Federal Reserve chair Janet Yellen has said that gradually increasing interest rates "makes sense" now that the U.S. economy is reaching full employment and inflation is "inching back" towards two per cent.
Speaking at the Commonwealth Club in San Francisco, Yellen said: "Waiting too long to begin moving toward the neutral rate could risk a nasty surprise down the road - either too much inflation, financial instability, or both."
In either of those events, the U.S. central bank would have to raise rates quickly, which could lead to a recession, she said.
Last month, the Fed raised short-term interest rates for the second time since the financial crisis. Yellen said the move showed the U.S. economy would continue to bounce back.
Fed policymakers are also expecting to raise the short-term rate "a few times a year" until the end of 2019, aiming for a rate of three per cent, Yellen said.
She also added that U.S. inflation was "inching back" to two per cent, which is the Federal Reserve's target. The unemployment rate in the U.S. is now 4.7 per cent.
"As the economy approaches our objectives, it makes sense to gradually reduced the level of monetary policy support," Yellen said.
The Fed chair made no comments on President-elect Donald Trump's imminent inauguration.