Federal Reserve Chairwoman Janet Yellen made a rookie mistake at her first press conference last week: She gave a clear, honest and reasonably informative answer when asked about the Fed’s likely policy course next year.
This is not the sort of slip that her two immediate predecessors were prone to make. The famously opaque Alan Greenspan once attached a black-box label to his comments: “I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.” Ben Bernanke, who followed Greenspan and preceded Yellen, tried to run a more open and communicative Fed, but he was generally careful to leave plenty of wiggle room for future changes in policy direction.
In what some considered a faux pas, Yellen gave answers to press questions last week that were, for the most part, more elaborate and specific than Bernanke was inclined to give. “The more experienced Bernanke knew to avoid clarifying deliberately vague statement language,” noted Michael Feroli, chief U.S. economist at JPMorgan Chase, according to Bloomberg Businessweek.
The markets interpreted these remarks, probably correctly, to mean that not only is the Fed’s quantitative easing program on schedule to end in the near future, probably by the end of this year, but that the era of near-zero interest rates that began with the crash of 2008 may pass into history as early as next year. The stock market took a moderate hit as a result.
The answer that arguably caused the most angst was Yellen’s elaboration on what the Fed governors meant by “a considerable time” between the end of quantitative easing and allowing interest rates to rise. Though she said it was “hard to define,” she did throw out a figure: around six months. This made it seem that Yellen, on purpose or otherwise, had moved the potential date of rising interest rates from late 2015 to early 2015, assuming QE ends around October of this year as expected, though she did caution that any future decision on rates would depend on economic conditions at the time.
If this was a mistake, though, it was a relatively minor one, and we can give her a pass. It is refreshing to have a central banker tell us what she actually thinks, and I believe the markets could get used to such honesty if given a chance.
As for the actual policy change Yellen was discussing, the timing is less important than the overall message. Whether it happens in early 2015, late 2015 or 2016, we can only get back to normal by encouraging normal economic conditions, not through a semi-permanent state of abnormally low interest rates. The American economy remains stuck in an odd environment in which borrowing costs are at rock bottom, but neither businesses nor consumers are in a mood to borrow because they don’t see a prospect of decent economic or wage growth.
I have written before about the reasons American consumers are unlikely to return to free-spending habits any time soon. As I observed a couple of years ago, one of them is that banks are hesitant to make loans due to newly aggressive laws and regulation and the risks of making any loans that could be considered exploitative or unsound. This has led to a strange state of affairs where borrowing money should be incredibly cheap, but yet it is hard for many individuals and small businesses to borrow any money at all.
Paradoxically, raising the rates that customers can get on bank deposits will actually encourage banks to make more loans more aggressively, which should in turn foster business expansion as long as credit standards don’t get too lax.
I wouldn’t worry about the stock market’s short-term dips as the prospect of moderately higher rates draws closer. Super-easy money has been described as a narcotic, and the market’s sweats are just a withdrawal symptom. Nor does the Fed show any signs of forcing the economy to quit cold turkey. The Fed indicated that rates will stay under what the institution considers normal – about 4 percent – for the foreseeable future, even as they rise.
In the end, a healthy economy relies on healthy saving and investment. To get them, we have to stop picking savers’ pockets to provide illusory benefits to borrowers.