Federal Reserve chair Janet L. Yellen told Congress on Wednesday that the U.S. economy is gathering strength, warranting further gradual increases in the Fed's benchmark interest rate and a reduction in its balance sheet later this year.
In a measured statement delivered as part of a semiannual address, Yellen described an economy that appears generally strong, with continued job gains and low unemployment, but that is dogged by stubbornly low inflation.
Despite low inflation, the Fed has lifted interest rates twice this year, in March and June, bringing its benchmark rate to between 1 percent and 1.25 percent.
In her testimony, Yellen did not specifically address the pace of rate hikes to come, but said monetary policy remains “accommodative” — meaning interest rates are low enough to stimulate economic growth, rather than restrain it. She added that the economy’s growth would continue to warrant “gradual increases in the federal funds rate over time.”
Over the multi-hour hearing, House members pressed Yellen on how the Federal Reserve would roll back its balance sheet, the central bank’s role in ensuring full employment and her views on bank supervision.
Republicans also welcomed the Fed’s decision to start shrinking the massive $4.5 trillion balance sheet of securities it purchased after the financial crisis, saying that the decision was overdue. Many investors anticipate that the Fed will launch its plan to reduce its balance sheet when it meets in September and postpone another rate hike until December.
Yet Yellen gave little new information on the Fed’s plan to pare back the balance sheet, reiterating that the Fed would reinvest a portion of these securities that exceed gradually rising caps, and that the central bank would begin the program later this year. The Fed would be prepared to start purchasing securities again if the economy turns downward, she said in her testimony.
House members questioned Yellen repeatedly on whether she would serve a second term should President Trump ask her to stay on when her post expires in February. She answered that it hadn't been discussed thus far. “It is certainly something that I would discuss,” she added.
In her testimony, Yellen reiterated that temporary factors appear to be holding inflation back and that the Fed will keep a careful eye on its path — both fixtures of her recent speeches.
The central bank is charged with a dual mandate of reducing unemployment and keeping inflation low and steady. With the unemployment rate at a low 4.4 percent in June, the Fed is largely thought to have accomplished the first of its goals. But inflation remains persistently below the Fed’s 2 percent annual growth target.
Yellen described an economy in which sustained growth would likely gradually raise inflation from its current low levels. As the economy continues to grow and employers are forced to compete for good workers, they theoretically will have to lift the inflation rate by raising their wages and prices — what Yellen referred to as “tightening resource utilization.”
But she admitted there was “uncertainty about when — and how much” inflation would respond to this process.
Yellen's statement added that possible changes in U.S. government policy introduced another source of uncertainty to the economy.
A few members of the Federal Reserve had raised their economic growth estimates in response to the Trump administration’s plans to slash taxes and raise infrastructure spending, measures that were expected to boost business growth but have yet to materialize, nearly six months into Trump’s term in office.
Yet most Fed members did not incorporate such factors into their estimates, saying they would wait until they could see the actual policy. Yellen has cautioned that some measures the Trump administration is considering, like tax cuts, could boost growth, but that others, like limits on immigration and trade, may reduce it.
Yellen also used her opening statement to caution against requiring the Fed to set interest rates in accordance with mathematical formulas — a popular position among some House Republicans.
In a four-page section in the accompanying 57-page report the Fed submitted to Congress, the central bank laid out the case for consulting these rules for guidance but not for using as a prescription.
“The small number of variables involved in policy rules makes them easy to use. However, the U.S. economy is highly complex, and these rules, by their very nature, do not capture that complexity,” the report read.