The Federal Reserve might consider keeping money looser for a longer period of time in order to counteract supply-side problems with the U.S. economy, chairwoman Janet Yellen suggested Friday.
Speaking at an event in Boston, Yellen said that it might be worth asking whether the Fed could help the economy by “temporarily running a ‘high-pressure economy,’ with robust aggregate demand and a tight labor market.”
Yellen’s comments challenged the common assumption that the central bank can only smooth out business cycles by influencing demand for goods and services, and cannot influence underlying long-term growth or the ability of the economy to produce those goods and services.
In the case of an economy scarred by the effects of the financial crisis, however, running the economy hot with monetary stimulus might undo some of the damage, improving the supply side of the economy.
Doing so, Yellen suggested, might spur additional capital outlays by business, or coaxing people who quit the workforce back into jobs. That second possibility was a major factor in the Fed’s September decision not to raise rates, Yellen said then.
Overall, the Fed may be able to “reverse supply-side damage after it has occurred,” Yellen speculated. That idea could be a justification for the Fed to keep its short-term interest rate target below 0.5 percent for longer even as the unemployment rate and other traditional indicators suggest that the Fed should tighten monetary policy.
Yellen acknowledged that trying to run the economy hot could risk inflating speculative bubbles or generating too-high inflation, fears that some other Fed officials have expressed in recent months, including at September’s meeting.
