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Analysis - For the Fed's Yellen 'conventional' unconventional policy is enough

FILE PHOTO -- Federal Reserve Chair Janet Yellen attends a news conference after chairing the second day of a two-day meeting of the Federal Open Market Committee to set interest rates in Washington, DC, U.S. on June 17, 2015. REUTERS/Carlos Barria/File Photo

By David Chance

WASHINGTON (Reuters) - For all the talk of a radical shift in central banking policy, from the permanent use of negative rates to helicopter money drops, Federal Reserve Chair Janet Yellen appears to believe she can tackle any future downturn using the tools currently at her disposal.

Speaking in Jackson Hole, Wyoming, on Friday after a Fed policymaker and other economists proposed a radical overhaul of central banking, Yellen argued that bond purchases and the ability to pay interest on excess reserves as well as forward guidance would be enough to combat any downturn.

"Our current toolkit proved effective last December (when the Fed raised rates)," Yellen said in a speech in which she firmed up expectations of a second rate rise from the Fed, possibly as soon as September.

"In an environment of superabundant reserves, the FOMC raised the effective federal funds rate...by the desired amount, and we have since maintained the federal funds rate in its target range."

So much for radical change of the type proposed by John Williams of the San Francisco Fed earlier this month. Williams made the case for an eventual move to nominal growth targeting or a shift in the inflation rate upwards to give central banks the tools to fight the next economic downturn.

"Helicopters, negative rates or a higher inflation target remain confined to other central banks or academic circles," Commerzbank economist Bernd Weidensteiner wrote after Yellen's speech.

Yellen's seeming reliance on more quantitative easing was challenged at Jackson Hole by Marvin Goodfriend, a professor of economics at Carnegie Mellon University and a former policy adviser at the Richmond Federal Reserve bank, who said he believed negative rates would be a far more effective policy tool.

"Interest rate policy is by far the most flexible, the least intrusive to markets, and has proven capable of targeting low inflation," he said in a presentation after Yellen spoke.


While Fed policy has been credited with helping unemployment fall to levels seen prior to the downturn, trillions of dollars of quantitative easing and eight years or zero or near-zero rates have failed to spark a rebound in economic growth.

Data released just before Yellen spoke on Friday showed the U.S. economy expanded by just 1.1 percent in the second quarter of the year, held back in part by stubbornly weak business spending.

Business investment as a share of gross domestic product since 2008 has averaged nearly a full percentage point below the previous decade's average, according to government data.

The Fed has also been charged with increasing inequality with its bond buying programme and negative rates, and with being overoptimistic in its forecasts of economic recovery and the pace of interest rate hikes.

In 2010, the year after the U.S. economy emerged from recession, the midpoint of Fed policymakers' predictions was for 3.3 percent growth in 2011. The economy actually grew at less than half that pace and forecasts since then have generally proved rosier than reality.

For 2016, the Fed is forecasting growth of 2.0 percent, which would require the economy to perk up after a sluggish performance in the first half.

Yellen on Friday defended the models used by the Federal Reserve.

She said that barring an "unusually severe and persistent" recession, its policy tools were sufficient and rates did not need to go negative, as even at the lower bound for interest rates asset purchases and forward guidance could push long-term rates even lower on average than when nominal rates fell below zero.

Given the forecasting errors of recent years, some economists were less than impressed, saying Yellen's speech showed past policy errors were being repeated.

"Yellen seems to have developed into the ultimate 'status quo'-chair," said Lars Christensen founder and owner of Markets and Money Advisory, an independent firm focused on monetary policy issues.

"It is clear that she fundamentally does not want to see any change to the Fed's policy framework despite the fact that inflation expectations have become de-anchored and markets have lost trust in the Fed really fundamentally wanting to deliver on its 2 percent inflation target," Christensen said.

(Additional reporting by Lindsay Dunsmuir and Lucia Mutikani in Washington, Howard Schneider, Ann Saphir and Jason Lange in Jackson Hole; Editing by Andrea Ricci)