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Yellen says March rate hike is on the table, effects from Trump policies remain unclear

Federal Reserve Chair Janet L. Yellen speaks about the Federal Reserve's semiannual report during a Senate banking hearing on Tuesday. (Brendan Smialowski/AFP/Getty Images)
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Federal Reserve Chair Janet L. Yellen declined to say whether the central bank would raise interest rates at its meeting in March in testimony before Congress on Tuesday, although she also said it would be “unwise” to wait too long to hike rates.

In her semiannual report to the Senate Banking Committee, Yellen indicated that the Fed would be carefully watching to see whether inflation accelerates in the months to come, as well as how the planned tax cuts, infrastructure spending and other measures promised by the Trump administration would affect American workers and the economy.

“We don’t want to base current policy on speculation about what may come down the line. We will wait to gain greater clarity on policy changes,” Yellen said, describing the administration's policy actions as “one of many factors” that could affect the central bank’s decisions on when to raise interest rates.

Yellen said that the U.S. labor market continues to strengthen, but she urged the government to focus on improving the long-run productivity of the economy. She also broadly defended the Dodd-Frank financial reforms passed in the wake of the financial crisis, which have been under fire from the Trump administration, as making the banking system safer for households and businesses.

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Markets expect the Fed to increase interest rates two or three times this year, as strengthening economic growth translates into rising wages and prices. As of midday Tuesday, futures markets put the chance of a rate hike in March at about 18 percent, with more investors confident of a rate increase in May or June.

In her testimony, Yellen said that the economy had added nearly 16 million jobs since employment hit a trough in early 2010, and that the unemployment rate had fallen by more than half from its peak in 2010 to January. Business sentiment has continued to improve in recent months while inflation has risen, as the effects of earlier declines in energy and import prices have diminished, Yellen said.

Yet economic growth has remained somewhat lethargic, with the gross domestic product expanding just 1.6 percent last year, the slowest growth since 2011.

On Tuesday, Yellen called the growth rate “disappointing.” She blamed the sluggishness on the country’s aging labor force, as well as slower gains in the productive capacity of the economy.

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In its meeting this month, the Federal Reserve choose to leave its key interest rate unchanged, although it suggested that the environment for rate increases is improving and measures of consumer and business sentiment continue to strengthen. In December the Fed raised interest rates for the second time in nearly a decade, to a range of between 0.5 percent and 0.75 percent.

The committee probed Yellen on when the central bank would begin paring down its $4.5 trillion balance sheet of mortgage-backed and Treasury securities, which it acquired in an effort to ease lending and stimulate the economy after the financial crisis. Some critics think that the Fed’s massive balance sheet is distorting market interest rates and have urged the central bank to move more quickly to unwind it.

Yellen emphasized that the central bank wants to be well on its way into the process of raising interest rates before it allows these assets to gradually mature and run off the balance sheet. That way, the Federal Reserve could have the scope to cut interest rates if attempts to reduce its balance sheet were to disrupt economic growth.

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“We want to wait to start this process until the process of normalization is well underway,” Yellen said.

Expectations for more spending and tax cuts under the Trump administration have driven up stock markets in recent weeks. U.S. stock indexes opened slightly lower Tuesday morning before climbing to record highs.

Yet Yellen suggested the Federal Reserve does not unanimously agree that the new administration’s policies will boost growth or inflation in coming months. In previous comments, Yellen indicated that about half of the committee that decides interest rates had taken the effect of fiscal measures on the economy into account in their interest rate projections.

Senators questioned Yellen about a wide range of economic issues, including wage increases, racial wealth inequality, immigration, climate change and capital requirements for community banks, as well as the lack of diversity among the officials at the Federal Reserve.

In her testimony, Yellen also appeared to counter recent claims by President Trump that Dodd-Frank regulations are preventing banks from lending to businesses. She cited a survey by the National Federation of Independent Businesses, which indicated that only 4 percent of respondents said they were unable to get all the loans they needed.

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“U.S. banks are generally considered quite strong relative to their counterparts,” Yellen said, when asked about the ability of U.S. banks to compete globally. At a separate point in the testimony, she acknowledged that regulations were holding back some institutions, such as community banks.

On Feb. 3, Trump signed an executive order asking the Treasury Department to carry out a review of all financial regulations, to judge whether regulations are acting to support certain “core principles.” The act was widely seen as an effort to repeal the curbs put in place after the financial crisis by the Dodd-Frank Act.

In her comments, Yellen said she agreed with the core principles and looked forward to working with the new treasury secretary to uphold them.

Trump will have the opportunity to significantly shape the actions of the central bank in years to come by appointing three new governors to the Board of Governors, the body that helps to set interest rate policy.

On Friday, Federal Reserve Governor Daniel Tarullo, who served as the point person for financial regulation under President Barack Obama, announced that he would step down from his post nearly five years before the end of his term. Yellen’s term is set to expire Feb. 3, 2018. On Tuesday, she reiterated that she intended to serve out her full term as chair.

During his campaign and after his election, Trump accused Yellen of keeping interest rates low to politically benefit the Obama administration. In September, he told CNBC that Yellen should be “ashamed” of herself.

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Yellen and other Fed bankers have fervently denied the accusations. “I can say emphatically,” she said during a September news conference, “that partisan politics plays no role in our decisions about the appropriate stance of monetary policy.”

“There could be a lot of turnover on the Fed in the next couple of years, but I would say that the Trump administration needs to think really carefully about the people they put up as nominees,” said Stephen Oliner, a resident scholar at the American Enterprise Institute. “They need to be people who the market finds credible and respected. Because nothing will be worse for his plans for the economy if the financial markets don’t trust the Fed.”

Others in Congress have called for abolishing or reining in the power of the central bank, notably with the campaign to “Audit the Fed.” Critics say such actions could compromise the central bank’s independence from the political process.

At the end of last month, Rep. Patrick T. McHenry (R-N.C.), the vice chairman of the House Financial Services Committee, sent a scathing letter to Yellen criticizing the Federal Reserve for “negotiating international regulatory standards for financial institutions among global bureaucrats in foreign lands without transparency, accountability, or the authority to do so. This is unacceptable.”

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“[T]he Federal Reserve must cease all attempts to negotiate binding standards burdening American business until President Trump has had an opportunity to nominate and appoint officials that prioritize America’s best interests,” the letter said.

Stephen G. Cecchetti, a professor at Brandeis International Business School and a former adviser at the Bank for International Settlements in Basel, Switzerland, criticized the letter in a blog post, saying that U.S. regulators have played a major role in shaping international financial regulations in past decades, to the benefit of American consumers and businesses. U.S. regulators are not required to implement international standards, but rather choose to do so because they think they are appropriate, he said.

“It would isolate the U.S. financial system,” said Cechetti. “The nature of New York as a financial center would be put at risk.”

Other proposals by Congress have suggested tying the Fed's monetary policy decisions to a mathematical formula. On Tuesday, Yellen said that one suggested formula, called the Taylor rule, would stipulate an interest rate of between 3.5 and 4 percent, far higher than the Fed's current interest rates, and that choice would substantially slow the economy.

“I believe we would have a much weaker economy if … we had followed the dictates of that rule,” she said.