Federal Reserve chair Janet Yellen backed a strategy for gradually raising interest rates, arguing that the central bank wasn’t behind the curve in containing inflation pressures but nevertheless can’t afford to allow the economy to run too hot.
“I consider it prudent to adjust the stance of monetary policy gradually over time,” she said on Thursday in remarks to the Stanford Institute for Economic Policy Research in California, while stressing the considerable doubt surrounding that outlook.
Yellen’s second speech this week comes just a day before the inauguration of Donald Trump as US president. She said that future alterations in fiscal policy were just one of the many uncertainties that the Fed would have to grapple with as it plots its monetary moves in the months ahead.
Not only is the size, timing and composition of such changes unclear, estimates of their impact on the economy by budget experts vary considerably, Yellen noted in a footnote to the speech. “She doesn’t feel like the economy is overheating,” said Laura Rosner, senior US economist at BNP Paribas in New York. “Nothing in her speech gave a strong signal that a hike is coming in March.” Policy makers next meet January 31-February 1, followed by a gathering on March 14-15.
In making the case that the Fed had not fallen behind the curve, Yellen said that wages had risen “only modestly” and the manufacturing sector was operating well below capacity.
What’s more, she didn’t see that changing soon. Payroll growth has slowed while the economic expansion “seems unlikely to pick up markedly in the near term” given weak foreign demand and prospective gradual increases in interest rates, she said.
Still, she saw dangers in permitting the economy to overheat and inflation expectations to get out of control. “Allowing the economy to run markedly and persistently ‘hot’ would be risky and unwise,” she said.
Another factor arguing for a gradual approach to raising interest rates is what Yellen called a “passive” removal of monetary accommodation via the Fed’s balance sheet.
In another footnote to her speech, Yellen said a shortening in the average maturity of the central bank’s bond holdings and the approach of an eventual reduction in its balance sheet could increase the yield on the 10-year Treasury note by 15 basis points this year. That would be roughly equivalent to two 25 basis point increase in the inter-bank federal funds rate. She did not say when the reduction in the balance sheet would begin. The Fed raised interest rates in December for the first time in a year, lifting its target range for the benchmark federal funds rate to 0.5% to 0.75%. Policy makers have pencilled in three quarter-point increases for 2017, according to the median of their quarterly estimates in December.
Yellen spelled out in detail a point that she also made in her shorter speech on Wednesday, namely, that the Fed was close to achieving its goals of full employment and stable prices.
The jobless rate stood at 4.7% in December, slightly below the level most Fed policy makers view as full employment. “In the coming months, I expect some further strengthening in labour market conditions as the economy continues to expand at a moderate pace,” Yellen said. The “strong labour market” should help lift inflation to the Fed’s 2% goal over the next couple of years, she added. As measured by the personal consumption expenditure price index, inflation rose 1.4% in the 12 months through November. That’s up markedly from 0.5% on the same basis in November 2015, in part because of a rebound in oil prices.
Answering audience questions, Yellen described the risks to stability of the financial system as “moderate” and nowhere near as big as they were in the midst of the 2008-09 crisis.


Related Story