Fed Chair Yellen's Legacy Case Study

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Fed Chair Yellen Begins Fight to Save Her Legacy
During 2016, I have emphasised how difficult it would be for the Fed to wean the US economy off near zero percent interest rates. This is partly due to the globalisation of financial markets and that overseas economies are in no shape whatsoever to withstand higher interest rates. Meanwhile, in recent weeks, it has become increasingly evident that Fed Chair Yellen is keen to avoid her legacy being judged as a disappointment via her inability to raise the federal funds rate. She has duly taken note of the failures of other central banks to raise their policy rates away from zero. As recently as last December, Fed Chair Yellen was confident the federal funds rate could be raised without causing
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He was concerned about survey-based measures displaying a new lower trend. This consequently appears to have caught the attention of Fed Chair Yellen. As recently as last September, she argued that well-anchored survey-based measures of inflationary expectations were a justification for policy normalisation, given the backdrop of an ever-tightening labour market. Chair Yellen has now recognised that inflationary expectations do indeed appear to have a downward bias. This could, therefore, make achieving the 2% target more difficult, particularly if they became unhinged. Furthermore, it appears that Chair Yellen believes that, given the limited availability of conventional policy tools, any attempts to re-anchor inflationary expectations back into line with its target could be difficult and would consequently be construed as a policy failure. This helps to explain why she is now prepared to accept overheating risks, because, once again, she is also concerned about her legacy. She does not want to be perennially associated as presiding over a permanent downward shift in inflationary expectations that prevented the Fed from escaping the clutches of zero percent interest rates. The behaviour of inflationary expectations could seemingly have major implications for US monetary policy. This phenomenon deserves, …show more content…
Meanwhile, economists at the International Monetary Fund (IMF) have recently attempted to explain this puzzle. Their conclusion was that the decline in prices had lowered inflationary expectations and the lack of scope that central banks currently had to lower policy rates meant that real interest rates had increased, thereby stifling aggregate demand, output and employment. This appears to be a compelling proposition: the decline in financial market measures of inflationary expectations has coincided with a period of sharply falling oil prices. The trouble is that the positive correlation does NOT necessarily imply causality. The FOMC has never really placed excessive faith in financial market measures of inflationary expectations, hence why they also pay attention to survey-based measures. Meanwhile, many other factors need to be considered, notably the exchange rate in determining inflationary expectations. Appreciating currencies will import deflation and export growth. This is what the Great Currency War is all about. Countries do not want to be presiding over strengthening currencies. Falling oil prices have recently become synonymous with a rising dollar exchange rate. The +20% appreciation in the trade-weighted dollar exchange rate since July 2014 is also culpable of driving inflationary

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