Federal Reserve Chair Janet Yellen told Congress this week that the US central bank could cause a recession if it waited too long to raise interest rates.
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Janet Yellen's warning about low rates causing a recession doesn't make sense
Less than a year ago, the Federal Reserve chair argued for a slower pace of interest-rate hikes.
Janet Yellen
Wait, what? Isn't it the other way around? Yes, according to Yellen's testimony just a year earlier.
In the past, Yellen and her most recent predecessor, Ben Bernanke, have emphasized that, because interest rates are still near zero and inflation has remained persistently below the Fed's 2% target, it is safer for policymakers to err on the side of leaving borrowing costs low for longer.
"The federal funds rate is still near its effective lower bound," she told Congress in June. "If inflation were to remain persistently low or the labor market were to weaken, the committee would have only limited room to reduce the target range for the federal funds rate. However, if the economy were to overheat and inflation seemed likely to move significantly or persistently above 2%, the FOMC could readily increase the target range for the federal funds rate."
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Why the confounding change of tune from a Fed chair who is supposed to speak deliberately given that markets hang on her every word? It is true that the labor market has shown gradual but steady improvement. Still, wages remain depressed, and underemployment is widespread. The unemployment rate is 4.8%, whereas it stood at 4.9% in June. Moreover, the rise of Donald Trump to the presidency has introduced a whole host of global uncertainties that are clouding the outlook. So it's hard to square Yellen's push for quickly raising rates in the near future.
The fact is, Yellen appears to again have locked herself into a promise — or at least a strong hint — that she may not be able to keep. Yellen and her colleagues are sticking to their forecast that they will raise interest rates three times this year. They began 2016 by talking about four rate increases and barely got one off at the December meeting. A similar pattern already seems to be emerging this year.
The argument for the Fed's forecast for three rate hikes is especially weak in light of mediocre economic and labor-market data.
Bernanke has been very forceful in saying the Fed was not keeping interest rates artificially low and there's no need to quickly raise rates now.
"The state of the economy, not the Fed, is the ultimate determinant of the sustainable level of real returns," Bernanke wrote in his Brookings Institution blog. "This helps explain why real interest rates are low throughout the industrialized world, not just in the United States."
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Narayana Kocherlakota, the former Minneapolis Fed president who is now a professor at the University of Rochester, says there could be a few reasons for Yellen's change of heart.
"I think that she sees several changes from last year," he said, including firmer inflation figures and sustained employment growth. But he's also somewhat befuddled about Yellen's logic.
"For reasons that I don't fully understand, Yellen has always been extremely concerned about having to raise rates 'too fast,'" he said.
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