Federal Reserve Chair Janet Yellen on Thursday argued that the U.S. recovery is unlikely to be bogged down by the sluggish global economy and reiterated plans to begin withdrawing the central bank’s extraordinary stimulus this year.
Her speech at the University of Massachusetts-Amherst offered a relatively optimistic view of America’s prospects despite ongoing fears of a slowdown in China and turmoil in world financial markets. So far, Yellen said, those concerns do not warrant a change in the fundamental outlook at home.
“We do not currently anticipate that the effects of these recent developments on the U.S. economy will prove to be large enough to have a significant effect on the path for policy,” she said in prepared remarks.
Just last week, Fed officials voted to keep their benchmark interest rate at zero – where it has been since the recession -- to give them time to sort through any damage caused by China’s recent sputtering. That helped spark a 1,000-point drop in the Dow Jones industrial average, while the dollar has appreciated 15 percent over the past year.
Yellen cited the uncertainty over the global outlook at a press conference last week as a reason why the Fed opted to stay its hand. But her remarks on Thursday suggested that the central bank is already beginning to write off those concerns. The economy is growing at a decent pace, and unemployment is nearing its lowest sustainable level.
“Prospects for the U.S. economy generally appear solid,” she said.
But what has perplexed the Fed – and economists around the world – has been the persistently low level of inflation. The Fed has set a target of 2 percent for price increases, a level that is generally associated with a healthy economy. But the latest reading clocked in at just 0.4 percent.
Much of Yellen’s speech was devoted to explaining why low inflation can be damaging. For households, low inflation can make debt more difficult to pay off. For central bankers, low inflation means they have less power to protect the economy when it goes off the rails.
In fact, inflation has been below the Fed’s target pretty much since the recession. That made sense at first: An economy in distress is often accompanied by low inflation. But the recovery has picked up over the past three years, and the Fed has pumped more than a trillion dollars into the financial system – yet prices have not budged
In their latest forecasts, Fed officials cut their estimates for inflation over the next few years once again. The median prediction is that inflation will not hit their 2 percent target until 2018, a year later than previously thought.
Yellen attributed about half of the shortfall this year to falling energy prices. Also important is the decline in import prices from the stronger dollar. Without those factors – which Yellen believed would eventually fade -- the country would be close to the Fed’s target.
“Much of the recent shortfall of inflation from our 2 percent objective is attributable to special factors whose effects are likely to prove transitory,” she said.
Yellen also sought to shift attention away from the moment the Fed decides to hike its benchmark rate, which she said would have only “minor implications” for the economy. Instead, she said the pace of subsequent increases was more important and emphasized that the moves would likely be gradual.
The ability to raise rates slowly is one argument for starting the process before inflation actually hits the Fed’s 2 percent target. Waiting too long could force the central bank to slam on the brakes and potentially undermine the U.S. recovery, Yellen argued.
“Such an abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession,” she said. “The more prudent strategy is to begin tightening in a timely fashion and at a gradual pace.”
Yellen delivered her remarks from a prepared statement that totaled 40 pages, including footnotes, charts and citations. But the ending was marred when she paused for long moments, appearing to lose her place in the text, and coughed several times. A Fed spokeswoman said Yellen had become dehydrated under the bright lights of the stage and was seen by medical staff at the university as a precaution, a Fed spokeswoman said. Yellen continued to a scheduled dinner after the speech.