While hedging that incoming data will determine whether the Federal Open Market Committee begins the normalization process this month, Federal Reserve Board Chair Janet Yellen suggested Wednesday that she's ready for a rate increase.
"I currently judge that U.S. economic growth is likely to be sufficient over the next year or two to result in further improvement in the labor market," she told The Economic Club of Washington, D.C., according to prepared text released by the Fed. "Ongoing gains in the labor market, coupled with my judgment that longer-term inflation expectations remain reasonably well anchored, serve to bolster my confidence in a return of inflation to 2 percent as the disinflationary effects of declines in energy and import prices wane."
Of course, the Fed has said it want to see further labor market improvement and be reasonably confident inflation will come near 2% in the medium term before it begins normalization.
While "many" FOMC members projected in September that they would be comfortable raising rates this year, while "some" wanted to hold off until next year, "but all agreed that the timing of a rate increase would depend on what the incoming data tell us about the economic outlook and the associated risks to that outlook," she said.
With rates near zero, Yellen said, "we can respond more readily to upside surprises to inflation, economic growth, and employment than to downside shocks. This asymmetry suggests that it is appropriate to be more cautious in raising our target for the federal funds rate than would be the case if short-term nominal interest rates were appreciably above zero. Reflecting these concerns, we have maintained our current policy stance even as the labor market has improved appreciably."
But with monetary policy working with a lag, a delay of "too long" in raising rates could result in "having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals. Such an abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession. Moreover, holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and thus undermine financial stability."
Still, incoming data "and their implications for the economic outlook" will be used to make policy, she said.
Risks to the outlook for the economy and labor markets are "very close to balanced," Yellen said. The price declines in oil and imports that have held down inflation "will diminish next year" and combined with "further tightening in U.S. labor and product markets," Yellen said, inflation should rise toward 2% "over the next few years."
The Fed will keep monitoring measures of inflation, some of which have been stable while others have edged down. But she dismissed those that fell since they usually respond only to large changes in inflation. "While the low level of these measures appears to reflect, at least in part, changes in risk and liquidity premiums, we will continue to monitor this development closely," she added. "Convincing evidence that longer-term inflation expectations have moved lower would be a concern because declines in consumer and business expectations about inflation could put downward pressure on actual inflation, making the attainment of our 2 percent inflation goal more difficult."
