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     Jul 8, '14

Yellen's punchbowl now
Commentary and weekly watch by Doug Noland

I have liberally excerpted from Janet Yellen's July 2 speech to the International Monetary Fund: "Monetary Policy and Financial Stability". I expect this paper to be critiqued for years (perhaps generations) to come. History will not be kind.

For now, exuberant markets see Yellen's comments as confirmation that she's determined to keep the punchbowl flowing. It is worth noting that Yellen's dovish doctrine was presented with US stock prices at record highs; corporate debt spreads at lows since 2007, record-pace corporate debt issuance, record-pace

collateralized loan obligations issuance, the most robust IPO market since 2000 and the strongest mergers and acquisition activity since 2007. Dr Yellen, take it away:

"In my remarks, I will argue that monetary policy faces significant limitations as a tool to promote financial stability: Its effects on financial vulnerabilities, such as excessive leverage and maturity transformation, are not well understood and are less direct than a regulatory or supervisory approach; in addition, efforts to promote financial stability through adjustments in interest rates would increase the volatility of inflation and employment.

"As a result, I believe a macroprudential approach to supervision and regulation needs to play the primary role. Such an approach should focus on "through the cycle" standards that increase the resilience of the financial system to adverse shocks and on efforts to ensure that the regulatory umbrella will cover previously uncovered systemically important institutions and activities. These efforts should be complemented by the use of countercyclical macroprudential tools, a few of which I will describe. But experience with such tools remains limited, and we have much to learn to use these measures effectively.

"I am also mindful of the potential for low interest rates to heighten the incentives of financial market participants to reach for yield and take on risk, and of the limits of macroprudential measures to address these and other financial stability concerns. Accordingly, there may be times when an adjustment in monetary policy may be appropriate to ameliorate emerging risks to financial stability.

"Because of this possibility, and because transparency enhances the effectiveness of monetary policy, it is crucial that policymakers communicate their views clearly on the risks to financial stability and how such risks influence the appropriate monetary policy stance. I will conclude by briefly laying out how financial stability concerns affect my current assessment of the appropriate stance of monetary policy ... More ... Doug Noland is a market strategist for the Prudent Bear Funds.

(Republished with permission from PrudentBear.com. Copyright 2005-2014 David W Tice & Associates. All rights reserved.)




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