account.

Chair Yellen addressed these concerns in her testimony, saying, “it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the 2 percent goal.” This suggests the Fed will keep rates low even if unemployment falls below 6.5 percent, as long as other indicators show weak job growth. However, it is notable that Yellen resisted simply lowering the threshold to 6 percent unemployment, which some officials have suggested.

If the Fed did choose to take other indicators into account, the U-6 unemployment rate appears to be a likely candidate. Unlike the official unemployment rate, the U-6 rate includes people who are working part-time even though they would prefer full-time work, discouraged workers, and those marginally attached to the labor force. The president of the Boston Federal Reserve bank, Eric Rosengren, has publicly stated his support for utilizing the U-6 unemployment rate.

Perhaps the Fed would be more successful at its dual mandate, growing employment and keeping a stable currency, if it dedicated its policies only to its original purpose: controlling inflation. A strong currency would breed a strong investment climate, and employment growth would likely follow.

It is unlikely the Fed will be able to look abroad for guidance on its future course of action.

The European Union economy is still lagging far behind the U.S. economy, with conditions reminiscent of the United States during the latest recession. The European Union’s unemployment rate is 12 percent, even though the European Central Bank has held its interest rates at a record low of .25 percent for three straight months. Every month since October has seen inflation rates below one percent. The Central Bank’s president, Mario Draghi, has been quick to emphasize that low inflation is not deflation, but has not ruled out increasing the money supply by purchasing private or government securities if deflation occurs.

Japan’s central bank is an even worse model to follow. Despite aggressively expansive monetary policies, the unstable Japanese economy has not shown signs of rebound. Japan, whose economy largely depends on exports, experienced its smallest current account surplus since 1985 (when collection of comparable data began). The surplus was just 3.3 trillion yen, or $32 billion USD. Japan’s government debt of $10 trillion was  a record high in 2013.

Despite their exclusion from January’s Federal Open Market Committee statement, emerging markets made an appearance in Chair Yellen’s testimony. “We have been watching closely the recent volatility in global financial markets. Our sense is that at this stage these developments do not pose a substantial risk to the U.S. economic outlook.” While some expected Yellen to discuss the possibility of working with other central banks, her statement indicates otherwise. It also suggests the financial situation in emerging markets will have little effect on the Fed’s monetary policy.

Regardless of the unemployment rate, it is time for the Fed to abandon the notion it can create jobs by weakening the currency. A monetary institution such as the Federal Reserve can only create a positive environment for job growth. The Fed itself cannot create jobs. Pursuing stable monetary growth through inflation targeting is the best way to create this positive environment. Now, it is up to Chair Yellen.

Jason Russell is a research assistant at Economics21, a center of the Manhattan Institute for Policy Research. You can follow him on Twitter here.