The “loony principle” of monetary policy

The “L-P”: Someone who does the same thing over and over and each time expects a different outcome!

At the Congressional Hearing today, Janet Yellen said:

Turning to monetary policy, let me emphasize that I expect a great deal of continuity in the FOMC’s approach to monetary policy. I served on the Committee as we formulated our current policy strategy and I strongly support that strategy, which is designed to fulfill the Federal Reserve’s statutory mandate of maximum employment and price stability.

Prior to the financial crisis, the FOMC carried out monetary policy by adjusting its target for the federal funds rate. With that rate near zero since late 2008, we have relied on two less-traditional tools–asset purchases and forward guidance–to help the economy move toward maximum employment and price stability. Both tools put downward pressure on longer-term interest rates and support asset prices. In turn, these more accommodative financial conditions support consumer spending, business investment, and housing construction, adding impetus to the recovery.

They may support asset prices but they sure don´t put downward pressure on long term interest rates. The charts illustrate.

You get downward pressure on interest rates at those times QE is pulled-back! (red lines). (One exception is the “taper hint” last May. Did the markets interpret that as indicating that the recovery would rebound?) QE is a signal of expansionary monetary policy. When it comes online rates rise given the expectations of more robust economic activity. When you “take it down” expectations turn pessimistic so long rates come down.

Anyway, it´s not that QE has been ineffective, only that it has been timid so that the economy is stuck in the “slow lane” of the “low lane” (see here).

“A great deal of continuity in monetary policy” is exactly what we don´t want and don´t need!