Former Fed Chair Janet Yellen says the U.S. central bank needs to raise short-term rates only three more times to achieve a neutral rate that allows the economy to grow and create jobs without pushing inflation much above the bank’s 2% target.
Speaking to a room filled with financial advisors who greeted her with a standing ovation at the Schwab Impact 2018 conference, Yellen said U.S. economic growth was currently running at a pace that’s unsustainable for very long given the tightness of the labor market. “Growth needs to slow in order for economy not to overheat,” said Yellen.
“The ratio of job openings to unemployed people is the highest level in recorded history. There are more job openings than people to fill them,” and the “unemployment rate is the lowest in 50 years.”
Yellen expressed concern about potential overheating of the economy but also confidence in the ability of current Fed Chairman Jerome Powell and other Fed policymakers to slow and stabilize growth.
“That’s a very tricky business,” said Yellen, explaining that Fed policy takes time to have an impact so the Fed has to be forward-looking. Acting too slowly and falling behind the curve, however, risks having to tighten so much to cause a significant recession.
Yellen doesn’t expect a recession until at least 2020 and even then one only a mild one that’s not “deep and terrible.”
The first and only female Fed chair expects that the federal funds rate will average around 3% over the next 10 years, which translates into a real (adjusted for inflation) rate of 1%. (The current fed funds rate is set at a range between 2% and 2.25%, which after adjusting for inflation of 2% is close to zero.)
“The normal level of real rates is likely to be low and stay low,” said Yellen, adding that most economists believe the average level of rates is trending downward due to an aging population, slow productivity growth and high demand for safe assets not only in the U.S. but in other developed economies.
Asked by Steve Liesman, CNBC’s senior economics reporter who interviewed Yellen on the Schwab stage, about President Donald Trump’s tweet-bashing of the Fed, Yellen called the criticism “unwise” and said the criticism, if continued, “could undermine the public’s confidence in the Fed. … Economies function better when the central bank is allowed to make policy independently.”
The former Fed chair is also concerned about Trump’s trade war policies, which could impact corporate investment spending as well as consumer spending but are “more likely deflationary than inflationary.”
She said it’s conceivable that the Chinese economy, which is already slowing, could retreat even further and that could have repercussions for the U.S. and global economies. In the meantime, the administration’s trade policies are adding to market volatility.
Yellen expects the growth of the U.S. economy will slow next year from a little more than 3% this year, with the unemployment rate falling even further and inflation possibly ticking up a tenth of percent or two. The U.S. economy cannot continue to grow at 3% annually unless the population and labor force grows, which could potentially boost productivity growth, said Yellen.
In addition to a potential overheating economy, White House Fed bashing and trade policies, Yellen is concerned about the buildup in nonfinancial corporate debt as well as the growing U.S. government debt burden.
U.S. debt is not at a “debt crisis level,” but it will escalate without policy changes, according to Yellen. “We’ve known for decades that as the population ages, Social Security, Medicare and Medicaid spending will move higher, from 10.5% of GDP to close to 15%,” and with rate hikes will be on an “unsustainable path.”
Given that expectation and the fact that tax collections have also fallen to low levels relative to U.S. history, she says the solution is higher taxes coupled with entitlement spending cuts, including “modest reform of Social Security.”
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