The Federal Reserve may have been wrong about the jobs market and inflation over the past half-decade, Chairwoman Janet Yellen acknowledged Tuesday, but the central bank remains convinced that slowly raising interest rates is the best course of action.
“My colleagues and I may have misjudged the strength of the labor market, the degree to which longer-run inflation expectations are consistent with our inflation objective, or even the fundamental forces driving inflation,” Yellen said in a speech prepared for a convention of business economists in Cleveland.
Despite her unusually direct admission that the central bank may not understand the workings of the economy, Yellen maintained that the best course of action remains to continue with the Fed’s ongoing program of gradually raising the central bank’s interest rate target and slowly withdrawing other stimulus measures.
The Fed is expected to raise rates for a third time later this year. It has begun slowly tightening monetary policy although inflation has mostly run below its 2 percent target for the past five years and has trended down this year.
Some economists, including officials within the Fed, have raised the possibility that inflation remains low because the labor market is weaker than the unemployment rate would suggest and that easier money is justified.
Yellen, however, said that she still believes that the recent low inflation is “probably temporary,” even though the Fed has reached the same conclusion over the past five years. She said the Fed would continue to watch carefully for signs that inflation is going to persistently fall short of the 2 percent target.
As for jobs, she said that the unemployment rate “probably is correct” in signaling that the jobs market has returned to pre-financial crisis health. At 4.4 percent, the unemployment rate is as low as it ever fell during the housing bubble and as low as it has been since 2001.
Other analysts have raised the possibility that the official unemployment rate doesn’t capture all the problems people have finding jobs. In particular, labor force participation fell in the wake of the crisis and has since flattened, suggesting that some people quit the job hunt altogether, falling out of the calculation of the unemployment rate.
That development, though, is hard to disentangle from ongoing demographic changes in the U.S., such as the retirement of the baby boomers. Yellen concluded that the economy is “not one in which substantial slack remains or one that is overheated.”
