NEW YORK (BLOOMBERG) - Federal Reserve chair Janet Yellen cautioned that raising interest rates too quickly risked stranding inflation below the US central bank's 2 per cent target and said there'd been "some hint" that expectations for future price increases may be drifting down.
"It can be quite dangerous to allow inflation to drift down and not to achieve over time a central bank's inflation target," she said on Tuesday (Nov 21), while also discussing perils of leaving rates too low for too long.
"One reason it's dangerous is because inflation expectations are likely to also drift down and indeed there is some evidence - I don't really think they've drifted down very much - but there's some suggestion," they may be drifting down, she said at an event at New York University moderated by former Bank of England governor Mervyn King. "That would be a very undesirable state of affairs."
The Fed announced on Monday that Yellen, 71, would step down once current Fed governor Jerome Powell - who President Donald Trump nominated to replace her when her term expires in February - is confirmed by the Senate and sworn into office.
Yellen, Powell and the rest of the US central bank's policy-setting Federal Open Market Committee are attempting to guide interest rates back to what they deem a more neutral level after years of keeping them near zero to combat the effects of the financial crisis.
Their median forecast pegged neutral at about 2.75 per cent when quarterly projections were last published in September. The Fed currently targets a range of 1 per cent to 1.25 per cent for its benchmark overnight rate.
Yellen said that with rates so low by historical standards, the central bank would have less scope than in the past to respond to economic weakness by easing policy."Removing policy accommodation too quickly risks leaving inflation below our target with all those dangers," she said. "On the other hand, removing policy accommodation too slowly also has risks and the labor market could tighten very quickly."
While unemployment fell to 4.1 per cent last month - the lowest in nearly 17 years - inflation has remained below the central bank's target throughout most of the expansion, and has slowed unexpectedly this year.
The deceleration led to increased investor pessimism about higher interest rates over the spring and summer, but guidance from Fed officials in the past two months that they are looking through what they see as a temporary abatement of price pressures has led to a rebound in market rates.
Investors are nearly certain the FOMC will raise the overnight rate when they gather next in December, and assign better-than-even odds to another hike in March, according to the prices of federal funds futures contracts. The FOMC projections published in September had three increases penciled in for 2018.
Yellen made no explicit reference to upcoming Fed policy decisions but assured the audience that "we don't want a boom-bust policy."