Federal Reserve Chair Janet Yellen said policymakers are prepared to keep interest rates low as long as unemployment remains high and inflation tame. (Reuters)


In her first monetary policy speech as Federal Reserve chair, Janet Yellen said Wednesday that the nation’s economic recovery will be nearly complete within two years, but cautioned that the economy still needs the central bank's support.

The Fed's own forecasts project that the unemployment rate will bottom out and inflation will pick up by the end of 2016, marking the first time in nearly a decade that the economy is running close to full steam. Still, Yellen noted those predictions are far from certain and argued that the Fed should remain flexible if conditions change.

“If the economy obediently followed our forecasts, the job of central bankers would be a lot easier and their speeches would be a lot shorter,” Yellen said in prepared remarks to the Economic Club of New York.

There's still plenty of debate over how and when the Fed should finally begin tightening its easy-money policies after it slashed its benchmark short-term interest rate to zero during the depths of the financial crisis in 2008. On Wednesday, Yellen framed the Fed’s decision on the health of the labor market, inflation expectations, risks from fiscal policies such as federal spending cuts, and international turmoil in areas such as Europe.

Yellen said the nation’s 6.7 percent jobless rate remains significantly above what the Fed considers a normal level – and that statistic may be understating the depth of the problem. As in previous speeches, Yellen pointed to the high number of long-term unemployed and people working part-time for economic reasons as additional signs of weakness in the labor market. She also reiterated that the some of the shrinkage of the country’s workforce is the result of discouraged workers giving up hope of finding a job.

One of the puzzles currently confounding economists is why inflation has remained so low even as the recovery has picked up steam. The Fed set a 2 percent inflation target but its preferred measure of price changes shows inflation is about half that. Yellen said a stronger job market will help push inflation back up. She noted that long-term price expectations are stable around the Fed’s target but also stepped up her assurances that the central bank would guard against deflation.

“The limited historical experience with deflation shows that, once it starts, deflation can become entrenched and associated with prolonged periods of very weak economic performance,” she said.

The Fed is trying to walk a fine line between preparing investors and the public for an interest-rate increase as the economy improves while, at the same time, providing assurance they will still remain low by historical standards for years to come.

Previously, the central bank promised it wouldn’t raise rates until at least the unemployment rate fell to 6.5 percent. But with the recovery hovering around that threshold, officials scrapped that language in favor of more vague wording that gives the central bank plenty of leeway in when to act.

The latest policy statement says only that the Fed will consider progress toward its goals of 2 percent inflation and full employment in deciding how long to keep rates near zero. Its assessment will encompass the health of the labor market, inflation readings and financial developments.

Such fuzzy language is a reflection of the challenge officials face in pinning down the moment when the economy will finally be ready to stand on its own. There are 16 people who contribute to the Fed’s policy decisions, each with his or her own model of how the recovery will progress and opinion on how the central bank should react.

But as chair, Yellen’s voice carries the most weight.

“The larger the shortfall of employment or inflation from their respective objectives, and the slower the projected progress toward those objectives, the longer the current target range for the federal funds rate is likely to be maintained,” she said Wednesday.

Despite those assurances, Yellen received spontaneous applause when she emphasized that the Fed is also ready to pull back its support as the economy returns to normal.

“As the recovery proceeds and healing occurs, it’s obvious that we will need to tighten monetary policy to ensure that we avoid overshooting our target. This is a judgement call that the Federal Reserve needs to make in every expansion,” Yellen said. “Overshooting that goal we’ve learned in past episodes and past recoveries can be very costly to reverse. That’s something we don’t want to happen.”