Friday 29 Mar 2024
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DEVELOPMENTS in the Greek crisis justifiably diverted attention from Federal Reserve chair Janet Yellen’s semi-annual testimony to Congress last week.

Most of the coverage tended to focus on her valiant efforts to parry attacks on the autonomy and accountability of the central bank. Yet she also provided insights into the future of interest rate policy:

1) Timing:  Yellen is inclined to initiate the Fed’s hiking cycle this year. Instead of waiting until 2016, when she might have to raise interest rates more aggressively, she would rather lead a gentle campaign of increases that starts this year and proceeds gradually, as new economic data warrants.

2) Rationale: Although wage growth remains too muted, Yellen anticipates the labour market will strengthen further, carried by robust job creation. Combined with moderate growth in domestic demand, the brighter employment picture is expected to underpin the continued rebound from disappointing first-quarter growth.

3) Not just cyclical: Yellen seems to be warming to the notion that the US economy faces more than cyclical headwinds. By taking into account the role of structural issues, including moderate productivity growth, she can be less worried about inflation persistently undershooting the Fed’s objective.
 
4) International context: Although the Greek crisis is of concern, Yellen doesn’t believe that its effects are limited to the downside. She also sees upside risk for Europe.

5) Format: The Fed chief provided further indications that this would not be a traditional cycle.  Previous Fed chairs have preferred to set hikes at each meeting until their desired rate destination is reached. Yellen will adopt a more conditional approach.

6) Terminal point: Yellen also is warming to the idea that the increases could end with a policy interest rate that is well below historical averages.

7) Global divergence: While concerns about the strength of the dollar could re-emerge, they weren’t described as an impediment to initiating the interest rate hiking cycle this year. At this stage, Yellen isn’t overly worried that the Fed, with a policy of reduced monetary accommodation, will diverge even further from other central banks. — Bloomberg View

Mohamed El-Erian is the chief economic adviser at Allianz SE.

 

This article first appeared in The Edge Financial Daily, on July 22, 2015.

 

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