An interest rate cut to 0.25% from 0.5% will stoke lending and spending less than a reduction to 2.75% from 3%. As borrowing costs approach zero, there just isn’t as much demand: households and companies with the means to borrow and spend will have done so at already historically low rates of interest. When Prime Minister Justin Trudeau says he thinks monetary policy has reached its limits, this is what he means.
But let’s not retire the central bankers just yet. They retain great influence over short-term sentiment in financial markets, which for better or worse retain great influence over consumer and business confidence. A few well-chosen words can chase away dark clouds in an instant, as U.S. Federal Reserve Chair Janet Yellen proved again on March 29.
She used a speech at the Economic Club of New York to state clearly that she is in no hurry to raise interest rates after doing so for the first time since before the financial crisis in December. While the Fed is inclined to lift borrowing costs gradually over the next few years, “this forecast is not a plan set in stone that will be carried out regardless of economic developments,” Yellen said. The Fed’s italics, not mine. Yellen went on to say that, “monetary policy will, as always, respond to the economy’s twists and turns so as to promote, as best as we can in an uncertain economic environment, the employment and inflation goals assigned to us by the Congress.” Equity markets around the world rose. The risk of the U.S. central bank prematurely depressing economic growth with higher interest rates receded the moment Yellen uttered those words.
Some will be annoyed by Yellen’s remarks. There is a lively debate about whether the Fed is ignoring clear signs of inflation. John Williams, the president of the San Francisco Fed, told Market News International last week that he was open to increasing the benchmark interest rate in April or June. A few of his colleagues expressed similar sentiments, creating doubts about about the Wall Street consensus that the Fed was inclined to leave borrowing costs unchanged until later in the year. But one must be careful with the comments of officials outside of the Fed’s inner circle of Yellen; her top deputy in Washington, Stanley Fischer; and William Dudley, the president of the Federal Reserve Bank of New York. There are currently 17 members of the Federal Open Market Committee—but only 10 actually vote on policy. Unlike the Bank of England, where the governor in the past has been out-voted, the Fed has a tradition of forming a consensus around the views of the chair. Rarely are there more than a handful of dissents. The noise from regional Fed presidents often is informative, but the signal always will come from Yellen.
Craig Torres, a senior economics reporter at Bloomberg News in Washington and one of the most reliable Fed watchers among mainstream journalists, described Yellen’s speech as a show of force by the Fed chair. If there was confusion over the Fed’s intentions, there isn’t now. Yellen said there are too many uncertainties currently to commit fully to higher interest rates. As Torres noted, Yellen will be watching many indicators, some more abstract than hiring and prices. The Fed will be looking for signs of economic stability in the U.S.’s biggest trading partners. A stronger dollar would argue against an interest-rate increase, as it would depress inflation and hurt exports. Commodity prices must stabilize, as financial markets overall seem geared to oil, and the Fed thinks housing should be contributing more to gross domestic product. Finally, Yellen said she is wary the signal being sent by inflation figures and will be watching closely.
“I continue to strongly believe that monetary policy is most effective when the FOMC is forthcoming in addressing economic and financial developments such as those I have discussed in these remarks, and when we speak clearly about how such developments may affect the outlook and the expected path of policy,” Yellen said in conclusion. “I have done my best to do so today, in the time you have kindly granted me.”
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