The Future for Yellen’s Fed by Joey Caffrey

When the time comes for the Fed to take the next step in terms of scaling back its accommodation it will need to figure out not only how to do so but how to communicate doing so.  As Bernanke emphasized in his time as the Chairman of the Fed, communication is key.  Once Janet Yellen and the Fed decide that it is time to further scale back its accommodation they need to make a strong case to the public that it is time to do so.  Assuming that the economy is strong once these discussions start happening, it is important that the Fed use the evidence in a convincing manner to show that the economy will hold up without accommodation.  The market has relied on the Fed’s accommodation for quite some time, and for that reason the Fed needs to be very clear with its communication as to what its plans are for the Fed Funds Rate and other policy tools in the future.  Bernanke adeptly laid out the future of the Fed Funds Rate by setting the unemployment rate threshold, but Yellen will need to begin to give further guidance to the public by hinting what exactly would trigger an increase in the Fed Funds Rate.

            Specifically, the Fed needs to be clear about what it will do with the Fed Funds Rate once the threshold of 6.5% for unemployment is reached.  However, the Fed should continue to be clear that the unemployment rate is just a threshold and not a trigger.  Also, it would be best to wait until the tapering is finished to address the Fed Funds Rate.  This way, the Fed can analyze the effects of the taper and get a good measure on the strength of the economy before moving forward.  Of course the inflation rate is another thing that the Fed needs to be wary of, because although the unemployment situation has been getting better the inflation rate is still lower than its 2% objective.  It would also be wise to make sure the indicators for unemployment do not have any serious underlying caveats before changing the Fed Funds Rate.  Taking into account all the indicators on the economy, the picture will likely become clear quite soon that it is time to remove the highly accommodative policy.  It started with the taper, and the Fed Funds Rate is the next, and likely final, step.

            The economy right now is not quite ready for the talk about whether or not the Fed should start to sell its securities.  Such a contractionary measure would only come once inflation starts to rise more closely towards its target, and if unemployment were to become exceptionally low.  Clearly, the Fed Funds Rate is the next thing on tap for the Fed, and other than that its other tools and strategies should stay just about the same.  Although the communication will now be coming from a different Chairperson, it is still one of the Fed’s most important tools and hopefully Janet Yellen will continue to lay out the path of the Fed’s policy for the public, as Bernanke prided himself on doing.  That being said, the economy is in a good place, this is a good conversation to be having, and hopefully the Fed Funds Rate will return to normal levels at the correct time.