Yellen: ‘Dangerous’ if People Don’t Believe Inflation Will Rise

YELLEN: “Now, inflation is running below where we want it to be, and we’ve talked about that a lot during this last hour. This past year, it's not clear what the reasons are, I think it’s not been mysterious in the past, but one way or another, we’ve had four or five years in which inflation is running below our 2 percent objective, and we’re also committed to achieving that. So the monetary policy path that we follow and the paths that my colleagues are writing down in our projections as ones they think will be appropriate given economic conditions are ones that we think are necessary to move inflation back up to 2 percent and to maintain a strong labor market on the sustainable basis. 

And in making these judgments about the path of policy, we have to balance various risks. One risk is that if we tighten policy too quickly, we may find out that although we don’t think this now, that the inflation shortfall is something that’s going to be persistent. And if we tighten too quickly, we could undermine inflation performance, leave it to a lower level inflation expectations could fall, and that could become engrained and that would be dangerous. So that’s a reason to be cautious about raising interest rates when inflation is as low as it is. But on the other hand, we have a strong labor market and a low unemployment rate and although the pace of job gains is not quite as strong this year as, for example, as it was in 2016, we’re still averaging 175,000 jobs a month this year, which is quite a bit above the pace of maybe 100 to 120,000, that would be consistent with stable unemployment rate if labor force participation begins to move down in the manner we expect. 

So if we don’t do anything to remove policy accommodation and the labor market tightens and just continues to tighten, as you mentioned, arguably, I mean we could — arguably financial conditions overall haven’t tightened that much. The economy could overheat, inflation could rise more quickly and above our objective, that is something that would occur with a lag, and that would force us later on on to tighten policy more rapidly than would be ideal and we could risk a recession if we did that. So there are risks on both sides to the objectives and most of my colleagues and I have concluded that gradual path of rate increases while constantly watching incoming data being open to revising our views on the outlook and revising our expectations about policy is the best way to manage that set of risks.”