Yellen: Lift rates gradually, don't run 'hot' economy

Federal Reserve Chair Janet Yellen reiterated Thursday that the Fed plans to raise interest rates gradually in her most pointed rebuttal yet of calls by Republican lawmakers to follow a rule that would push up rates more rapidly.

At the same time, Yellen stressed the Fed has no plans to keep interest rates lower for longer to run a “hot” economy that aims to undo some of the lingering damage from the 2008-09 financial crisis. Surprisingly, she said she believes slack in the labor market that had kept unemployment elevated —  giving the Fed more leeway to keep rates low —  has dissipated, reversing a view she expressed just a few months ago.

Yellen thus took pains to carve out a middle ground just as President-elect Donald Trump prepares to take office Friday. Trump criticized Yellen in September for keeping rates low to help outgoing President Obama, and presumably by extension, Democratic nominee Hillary Clinton.

Last month, the Fed raised its benchmark interest rate by a quarter percentage point to a range of 0.5% to 0.75%, its first hike since it lifted the rate in late 2015 for the first time in nearly a decade. Fed policymakers also surprised markets by forecasting three rate increases in 2017, up from its previous forecast of two.

Speaking of rules that would push up rates faster, Yellen said they “should not be followed mechanically, since doing so could have adverse consequences for the economy.” Her comments were in prepared remarks she planned to deliver at 8 p.m. at the Stanford Institute for Economic Policy Research.

Fed: Low unemployment, Trump fiscal stimulus could speed rate hikes

In recent years, some Republican members of Congress have urged the Fed to raise or lower rates based on a rule that takes into account inflation and other factors.  Yellen has repeatedly said such a construct would be too rigid and fail to consider the lingering economic headwinds left by the devastating recession and financial crisis. Such efforts, however, could gain more momentum with Trump in the White House.

And Yellen on Thursday provided more specific reasons for her aversion to the constraints. For example, the most prominent guidepost, the Taylor rule, figures inflation and the gap between actual economic output in the economy’s potential. That formula results in much faster rate hikes than those forecast by Fed policymakers in December.

But Yellen said that’s because it assumes the longer run inflation-adjusted neutral interest rate —  the rate needed to keep inflation and employment on an even keel —  is 2%. Yet she said that rate is now deemed to be 1% or lower because of slow productivity growth and a weak global economy, among other factors.

At the same time, Yellen said that “allowing the economy to run markedly and persistently ‘hot’ (by keeping rates low) would be risky and unwise … driving actual inflation higher and making it harder to control.” In October, she appeared to endorse such an approach.

Yellen added that labor market slack —  such as discouraged workers on the sidelines who were keeping unemployment elevated by resuming their job searches —  “looks to have largely disappeared.”

Fed officials also have said Trump's fiscal stimulus plan could result in faster rate hikes.