COLUMN-Negative rates the elephant in Yellen's speech: James Saft

(The opinions expressed here are those of the author, a columnist for Reuters)

By James Saft

Aug 26 (Reuters) - Remember the phrase "negative interest rates"? Neither, it seems, does Janet Yellen.

Sure, rates are negative in Japan and the euro zone. And in Denmark, Sweden and Switzerland, making it the rule of the day for economies comprising about a quarter of global output.

And yet, in a long discussion of the Federal Reserve's tools to fight the next downturn, the word "negative" did not pass Yellen's lips in her Jackson Hole speech, much less in any combination with "interest," "rate," or "policy".

In an odd way, this is a gift from Yellen to her peers in Europe and Japan.

It is also all the more remarkable given that the very first chart Yellen used in support of her remarks, portraying the Fed's projections for fed funds and employing a band to show a range of likely outcomes, shows a reasonable chance of rates bumping along at or below zero next year. (http://www.federalreserve.gov/newsevents/speech/yellen-figure1-20160826.png)

To be sure, negative rates do make an appearance, but under the somewhat euphemistic guise of "hypothetical unconstrained policy," or HUP as perhaps it will become known.

Yellen only raised HUP in order to argue that she and the Fed can do better via other avenues.

"Despite the lower bound, asset purchases and forward guidance can push long-term interest rates even lower on average than in the unconstrained case (especially when adjusted for inflation) by reducing term premiums and increasing the downward pressure on the expected average value of future short-term interest rates," Yellen said in a much-anticipated talk at the Kansas City Fed's annual monetary policy conference.

"Thus, the use of such tools could result in even better outcomes for unemployment and inflation on average."

There is a fundamental and inherent conflict between relying on forward guidance as a bulwark of monetary policy while at the same time acknowledging the need to study revolutionary new tools such as inflation or output-level targets. Forward guidance, as recently practiced, is when a central bank commits to hold rates lower for longer, thus hopefully driving longer-term interest rates down. That depends critically on the credibility of the central bank.

And while the Federal Reserve has many admirable qualities, their track record in forecasting the economy has not been a strong one in recent years, as output, productivity and inflation have all fallen in ways the bank did not anticipate.

JANET'S GIFT

As for negative interest, again it doesn't come in for a mention when Yellen discussed some options for the future.

"Future (Other OTC: FRNWF - news) policymakers may wish to explore the possibility of purchasing a broader range of assets," she said.

"Beyond that, some observers have suggested raising the FOMC's 2 percent inflation objective or implementing policy through alternative monetary policy frameworks, such as price-level or nominal GDP targeting."

Negative interest rates do carry many unfortunate costs. They imperil the entire banking and insurance business model, which depend on using time to trade money today for more money in the future. A similar, and not widely discussed issue, is the impact of negative rates on pensions. Not only do low interest rates make future pension liabilities larger in terms of regulatory calculations, they very possibly reduce the future growth of capital.

Central banks which are willing to employ negative interest rates are one big winner out of the Fed's unwillingness, at least at first. Not only did Yellen seem willing to hike rates this year, an outcome financial markets expect in December, but she all but discarded one tool if she wants to ease. That makes the gap between U.S (Other OTC: UBGXF - news) . rates and those in the euro zone or Japan both greater and more secure.

The dollar strengthened sharply after the speech, rising against a trade-weighted basket of currencies by 0.44 percent. That's great news for the negative rate block, which has generally suffered as the dollar weakened this year, blunting the impact of their own policies.

If negative rates are not going to be part of the Fed's arsenal, and if other changes, like permission to buy stocks and bonds, will take time, more stress will fall on forward guidance.

Given that forward guidance amounts to the Fed asking us to believe its long-term commitment about events it isn't good at predicting while it considers huge changes to how it operates, that may be a losing strategy.

(Editing by James Dalgleish)