The Federal Reserve needs to continue gradual rate hikes despite broad uncertainty about the path of inflation, Fed Chair Janet Yellen said on Tuesday in remarks that acknowledged the central bank’s struggles to forecast one of its key policy objective, APA reports quoting Reuters.
It is possible, Yellen said, that the Fed may have “misspecified” its models for inflation, and “misjudged” key facts like the underlying strength of the labor market and whether inflation expectations are as stable as they seem, and central bankers need to remain open to that possibility as they decide on policy.
Still, recent low inflation was likely a reflection of factors that would fade over time and despite uncertainties, it “would be imprudent to keep monetary policy on hold until inflation is back to 2 percent,” Yellen said in a 37-page address to the National Association for Business Economics
“Without further modest increases in the federal funds rate over time, there is a risk that the labor market could eventually become overheated, potentially creating an inflationary problem down the road that might be difficult to overcome without triggering a recession,” she said.
Yellen’s remarks attempt to resolve a debate that has split members of the central bank among those worried that inflation may be permanently anchored below the Fed’s 2 percent target because of structural changes in the global economy, and those who feel it is only a matter of time before tight labor markets lead wages and prices to rise.
She did not provide a definite answer, noting that in current forecasts there was a 30 percent chance inflation could range anywhere from 1 percent to 3 percent, vastly different outcomes either of which could rewrite the Fed’s policy approach. But she did make clear the Fed still feels a gradual pace of rate hikes remains the base case.
Kevin Logan, chief U.S. economist at HSBC Securities, in New York, said her message is that “they’re not really sure” whether the weak inflation is transitory but that “nonetheless policy is accommodative.”
“The gradual approach means that, even if they are wrong on inflation it won’t be a big mistake. That’s the message they are trying to convey.”
The dollar shot up then retreated after Yellen’s comments, reflecting uncertainty about her message. Treasury yields and stocks edged slightly higher.