Yellen's dilemma: a downturn with no easy response

Fri Feb 12, 2016 1:15am EST
 
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By Howard Schneider and Ann Saphir

WASHINGTON (Reuters) - The Federal Reserve's carefully scripted decision to raise interest rates last December, and begin a return to "normal" policy, may now become a nightmare for the U.S. central bank if an economic downturn forces a return to unconventional methods.

Fed chair Janet Yellen told lawmakers this week she was studying ways to "be prepared" in the event the current slide in world stock markets, concern about financial sector stress, and slowing economic growth all translate into a recession or another financial crisis.

But Yellen said the policy tool of negative interest rates, now favored by some foreign central banks offers no sure bet for the U.S. economy.

"We need to consider the U.S. institutional context. They are not automatic...We previously studied them and decided they would not work well," Yellen told the U.S. Senate Banking Committee on Thursday, when asked whether the Fed was "out of ammunition" to fight a new downturn.

After mistakenly raising interest rates briefly in 2011, the European Central Bank turned to negative interest rates last year as a policy tool, and the Bank of Japan followed suit in January in another bid to avoid deflation and promote economic growth.

FED'S DILEMMA

Yellen's two days of testimony to the U.S. Congress this week, a semi-annual appearance mandated by law, brought home the dilemma the Fed faces.   Continued...

 
U.S. Federal Reserve Board Chair Janet Yellen testifies at the House Financial Services Committee in Washington, February 10, 2016. REUTERS/Gary Cameron