Yellen to Detail Stab Concerns, Mon Pol Impact in Jackson Hole

By Karen Mracek

     WASHINGTON (MNI) - Just because the topic of Federal Reserve Chair Janet

Yellen's speech in Jackson Hole this week is financial stability doesn't mean it

won't have implications for monetary policy.

     Yellen is the 10 a.m. ET keynote speaker Friday at the Kansas City Fed's

annual economic symposium, the topic of which is "Fostering a Dynamic Global

Economy."

     But while the topic of Yellen's speech usually has more to do with

regulation than rates and could turn off some Fed watchers, there's more than a

few reasons to tune in.

     For starters, Yellen spoke in the same time slot at the conference last

year, and although her speech was on "The Federal Reserve's Monetary Policy

Toolkit: Past, Present and Future," she dedicated time early on in her largely

academic presentation to talk about the current economic conditions and the

outlook. Expect her to do the same this year.

     A more important reason to pay attention, however, is the increasing

concern about financial stability risks and their role in the Fed's monetary

policy setting.

     Several Federal Open Market Committee members have cited financial

conditions easing despite Fed rate increases as a reason to keep pace with their

tightening plans. Fed Vice Chair Stanley Fischer in a recent Financial Times

interview expressed concern about the persistently low level of real long-term

interest rates and the recent rise in equities.

     The growing debate about financial stability was evident in the minutes of

the July FOMC meeting which detailed a discussion about the impact of financial

conditions on the timing of removing policy accommodation.

     While it is largely expected that the Fed will begin to reduce the balance

sheet in September by tapering the amount of securities it reinvests each month,

the FOMC said it will weigh financial stability issues when making this

decision.

     More than just the balance sheet, though, the minutes said a number of

participants "commented that the appropriate pace of normalization of the

federal funds rate would depend on how financial conditions evolved and on the

implications of those developments for the pace of economic activity."

     Financial stability is not officially part of the Fed's dual mandate for

price stability and maximum employment, but it is never far from the discussion

about policy. 

     Among concerns the FOMC has is the downward pressure on longer-term yields

caused by the $4.5 trillion balance sheet, "and how this pressure would diminish

over time as balance sheet normalization proceeded," the minutes said.

     The FOMC is also concerned about "the strength and degree of persistence of

other domestic and global factors that had contributed to the easing of

financial conditions and elevated asset prices," the minutes said.

     Yellen made headlines in July when she told Congress that "Because the

neutral rate is currently quite low by historical standards, the federal funds

rate would not have to rise all that much further to get to a neutral policy

stance."

     However, the next sentence in her testimony was largely overlooked. "But

because we also anticipate that the factors that are currently holding down the

neutral rate will diminish somewhat over time, additional gradual rate hikes are

likely to be appropriate over the next few years to sustain the economic

expansion and return inflation to our 2% goal."

     Just how much the neutral rate of interest "would rise as the economy

continued to expand," was discussed by the FOMC at its July meeting.

     The FOMC noted longer-term real and nominal Treasury yields "remained very

low by historical standards, apparently weighed down by accommodative monetary

policies abroad and possibly by declines in the long-term neutral real interest

rate over recent years."

     A number of participants "pointed to potential concerns about low

longer-term interest rates, including the possibility that inflation

expectations were too low, that yields could rise abruptly, or that low yields

were inducing investors to take on excessive risk in a search for higher

returns," the minutes said.

     Different assessments were expressed, the minutes said, about the

implications of this development for the outlook for aggregate demand and,

consequently, appropriate monetary policy. This seems to be a debate Yellen is

likely to weigh in on in her Jackson Hole remarks.

     One view at the meeting was that easy financial conditions have offset "by

other factors influencing financial markets, and that a tighter monetary policy

than otherwise was warranted," the minutes said.

     The FOMC gets a regular briefing on financial stability at every other

meeting -- when there is not an update to the Summary of Economic Projections

and a press conference by the chair. But July's minutes showed a lengthier

discussion than usual about these financial stability issues.

     While Yellen is likely to articulate her view on the impact of financial

stability on monetary policy, she will likely keep the option of another rate

hike this year on the table, just like New York Fed President William Dudley did

earlier in the month in an Associated Press interview.

     "I think it depends on how the economic forecast evolves," he said. "If it

evolves in line with my expectations, I would expect -- I would be in favor of

doing another rate hike later this year."

     With the balance sheet decision looming at the September meeting, the FOMC

has time before the December meeting to decide if the drop in inflation really

is temporary or if they are dealing with something more permanent, and if

another rate hike this year is appropriate.

--MNI Washington Bureau;tel: +1 202 371-2121; email: karen.mracek@marketnews.com

[TOPICS: MMUFE$,M$U$$$,MT$$$$]