Fed official: Communications crucial for unconventional policy

Strong communications from the Federal Reserve are playing a key role in implementing recent unconventional policy, a Fed official said Friday.

However, any phrasing by the Fed that would indicate future actions must leave room for adjustments depending on market conditions, according to Janet Yellen, vice chair of the Fed's board of governors.

Speaking to the University of Chicago School of Business, Yellen specifically dissected the Fed decision, beginning in Dec. 2008, to announce that the federal funds rate would need to stay "exceptionally low" for some time in the future.

The move came after the Fed, in response to continued economic struggles, lowered its fund rate target to a range of 0 to 1/4 percentage point. Once the Fed hit that bottom, it began informing the market that the rate would stay that low "for some time," which was later changed to "for an extended period."

Providing the market with the knowledge and confidence that low rates would be sticking around likely improved market conditions, Yellen said.

However, a key component of that language is that it provides flexibility for the Fed to adjust its policy if conditions require it.

"The committee's forward guidance has been framed not as an unconditional commitment to a specific federal funds rate path, but rather as an expecdtation that is explicitly contingent on economic conditions," she said in her prepared remarks.

Once the economic recovery is "well established" and it appears the Fed needs to think about hiking rates, the central bank will need to change its "extended period" language and adopt different terms to communicate the new outlook to the market.

But if the recovery falters and the Fed sees the need to keep its rates low, the current language allows for that contingency, she said. In fact, if markets begin to expect policy changes before Fed officials are prepared to make them, the Fed could further tweak its forward guidance to make clear it is operating under a longer timeframe.

Yellen's comments are the latest indication that the Fed is seriously considering how it communicates its policy moves to the public -- potentially driven in part by a rising amount of central bank criticism from congressional Republicans. Yellen chairs a newly created Fed committee exploring its communications policies, and Fed Chairman Ben Bernanke held a rare press conference with reporters at the beginning of February.