With newly confirmed Federal Reserve Chairman Janet Yellen, investors often parse her testimony to gain insight on the future direction of interest rates. In last week’s testimony, Yellen inferred that easy money policy is still plausible because labor markets remain slack. Here’s Jon Hilsenrath of Wall Street Journal’s Real Time Economics take,
“In her testimony to Congress Tuesday, Federal Reserve Chairwoman Janet Yellen said high levels of long-term U.S. unemployment signaled high levels of slack in the economy which will keep inflation low.”
First, Janet Yellen heads up the Federal Open Market Committee that influences interest rates through their monetary policy. They have a dual mandate of stabilizing prices and achieving full employment. While both are attractive, it is very difficult to choose a strategy that can accomplish both.
By saying that U.S. long-term unemployment remains high, while inflation is low, we can guess that Yellen will maintain an easy money strategy, as opposed to a tight money strategy. This means that access to credit for consumers and businesses will continue to be relatively cheap, thus interest rates should not rise much based on the announcement. It is hoped that this action will improve labor markets and alleviate the plight of the long-term unemployed.
The downside of this strategy is that it might continue to create turmoil in emerging countries. Their concerns are rooted in U.S. exports being cheaper than theirs. In order for them to compete more effectively, they might choose to devalue their currencies, which could result in rapid inflation, which erodes living standards and impedes growth. Therefore, this policy can still be problematic even if current labor markets are keeping wages depressed, thus minimizing the impact of higher U.S. inflation.
With the U.S. economy so interconnected with the rest of the world, the long-term implications can be severe for the U.S., even if it might be bright in the near future.