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Abu Dhabi, UAEMonday 17 December 2018

Yellen defends legacy as Trump ponders next Fed chair selection 

New chair will begin duties in February, Yellen among those shortlisted

Federal Reserve chairman Janet Yellen has defended the use of quantitative easing, a tactic opposed by Republicans. Susan Walsh / AFP
Federal Reserve chairman Janet Yellen has defended the use of quantitative easing, a tactic opposed by Republicans. Susan Walsh / AFP

The Federal Reserve chairman Janet Yellen defended the central bank’s use of unconventional and often unpopular monetary policy tools after the Great Recession, highlighting some of her achievements at the helm as the USresident Donald Trump weighs her reappointment.

“The US economy is much stronger today than it would have been without the unconventional monetary policy tools deployed by the Federal Reserve in response to the Great Recession,” Ms Yellen said in Washington.

Ms Yellen, on a shortlist of potential Fed chairs being reviewed by Mr Trump, made the case for preserving policymakers’ ability to confront the next recession with more bond purchases, a strategy known as quantitative easing aimed at lowering borrowing rates.

“While I believe that influencing short-term interest rates should continue to be our primary monetary policy lever in normal times, our unconventional policy tools will likely be needed again should some future economic downturn drive short-term interest rates back to their effective lower bound,” she said.

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Ms Yellen and her predecessor Ben Bernanke were heavily criticised by Republicans in Congress for bloating the Fed’s balance sheet with US$3.5 trillion in Treasuries and mortgage-backed securities. They often claimed the effort only served to encourage government deficit spending and risk-taking by investors.

The Fed began shrinking that balance sheet this month.

“One should recognise that the recovery could have been much slower in the absence of our unconventional tools,” Ms Yellen said. She said evidence “strongly suggests” that bond purchases helped spur economic activity and lower unemployment.

If the Fed does consider bond purchases again, it is unclear whether Ms Yellen will have any role. Her four-year term as chairman is set to expire in February.

Mr Trump said on Friday he was considering Ms Yellen along with the Fed governor Jerome Powell, Stanford University professor John Taylor and “a couple of others”.

“Most people are saying it’s down to two - Mr Taylor and Mr Powell,” Mr Trump said in an interview with Fox Business to be broadcast on Sunday and Monday. “I also met with Janet Yellen, who I like a lot, I really like her a lot,” he said. “So I have three people that I’m looking at, and there are a couple of others. I’d say I will make my decision very shortly.”

Mr Taylor has questioned bond-buying. If rates were to return to zero, he has suggested it would be sufficient to rely on public assurances by the Fed to hold rock-bottom rates for an extended period of time — a communications strategy known as forward guidance — to help bring long-term borrowing costs down.

Amid the drama surrounding the Fed chair selection, officials are still struggling to understand contradictory economic data and what that should mean for monetary policy.

The Federal Open Market Committee hiked rates in March and June, primarily spurred by the expectation that robust job gains would eventually raise wages and inflation. Surprisingly low inflation in recent months, however, has caused several policymakers to waiver in their resolve to move again in December.

Unemployment fell to 4.2 per cent in September, its lowest level in more than 16 years. Despite that, the Fed’s favourite measure of inflation languished at 1.4 per cent in the 12 months through August, well below the central bank’s 2 per cent target.

Ms Yellen has called this a “mystery,” but has signalled her desire to continue raising rates gradually. Investors see the probability of a December hike at about 80 per cent, according to pricing in federal funds futures contracts.

Noting that the economy is operating near maximum employment and inflation is expected to rise to 2 per cent over the next couple of years, Ms Yellen said on Friday the US economy has made “great strides.”

Mr Trump is pushing Congress to overhaul the US tax code. Ms Yellen declined to comment directly on measures being debated on Capitol Hill and said the response of the central bank to fiscal stimulus would depend on the nature of the tax package that is put into effect.

She said that given low US potential growth and tepid productivity, “my personal hope is that whatever Congress passes will be a package that is rich in incentive-effects on the supply side that would boost capital formation and spur productivity growth”.