Yellen: Negative rates not "off the table"

Federal Reserve Chair Janet Yellen told Congress Thursday the central bank has not ruled out imposing negative interest rates if the economy takes a downward turn but is investigating their viability.

“I wouldn’t take them off the table but we would have work to do to make sure they would be workable,” she told the Senate Banking Committee in her semiannual monetary policy report to Congress. Yellen testified before the House Financial Services committee Wednesday.

The Fed raised its benchmark interest rate in December for the first time in nine years -- from near zero to 0.4% -- amid strong job growth and near-normal unemployment. But global economic troubles and a market selloff have raised concerns about a U.S. slowdown and even recession.

Still, Yellen said Thursday she doesn't expect the economy to wobble enough to warrant a cut in interest rates, let alone a drop into negative territory.

Fed's Yellen cites growing risks to economy

A negative rate  likely 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.

Yellen said the Fed decided against using negative rates in 2010, largely because they would hurt money market funds, which play a key role in market liquidity for corporations and governments. Another issue, she said, is that they could disrupt interbank payments, such as check clearing, by reducing the funds banks keep at the Fed.

But last month, Japan’s central bank joined those in Denmark, Sweden and Switzerland, as well as the European Central Bank, in imposing negative rates. As a result, she said, “We’re taking a look at them again because we want to be prepared in the event we would want” to stimulate a sluggish economy.

Yellen said the Fed is investigating its legal authority to deploy negative rates, but added, “At this point, I am not aware of any legal constraint.”

After the Fed pushed its key rate near zero amid the 2008 financial crisis, it purchased several trillion dollars in Treasury and mortgage-backed bonds to drive down long-term interest rates. But the Fed’s balance sheet is now bloated at more than $4 trillion and some economists have raised concerns that unwinding it could rattle markets and the economy. Negative rates thus could serve as an alternative tool if the economy falters again.

Yellen, however, rejected one lawmaker's suggestion that prospect of further Fed rate hikes has contributed to the recent fall in stocks, noting markets largely were "tranquil" In response to the Fed's December increase. Instead, she blamed speculation of further devaluation of China's currency and the plunge in oil prices for the market turmoil.

"I think that they have been the drivers," she said. Her view of the relationship between Fed rate increases and stocks could affect future Fed moves.

In repeating the prepared testimony she delivered in the House on Wednesday, Yellen also said the labor market is strong but the recent rout in stocks and sluggish growth overseas pose threats to the U.S. economy. That could jeopardize the Fed’s plans to raise its benchmark interest rate in March and nudge it up gradually this year.

She reiterated that a strong dollar and low oil prices have been pushing down inflation. That could discourage the Fed from acting. Although she said she expects those effects to fade, she noted that market-based measures of inflation expectations, such as certain Treasury bonds, have fallen to historically low levels.

Yellen has not ruled out a March hike and said the Fed will be closely monitoring economic data over the next few weeks. But many economists now think the central bank will lift rates just twice this year, possibly in June and December, instead of the four times suggested by Fed policymakers forecasts in December. Late last year, the Fed raised its federal funds rate by a modest quarter percentage point to a still-low 0.4% amid strengthening job growth and falling unemployment, its first hike in nine years.

The unemployment rate is now 4.9%, down from 10% in 2009, a level at or close to what the Fed considers full employment.