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Case Study: Modestly Accommodative Policy

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Janet Yellen made a dovish decision to continue pursuing “modestly accommodative policy” at the September meeting despite the three FOMC participants’ votes for a rate increase. The meeting was full of debate, yet the hawkish FOMC participants did not manage to convince the Fed Chair to increase federal funds rates by 25 bps. Prizing consensus during the FOMC meetings, this time Janet Yellen made a decision to keep rates unchanged regardless of the dissent. Reasons leading to this decision were labor market slack, near zero short-term interest rates and recent signs of the expanding economy. The Chair stated that there was a strengthened case for an increase of the federal funds rate but needed to wait for further evidence of continued progress…show more content…
This decrease has largely been attributed to post-crisis regulations but also to the dominating excess of savings shaping the market to forego investment opportunities. When looking at the trend towards savings from the global perspective, there is a clear accumulation of safe assets, namely US Treasuries. Moreover, in the presence of low interest rates and low inflation there is a greater appetite for risk among investors, which can lead to financial instability.
In the early September statement, Governor Lael Brainard also rejected the need for a federal funds rate hike stating that “the low neutral rate looks likely to persist.”(p.8) The Governor explained that in this economy, monetary policy should remain “modestly accommodative” because of sluggish ½ percent average productivity growth over the last five years, weak foreign consumption and
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Each presented compelling reasons that required a more detailed analysis.
Loretta Mester suggested accepting a historically low level of r* and proposed the first gradual increase in the rates in September as a way to prolong economic expansion and support economic growth rebound in the second half of the year. The President argued that the economy demonstrated lower trend growth and productivity in recent years, and as a result, the neutral federal funds rates would have to be lower as well.
Monetary policy has to be forward looking in order to allow the market to form expectations accordingly. Hence, it was appropriate in September to start gradual increases in the federal funds rates in order to exit gracefully from the prolonged accommodative trend. Quick increases in rates at a later date will present a higher risk for economic recession. Seeing limitations in monetary policy, the President suggested turning to “policies that encourage investments in technology and human capital, tax and regulatory changes, and longer-run fiscal
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