Because monetary policy works with a lag, if the economy grows as expected, the time will be right to raise interest rates sometime this year, Federal Reserve Board Chair Janet Yellen said Friday.
"Because of the substantial lags in the effects of monetary policy on the economy, we must make policy in a forward-looking manner," she told the Providence Chamber of Commerce according to text release by the Fed. "Delaying action to tighten monetary policy until employment and inflation are already back to our objectives would risk overheating the economy."
But, before normalization begins, Yellen wants to see "continued improvement in labor market conditions, and I will need to be reasonably confident that inflation will move back to 2 percent over the medium term."
Once the rate hikes start, Yellen reiterated, "I anticipate that the pace of normalization is likely to be gradual. The various headwinds that are still restraining the economy, as I said, will likely take some time to fully abate, and the pace of that improvement is highly uncertain. If conditions develop as my colleagues and I expect, then the FOMC's objectives of maximum employment and price stability would best be achieved by proceeding cautiously, which I expect would mean that it will be several years before the federal funds rate would be back to its normal, longer-run level."
Yellen also stressed that data will drive policy, and there are no pre-determined rate hikes, nor will there be any after liftoff. "Rather, we will adjust monetary policy in response to developments in economic activity and inflation as they occur. If conditions improve more rapidly than expected, it may be appropriate to raise interest rates more quickly; conversely, the pace of normalization may be slower if conditions turn out to be less favorable."
