Federal Reserve chair Janet Yellen today admitted the central bank may have “misjudged” the factors dragging on US inflation, but reiterated her view that gradual monetary policy rises should continue.
Speaking in Cleveland, Ohio, Yellen said: “My colleagues and I may have misjudged the strength of the labour market, the degree to which longer-run inflation expectations are consistent with our inflation objective, or even the fundamental forces driving inflation.”
However, she prefaced that clear acknowledgement that US inflation dynamics had suprised policymakers with her view that “this low inflation likely reflects factors whose influence should fade over time”, keeping the Fed on course to raise rates for the third time this year in December.
Yellen said a “gradual” approach to raising rates is necessary, but also warned that “we should also be wary of moving too gradually.”
She said: “Without further modest increases in the federal funds rate over time, there is a risk that the labour market could eventually become overheated.”
Weaker than expected inflation has become a key concern for the Fed as its rate-setting Federal Open Market Committee tries to “normalise” monetary policy by raising its key federal funds rate back to levels seen before the financial crisis.
Yellen’s latest intervention acknowledged the limits of economic forecasts of inflation, with an almost one-in-three chance that inflation could be more than one percentage point away from the Federal Reserve’s two per cent target in a year’s time.
She said: “Our framework for understanding inflation dynamics could be misspecified in some fundamental way, perhaps because our econometric models overlook some factor that will restrain inflation in coming years despite solid labour market conditions.”
Those factors could include globalisation keeping down margins on prices, or effects in the domestic economy such as slower growth in prices for health care, for which US consumers pay directly.