On June 2, Janet Yellen, Vice Chair of the Board of Governors of the Federal Reserve System, gave a speech titled “Assessing Potential Financial Imbalances in an Era of Accomodative Monetary Policy” (pdf)
While I don’t agree with many of her points and assertions, I nonetheless think the topic is very important. As such, here are a few excerpts that I think are notable:
page 1 :
Monetary policy in the United States has been highly accommodative now for a number of years. Since late 2008, the Federal Open Market Committee (FOMC) has kept the target federal funds rate close to zero and has purchased a substantial amount of longer-term Treasury and agency securities. My reading of the evidence is that those securities purchases have proven effective in easing financial conditions, thereby promoting a stronger pace of economic recovery and checking undesirable disinflationary pressures. Moreover, I believe that the current accommodative stance of U.S. monetary policy continues to be appropriate because the unemployment rate remains elevated and inflation is expected to remain subdued over the medium run.
In the aftermath of the crisis, the primary objective of U.S. monetary policy was to promote financial conditions likely to spur spending on goods and services through a number of channels. To this end, the Federal Reserve first lowered the federal funds rate and other rates at the short end of the yield curve and, once the zero lower bound was binding, sought to push down yields at the longer end through large-scale purchases of longer-term Treasury and agency securities. We anticipated that lowering rates on these securities would place downward pressure on a range of private yields as well, in turn supporting home values, equity prices, and other asset prices. After all, this is the primary mechanism through which monetary policy in its conventional form stimulates the economy. But a sustained period of very low and stable yields may incent a phenomenon commonly referred to as “reaching for yield,” in which investors seek higher returns by purchasing assets with greater duration or increased credit risk.
Misaligned asset prices are notoriously difficult to detect in a timely fashion, and no single metric or set of metrics can consistently and reliably identify stretched valuations. Nonetheless, it is clearly worthwhile to track a wide range of metrics and to view them in the context of their historical norms. Current conditions can be evaluated against a baseline of past experience, and then assessed in light of the various institutional and market factors that could conceivably account for deviations from historical ranges. The Federal Reserve tracks a large number of indicators, and I will highlight a few examples. Overall, these indicators do not obviously point to significant excesses or imbalances in the United States.
Therefore, the risk of a rapid and disorderly deleveraging in the event of a swift change in market sentiment seems to be limited at this point.
First, important classes of generally unlevered investors (for example, pension funds) are reportedly finding it difficult in the present low interest rate environment to meet nominal return targets and may be reaching for yield by assuming greater interest-rate and credit risk in their portfolios.
If substantial evidence of financial imbalances on a broader scale were to develop, particularly if accompanied by significant use of leverage, I believe that supervision and regulation should constitute our first line of defense. Indeed, in the wake of the crisis, our supervisory process has been significantly modified to take more explicitly into account possible financial stability implications and effects on the broader economy, a perspective that is frequently described as “macroprudential.” Our concerns now extend beyond the capacity of individual institutions to protect their capital and balance sheets.
The Special Note summarizes my overall thoughts about our economic situation
SPX at 1279.56 as this post is written