CLEVELAND • The United States Federal Reserve needs to continue gradual rate hikes despite broad uncertainty about the path of inflation, Fed chairman Janet Yellen said on Tuesday in remarks that acknowledged the central bank's struggles to forecast one of its key policy objectives.
She said it is possible that the Fed may have "misspecified" its models for inflation, and "misjudged" key facts like the underlying strength of the labour market and whether inflation expectations are as stable as they seem, and central bankers need to remain open to that possibility as they decide on policy.
Still, recent low inflation was likely a reflection of factors that would fade over time and despite uncertainties, it "would be imprudent to keep monetary policy on hold until inflation is back to 2 per cent", Dr Yellen said in a 37-page address to the National Association for Business Economics.
"Without further modest increases in the federal funds rate over time, there is a risk that the labour market could eventually become overheated, potentially creating an inflationary problem down the road that might be difficult to overcome without triggering a recession," she said.
Her remarks attempt to resolve a debate that has split the central bank's members. Some worry inflation may be permanently anchored below the Fed's 2 per cent aim due to structural changes in the global economy. Others feel it is only a matter of time before tight labour markets lead wages and prices to rise.
She made clear that the Fed still feels a gradual pace of rate hikes remains the base case.
HSBC Securities chief US economist Kevin Logan said her message is that "they're not really sure" whether the weak inflation is transitory but that "nonetheless policy is accommodative". He added: "The gradual approach means that, even if they are wrong on inflation it won't be a big mistake."
The Fed, which has raised rates twice this year, last week held rates steady.