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UPDATE 2-Fed's Yellen-Fed may need to modify rate plans
Thu Oct 21, 2004 10:27 PM ET
By Adam Tanner
SAN FRANCISCO, Oct 21 (Reuters) - The Federal Reserve may need to speed up or slow down its rate-tightening campaign, depending on economic activity and inflation, San Francisco Federal Reserve President Janet Yellen said on Thursday.
"We must remain very watchful as developments unfold, and be prepared to consider modifications in our course of action as needed to ensure price stability and full employment," Yellen told a meeting of risk professionals and security analysts in San Francisco.
She said if inflation showed signs of rising significantly, the Fed would need to consider moving more aggressively. Alternatively, the Fed may need to pause rate hikes if economic activity or the job market slows.
Financial markets widely expect the Fed to raise the 1.75 percent federal funds rate again at its next meeting in November, and then pause in December.
Yellen, who is not a voting member of the Fed's policy committee this year, said policy is still accommodative, or supportive of growth, and the inflation-adjusted federal funds rate is still slightly below zero. "This suggests that short-term interest rates eventually will have to go up to prevent an increase in inflation," she said.
Still, she said a medium-term neutral rate for the federal funds rate, which neither boosts nor drags on the economy, appears to be below the level that would be neutral in the long term.
Futures markets expect the fed funds rate to be near 3.0 percent at the end of 2005.
DOLLAR STILL 'RELATIVELY HIGH'
Yellen also cited the U.S. dollar as a concern, saying it has remained "relatively high despite our large and growing trade deficit." Cheaper imports undermined demand for domestic goods, and therefore interest rates were lower than they would otherwise be to support economic activity, Yellen said.
On the recent surge in oil prices, Yellen said the risk is they would put a further drag on spending and simultaneously create inflation pressures. Still, so far inflation seemed to be relatively well contained, she said.
"The evidence suggests that inflationary expectations are well anchored," Yellen said.
Yellen said absent upward pressure on wages, higher oil prices should have only a one-time inflationary impact if the Fed avoids the mistakes of the 1970s when she said it allowed inflationary expectations to rise.
"I believe it is very important that the Federal Reserve learn from the experience of the 1970s and make sure that we do not repeat it," Yellen said. "I am confident the Federal Reserve will not repeat that mistake."
Among other risks on the economic outlook, the Fed official cited the low U.S. savings rate and a sluggish labor market.
"In terms of the consumer, the sluggish job market could significantly restrain spending, as it lowers growth in disposable income and threatens to undermine consumer confidence," Yellen said.
She added that she did not see the currently high real-estate prices in many regions of the United States as indicating any type of a bubble in the market. She did express concern about rising wage inequality in the United States and about the long-term implication of the federal budget deficit.
Yellen was the last of four Fed officials to speak on Thursday. Fed Governor Ben Bernanke said earlier the central bank's response to record-high oil prices will depend on the health of the U.S. economy and the potential for inflation. He added that interest rates still could go up at a gradual pace.
© Reuters 2004. All Rights Reserved.
