U.S. economy still needs ultra-low rates

23. Feb. 2010

SAN DIEGO - The U.S. economy still needs extraordinarily low interest rates, as inflation is "undesirably low" and growth will likely be sluggish for several years, a top Federal Reserve official said Monday.

San Francisco Federal Reserve Bank President Janet Yellen told the University of San Diego's business school that the U.S. economy will likely grow at a pace of about 3.5 percent this year and 4.5 percent next year.

"Even though the recession appears to be over, it does not mean that we are where we want to be. Even with my moderate growth forecast, the economy will be operating well below its potential for several years," Yellen said, according to prepared remarks.

Unemployment, currently at an "unacceptably high" rate of 9.7 percent, will likely only decline to 9.25 percent this year and 8 percent by the end of next year, she said.

The Fed has kept its target interest rate for bank-to-bank overnight lending at near zero since December 2008 to combat the worst financial crisis and economic downturn since the Great Depression. It has also injected more than $1 trillion into the economy.

"Accommodative policy is appropriate, in my view, because the economy is operating well below its potential and inflation is undesirably low," Yellen said. "I believe this is not the time to be removing monetary stimulus."

Speculation on the likely timing of monetary tightening heated up last week after the Fed raised the interest rate it charges for emergency bank loans to 0.75 percent from 0.50 percent. But Fed officials stressed that the move, the first increase in any of the Fed's lending rates since the financial crisis began in 2007, did not amount to monetary tightening.

Yellen said the increase in the discount rate reflected a return to more normal financial conditions, since banks are now better able to tap private markets for borrowing.

When the time does come for monetary tightening, raising the interest rate the Fed pays on reserves will take a "lead role," she said.

Only after economic conditions improve and monetary tightening underway will the Fed possibly sell some of the assets that currently bloat its balance sheet, she said.

But Yellen's speech suggested such moves may be far away. While other Fed officials like Kansas City Fed President Thomas Hoenig have warned the ballooning federal deficit could lead to runaway inflation, Yellen played down such fears.

"There's no evidence that big government deficits cause high inflation in advanced economies with independent central banks, such as the Fed," she said.

In fact, she said, inflation is "already very low and trending downward."

"With slack likely to persist for years and wages barely rising, it seems quite possible that core inflation will move even lower this year and next," she said.

Yellen is not a voting member of the Fed's monetary policy-setting Federal Open Market Committee this year.

Next month the Fed plans to end its $1.25 trillion program to purchase mortgage-related debt, one of the tools it has used to help revive the economy.

With the housing market stabilized but falling far short of revitalization, ending the program could make the housing market weaken again, she said.
[Reuters]