As predicted by many economists, the Federal Reserve is indeed considering raising the Federal Funds Rate later this year, Fed Chair Janet Yellen said Friday.
In a speech at the Providence Chamber of Commerce in Providence, RI, Yellen said that the Fed is seeing widespread economic improvement and expects that improvement to continue. And if the economy improves as expected, she believes it will be “appropriate” for the Fed to raise the Federal Funds Rate this year, which in turn, would affect mortgage interest rates.
“Because of the substantial lags in the effects of monetary policy on the economy, we must make policy in a forward-looking manner. Delaying action to tighten monetary policy until employment and inflation are already back to our objectives would risk overheating the economy,” Yellen said.
“For this reason, if the economy continues to improve as I expect, I think it will be appropriate at some point this year to take the initial step to raise the federal funds rate target and begin the process of normalizing monetary policy,” Yellen said. “To support taking this step, however, I will need to see continued improvement in labor market conditions, and I will need to be reasonably confident that inflation will move back to 2% over the medium term.”
Yellen said that the labor market is “approaching” its full strength but not there yet. Her comments set off a firestorm in the media, with the Washington Post calling her words "affirmation" that higher rates are coming soon.
“I say ‘approaching,’ because in my judgment we are not there yet. The unemployment rate has come down close to levels that many economists believe is sustainable in the long run without generating inflation,” Yellen said.
“But the unemployment rate today probably does not fully capture the extent of slack in the labor market. To be classified as unemployed, people must report that they are actively seeking work, and many people without jobs say they are not doing so–that is, they are classified as being out of the labor force,” Yellen said.
“Most people out of the labor force are there voluntarily, including retirees, teenagers, young adults in school, and people staying home to care for children,” Yellen continued. “But I also believe that a significant number are not seeking work because they still perceive a lack of good job opportunities.”
Despite those issues, Yellen said she the labor market is improving.
“Putting it all together, the economic projections of most members of the Federal Open Market Committee call for growth in real gross domestic product of roughly 2.5% per year over the next couple of years, a little faster than the pace of the recovery thus far, with the unemployment rate continuing to move down to near 5% by the end of this year,” Yellen said. “And for inflation, as I noted earlier, my colleagues and I expect inflation to move up toward our objective of 2% as the economy strengthens further and as transitory influences wane.”
Yellen said if and when the Fed raises rates, she expects the “pace of normalization” to be gradual.
“The various headwinds that are still restraining the economy, as I said, will likely take some time to fully abate, and the pace of that improvement is highly uncertain,” Yellen said. “If conditions develop as my colleagues and I expect, then the FOMC's objectives of maximum employment and price stability would best be achieved by proceeding cautiously, which I expect would mean that it will be several years before the federal funds rate would be back to its normal, longer-run level.”
Yellen said that despite her expectation that the Fed will engage in raising rates this year, the actual course of Fed policy will continue to be determined by the incoming economic data.
“We have no intention of embarking on a preset course of increases in the federal funds rate after the initial increase. Rather, we will adjust monetary policy in response to developments in economic activity and inflation as they occur,” Yellen said. “If conditions improve more rapidly than expected, it may be appropriate to raise interest rates more quickly; conversely, the pace of normalization may be slower if conditions turn out to be less favorable.”