Senator Challenges Yellen on Interest Rate

The Federal Reserve is the central bank of the U.S. (Creative Commons)

By Lucy Ren

“The financial and economic crisis has been over for at least six or seven years,” Senator Pat Toomey (R-Pa.) said in the Senate Banking Committee hearing on Tuesday, opposing the Federal Reserve’s sustaining “crisis level interest rates.”

Toomey laid out a list of evidence supporting his statement, including low unemployment, the absence of a “wave of defaults or massive bankruptcies,” relatively high consumer sentiment and “solid” economic recovery specified by FOMC.

Senator Pat Toomey (R-Pa.)
Sen. Pat Toomey (Wikimedia Commons)
Furthermore, Toomey said, Wal-Mart’s announcement to raise its hourly wage “suggests we might be approaching NAIRU,” or non-accelerating inflation rate of unemployment.

BBVA Compass economist Shushanik Papanyan said in an interview her company estimates that the unemployment rate will approach NAIRU in 2016, mostly “based on analysis of the potential GDP, and the declining long-run unemployment rate.”

Toomey also urged the Fed to consider the impact of savers’ losing their purchasing power. “It’s not as though there’s no price to be paid by having this unbelievably accommodative policy,” Toomey said. Regarding the near-zero interest rate that has been kept for the past six years, Toomey raised the concern of people “who may have spent the lifetime working hard” to use the savings to supplement a modest pension or Social Security payments. “Of course, their reward now is that they get nothing, zero, that’s what they earn on their savings, year after year.”

He questioned the Fed for aiming for 2 percent inflation, since the rate will cause savers’ losing 2 percent of their savings annually.

RELATED: Labor market not ready for interest rate hike, Janet Yellen says. Full Story.

In response, Federal Reserve Chairwoman Janet Yellen attributed the 2 percent goal for inflation to the “upward biases in price indices” and the danger of deflation.

Substitution bias, one of the upward biases that Yellen referred to, arises if consumers change their purchasing behavior in response to relative price changes.

“As prices increase, people would start to substitute expensive goods for cheaper goods,” Papanyan explained, “and that effect is not counted in the prices indices, and thus inflation indices would overestimate the actual expenses.”

“An environment with extremely low interest rate makes it difficult for monetary policy to response to upward shocks,” Yellen said, regarding the danger of deflation. “In order to avoid damaging episodes of deflation, it’s wise to have a small buffer that gives greater room for monetary policy to operate.”

Yellen will testify before a House of Representatives committee on Wednesday.

The Standard & Poor’s 500 Index rose 0.28 percent to 2115.48 on Tuesday, hitting new record high.

Photo at Top: The Federal Reserve is the central bank of the U.S. (Creative Commons)