Being Impressed by Janet Yellen

L: Dr. Janet Yellen is the Chair of the Board of Governors of the Federal Reserve System. She spoke on Tuesday at the National Association for Business Economics Annual Meeting (in Cleveland!). I was there. She was wonderful.

As is required of all members of the Federal Open Market Committee (which is led by Dr. Yellen), she read her speech. They do that to make sure that the words they are using are the ones they INTEND to be using. The media and market and economic analysts parse the words of these folks so thoroughly that word choice is extraordinarily important. That being said, she was wonderful. Her reading was cadenced and lively.

Her message was clear to me, though apparently even carefully delivered wording can be understood differently by different audiences. I heard her say that the Fed (actually meaning the FOMC) would prefer to be raising the Federal Funds rate gradually right now so they would have some room between the "current" rate and zero to cut them when the next recession arrives. Others were not so sure that's what she meant.

As an FYI, the FOMC raises rates to reduce the rate of growth of the money supply to choke off rising inflation. When a recession appears to be imminent, they reduce the Federal Funds rate to raise the growth rate of the money supply and allow faster credit growth and thus more economic growth. Historically, they usually miss the "imminent" signal and continue raising rates until they create an inverted Treasury yield curve that lasts four months or longer, which actually helps cause the recession by reducing the money supply too much. THEN they start cutting rates with a vengeance.

Ideally, economic indicators would all be signaling the same thing: either the economy is growing fast enough to induce inflation and therefore should lead to an increase in interest rates OR the economy is not growing fast enough (or not growing) and interest rates should be lowered. However, economic indicators these days are not all that obvious. So, Dr. Yellen's main message was that the uncertainty in the system leads to constant decision-making (watch the indicators as they get reported and make a decision using those data) so that no one really knows exactly when the next rate increase will occur and how frequently other increases will follow.

Jim's forecast has generally been that the Federal Funds rate would be raised 25 basis points every other meeting of the FOMC because he believes the economy can take the raises without ill effects and the interest rates need to rise for the same reason Dr. Yellen described. Today, market participants are reporting a 67% chance that the Fed Funds rate will be raised by 25 basis points at the December FOMC meeting and Jim agrees with that. Guess we'll see.