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Yellen says QE was effective, rethinking inflation target may be helpful

Former Federal Reserve Chair Janet Yellen thinks the Fed's quantitative easing program was effective in lowering longer-term interest rates, she said Feb. 27, countering a study released last week that questioned that wisdom.

A paper presented at the U.S. Monetary Policy Forum said the Fed's efforts did not push down bond yields as much as previously thought and suggested that large-scale purchases should not be a primary tool of monetary policy.

Yellen said at a Brookings Institution event that an "overwhelming set of studies" shows that the program, which grew the Fed's balance sheet to $4.5 trillion, was effective in lowering longer-term rates. She said academics will continue reviewing QE over the years but noted that it is difficult to capture the full effects, partly because some investors anticipated that the Fed might take on purchases and may have priced in that factor.

Plus, she added, the Fed felt the urge to boost the economy at a time when it had already pushed short-term interest rates near zero.

"I thought it was an all-hands-on-deck type of situation, and we should do everything that we could plausibly think of to try to help," she said.

Yellen was interviewed at the event by her predecessor Ben Bernanke, who led the central bank through efforts to fight the financial crisis. Under Yellen, the Fed began to gradually raise short-term interest rates in December 2015 and more recently got underway in trimming its balance sheet.

Her approach as chair, she said, was similar to Bernanke's — encouraging discussions at the Federal Open Market Committee to try to reach a consensus. She listed as an example the FOMC's decision on how exactly the Fed's gradual balance sheet reductions would function.

In those discussions, Yellen said, Fed officials discussed a wide variety of options until they narrowed the choices down to one. She likened that effort to an interior designer trying to get people to choose the color of a room.

"I would feel my job is to get everybody to see that off-white is not a bad alternative," she said. "And as brilliant as your choice was, maybe you can live with off-white, and it's not so bad, and we can converge on that, and it's going to function just fine."

Asked for her outlook on inflation, Yellen reiterated her stance that she thinks it has been held down by temporary factors, such as a sharp decline in cell phone prices early in 2017 that are still being stripped out of annual inflation readings. Recent inflation data, Yellen said, are "not inconsistent" with her outlook.

Inflation has continually undershot the Fed's 2% target since the central bank made that goal explicit in 2012. At the same time, some economists are beginning to look at what tools the Fed may have during the next recession, worrying that the Fed may have less room to cut interest rates in the future.

Those developments have prompted discussions on whether the Fed needs to rethink its 2% inflation target and its overall monetary policy framework.

Yellen said the "new normal" that some have pointed to, where Fed officials may not be able to cut interest rates as much, poses a serious issue.

"This really is a problem, and it behooves policymakers and researchers more generally to think about: Are there changes we can make to the monetary policy framework that would be helpful in dealing with that?" she said.

Still, she cautioned against a proposal from some to raise the target to a higher number, such as 3% or 4%. Doing so, she said, is a "tricky business," starting with likely concerns from Congress that the switch is inconsistent with the Fed's mandate of keeping prices stable. She said the Fed's 2% target has helped anchor the public's inflation expectations around the target, and moving to a higher goal could throw off that achievement.

Fed officials have also discussed other options such as a nominal GDP target or a price level target, which would let the Fed compensate for past misses in inflation later on. Yellen said those options, including one that Bernanke has laid out, are "worth considering" but would need to be done at a time when the Fed has already achieved its goal.