Speaking Friday at a conference of top central bankers in Jackson Hole, Wyo., Yellen acknowledged that the Fed is nearing a tipping point in its calculation between tightening monetary policy at the risk of creating more unemployment and keeping money too loose for too long. Too much monetary stimulus would risk stoking too-high inflation that would harm U.S. consumers by raising the cost of everything.
While the Fed under Yellen and her predecessor Ben Bernanke has been preoccupied with helping U.S. businesses and workers recover from the financial crisis with a mix of near-zero interest rates and large-scale bond purchases, it’s now “naturally shifting to questions about the degree of remaining slack” in labor markets, Yellen said Friday.
Previously, soaring unemployment had made the case for continued stimulus “unambiguous,” Yellen said. But with unemployment falling rapidly over the past year to 6.2 percent in July, “assessments of the degree of remaining slack in the labor market need to become more nuanced,” she explained.
Yellen said that the Fed will continue to take into account a wide range of labor market indicators beyond the unemployment rate, including part-time work and labor force participation, but that there was no one way to gauge the true underlying strength of the U.S. economy. Even rising wages, which so far have been missing from the recovery, would not necessarily presage rising inflation and send a clear signal to the Fed to tighten money, Yellen said.
Yellen spelled out her view of the relationship between underemployment and inflation in a speech in Chicago in March. Then, she said that the “considerable slack” in the labor market – including weakness not captured in the unemployment rate, such as the number of people forced into part-time work – is one reason she believes it is “appropriate” for the Fed to continue its efforts to ease the money supply.
But with different measures of underemployment now sending conflicting messages to labor market economists, there is “no simple recipe for appropriate policy,” Yellen cautioned.
Other members of the Fed already believe the labor market has shown enough progress to begin moving up the planned date for raising short-term interest rates from near-zero levels. Currently, polls of investors and bond market prices indicate that the first rate hike is expected around mid-year in 2015.
Charles Plosser, the president of the Federal Reserve Bank of Philadelphia who has consistently called for the Fed to rein in its stimulus policies, said in an interview with CNBC at the conference in Jackson Hole Thursday that it was “risky” for the Fed to not move to raise rates earlier.
Continuing to delay raising rates could “traumatic at some point in time if we're not careful,” Plosser warned, “because then we'll have to turn around and race to catch up” to prevent inflation expectations from rising out of control.
Plosser was the only member of the Fed’s monetary policy committee to dissent from its July decision to keep its guidance about interest rates unchanged, arguing that the Fed’s policies didn’t reflect the extent of progress the economy has made.
The minutes for that meeting released earlier this week revealed that a growing number of Fed officials share the view that the labor market has improved enough to steer policy toward tightening earlier to avoid inflation rising out of hand.