Federal Reserve Vice Chair Janet Yellen on Wednesday laid out the case for the U.S. central bank to ease monetary conditions further to shield a fragile economy as financial turmoil in Europe mounts.
Yellen's views carry great weight with Fed Chairman Ben Bernanke, and her comments suggest the Fed may be close to taking more easing steps this month in response to ongoing housing problems, a weak jobs market and the escalating euro zone crisis.
"There are a number of significant downside risks to the economic outlook, and hence it may well be appropriate to insure against adverse shocks that could push the economy into territory where a self-reinforcing downward spiral of economic weakness would be difficult to arrest," she said in a speech prepared for delivery at an event organized by the Boston Federal Reserve Bank.
Bernanke, himself, is due to speak on the economic outlook in testimony to Congress on Thursday, and his comments will show how closely his views align with Yellen's.
The Fed will weigh the impact of recent labor market developments and financial strains on its economic forecasts at its next policy meeting, on June 19-20. If policymakers decide the recovery is at risk of losing momentum, they could either push back the date of the expected first interest rate hike or they could buy more bonds, Yellen said.
Asset purchases could take the form of an outright balance sheet expansion or an extension of the program exchanging shorter-term securities for longer-term ones, Yellen said.
While both communications tools and changes to the balance sheet have limitations, risk management considerations make a strong case for additional monetary accommodation, Yellen said.
The Fed cut benchmark rates to near zero in December 2008 and has bought $2.3 trillion in long-term securities to pull the economy out of recession. To gird a flagging recovery, the Fed rebalanced its portfolio with longer-term bonds to press down longer-term interest rates and pledged conditionally to hold rates exceptionally low until late 2014.
Policymakers had seemed on track to take no further action, as economic data had been indicating that the recovery was gaining momentum. But in recent days rising financial stress in Europe and surprisingly weak labor market data for May have raised speculation the Fed would need to mull further easing.
In making a case for monetary policy insurance for the U.S. recovery, Yellen cited risks that the European sovereign debt crisis could spin out of control.
"The deterioration of financial conditions in Europe of late, coupled with notable declines in global equity markets, also serve as a reminder that highly destabilizing outcomes cannot be ruled out," she said.
(Reporting By Mark Felsenthal; Editing by Leslie Adler)