Federal Reserve Chair Janet Yellen said Wednesday she still foresees only "gradual" interest rate increases in the few years ahead, as the US economy grows stronger and employment expands. Key question marks remain however about how the economic outlook will play out, and possible shifts in policy and spending by President Donald Trump's administration are one "source of uncertainty," Yellen said in her semi-annual testimony to Congress.
Another big unknown is whether stubbornly low inflation will finally move closer to the Fed's two percent target rate, from the current 1.4 percent. Sluggish US inflation is something that has baffled and worried economists given the very low unemployment rate which would normally drive prices higher.
But Yellen once again expressed the view held by many US central bankers that the low pace of price increases "are partly the result of a few unusual reductions in certain categories of prices" which will eventually drop out of the calculations. These include costs for cell phone services and medications, economists say.
While such low inflation normally would be likely to keep the Fed from raising interest rates, it has instead hiked rates twice this year, and expects to do so once more. But Yellen pledged to "carefully monitor" the situation.
After tepid annual growth in the first quarter of 1.4 percent, Yellen said "Indicators suggest growth rebounded in the second quarter," including rising household spending and business investment, and an improving housing market. Meanwhile, confidence is rising and growth overseas bodes well for US exports and manufacturing, she said.
As a result, "additional gradual rate hikes are likely to be appropriate over the next few years to sustain the economic expansion and return inflation to our two percent goal," Yellen told the House Financial Services Committee in the first day of her two-part testimony. She appears before the Senate Banking Committee on Thursday.
However, Yellen said, the benchmark interest rate "would not have to rise all that much further to get to a neutral policy stance," one where it is neither stimulating nor restraining the economy. She stressed that "monetary policy is not on a preset course," and central bankers will adjust their views as more data becomes available. Among the data policymakers will be watching are wages and inflation which have remained surprisingly low, despite an average increase in employment of 180,000 a month this year and an unemployment rate of 4.4 percent in June.
But Yellen said the positive signs in the economy should spur continued consumer spending and business investment, which in turn should foster "a stronger pace of wage and price increases." Yellen cautioned however that "possible changes in fiscal and other government policies here in the United States represent another source of uncertainty." While she did not address the specifics in her prepared statement, economists have noted that a large infrastructure spending program Trump has promised could spur growth, but restrictive trade policies or a rising deficit could have the opposite effect.
Together with other uncertainties, including prospects for the global economy, Yellen said there are "roughly equal odds" the US economy will be stronger or weaker than currently forecast. Anticipating likely questions from Republican legislators, many of whom have been pushing for the Fed to be required to use a strict formula to set interest rates, Yellen again explained why rigid rules could be harmful. While the Fed always consults such monetary policy rules to compare to their own assessments, "such prescriptions cannot be applied in a mechanical way," she warned. And "there are many considerations these rules do not take into account," she said.