Fed Chair Yellen Testimony Raises Concern About a Negative Interest Rate Environment

As Federal Reserve Chair Janet Yellen wrapped up her semiannual monetary policy report testimony in front of the House Financial Services Committee Wednesday morning, Congress questioned her about possibly implementing a drastic measure in the event that the U.S. economy takes a turn for the worst.

When asked about imposing a negative interest rate, Yellen did not rule it completely out as an option, but said the further investigation would need to be conducted.

“In the spirit of prudent planning, in light of European experience, we will look at, we should look at," Yellen explained. "It isn’t just a question of legal authority, it’s also a question of could the plumbing of the payments system in the United States handle it. Is our institutional structure of our money markets compatible with it? We have not determined that."

After being at a near-zero interest rate for nine years, the Fed raised its benchmark rate by a quarter of a percentage point. The rates were cut so low in order to stimulate the hurting economy during the 2008 financial crisis. Although Yellen mentioned that the Fed would consider the option of turning to negative rates, she said in her testimony that she does not believe the economy will warrant the need for that.

USA Today writer Paul Davidson reported that negative interest rates would "force banks to pay to keep reserves at the Fed, instead of paying the banks interest, as the Fed currently does. That theoretically would incentivize banks to lend more and could spur them to move money to higher-yielding assets such as stocks, stimulating markets and making consumers feel wealthier so they’ll spend more."

In 2010, shortly after the crisis, the Fed decided not to dip rates into the negatives because of the dire consequences: "hurt money market funds, which play a key role in market liquidity for corporations and governments" and "interrupt interbank payments, such as check clearing, by reducing the funds banks keep at the Fed," Davidson wrote.

Yesterday, while testifying before Congress, Yellen noted that persistent economic headwinds have kept the federal funds target rate at a historically low level—and that future rate hikes may occur even more gradually than originally anticipated, a message she once again shared at her testimony today.

In her testimony before the House Financial Services Committee, Yellen identified factors that have weighed on aggregate demand, such as limited access to credit for some borrowers, weak growth abroad, and the dollar’s significant appreciation. Inflation also remains way below the Fed’s 2 percent objective.

The nation experienced paltry GDP growth (0.7 percent) in the first estimate for the fourth quarter and job gains of only 151,000 for January, slightly more than half of the monthly average for October through December. One notable aspect of the most recent employment summary is that in January, the unemployment rate dipped below 5 percent for the first time in eight years.

“The FOMC anticipates that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate,” Yellen said. “In addition, the Committee expects that the federal funds rate is likely to remain, for some time, below the levels that are expected to prevail in the longer run. This expectation is consistent with the view that the neutral nominal federal funds rate—defined as the value of the federal funds rate that would be neither expansionary nor contractionary if the economy was operating near potential—is currently low by historical standards and is likely to rise only gradually over time.”