Caution is the appropriate step for the Federal Open Market Committee to take when it comes to raising rates, Federal Reserve Board Chair Janet L. Yellen said Tuesday.
“Given the risks to the outlook, I consider it appropriate for the Committee to proceed cautiously in adjusting policy,” Yellen told the Economic Club of New York, according to prepared text released by the Fed. “This caution is especially warranted because, with the federal funds rate so low, the FOMC’s ability to use conventional monetary policy to respond to economic disturbances is asymmetric.”
And while she believes “inflation expectations are well anchored,” she noted, “continued low readings for some indicators of expected inflation do concern me.”
While expecting gradual increases in the fed funds rate target, Yellen said, “policy will evolve as needed.”
Volatility in oil prices and stocks “have not materially altered the Committee’s baseline--or most likely-- outlook for economic activity and inflation over the medium term,” she said.
The FOMC expects labor markets to continue improving and inflation to hit 2% “over the next two or three years.”
If “headwinds gradually fade as I expect, the neutral federal funds rate will also rise, in which case it will, all else equal, be appropriate to gradually increase the federal funds rate more or less in tandem to achieve our dual objectives,” she said. “Otherwise, monetary policy would eventually become overly accommodative as the economy strengthened.”
While the outlook hasn’t changed, Yellen said, “this is not to say that global developments since the turn of the year have been inconsequential. In part, the baseline outlook for real activity and inflation is little changed because investors responded to those developments by marking down their expectations for the future path of the federal funds rate, thereby putting downward pressure on longer-term interest rates and cushioning the adverse effects on economic activity.”
Indicators this year have been mixed, with labor, consumer spending and housing trending positive, while manufacturing and net exports have lagged.
“Looking forward however, we have to take into account the potential fallout from recent global economic and financial developments, which have been marked by bouts of turbulence since the turn of the year,” she said.
Slower economic growth abroad and lowered earning expectations have been “partially offset by downward revisions to market expectations for the federal funds rate that in turn have put downward pressure on longer-term interest rates, including mortgage rates, thereby helping to support spending.”
As a result, Yellen expects the impact on the U.S. economy to “be limited, although this assessment is subject to considerable uncertainty.”
But the developments since the December meeting will slow the pace of rate hikes, she acknowledged, with “the median of FOMC participants’ projections for the federal funds rate is now only 0.9 percent for the end of 2016 and 1.9 percent for the end of 2017, both 1/2 percentage point below the December medians.”
Also, she noted, the economy’s neutral real rate “is likely now close to zero. However, the current real federal funds rate is even lower, at roughly minus 1-1/4 percentage point, when measured using the 12-month change in the core price index for personal consumption expenditures (PCE), which excludes food and energy. Thus, the current stance of monetary policy appears to be consistent with actual economic growth modestly outpacing potential growth and further improvements in the labor market.”
