At SIEPR, Yellen warns against running a “hot” economy

In a pointed rebuttal to what some lawmakers are calling for, Federal Reserve Chair Janet Yellen said it would be “risky and unwise” to run a “hot” economy and defended the Fed’s current approach of gradual interest rate adjustments. 

Yellen spoke at an event hosted by the Stanford Institute for Economic Policy Research on Jan. 19, after meeting with a group of Stanford students. Her visit to SIEPR came on the eve of Donald Trump’s presidential inauguration, and her remarks explaining the Fed’s decision-making strategy signaled potential conflicts with the White House in coming months.

Trump has criticized Yellen for keeping interest rates low and echoed the push of Republican members of Congress to follow a rules-based monetary policy.

While the Fed has not followed a hard-and-fast rule, Yellen noted that its governing board takes into account the guidance posed by several monetary-policy rules, including the prominent Taylor rule — named after John Taylor, the Stanford economist who proposed it.

The constraint of such a rule of “systematic adjustments” would have prescribed a higher path for the federal funds rate than what the Fed has followed to date, she said. But the board’s actions in recent years has helped it get close to achieving its goals of full employment and stable prices.

The jobless rate stood at 4.7 percent in December, slightly below the level most Fed policymakers view as full employment. In terms of inflation, “we are now much closer” to the Fed’s 2 percent objective than we were just a year ago, she said.

Yet, “with the unemployment rate near its longer-run normal level and likely to move a bit lower this year, a natural question is whether monetary policy has fallen behind the curve,” she said. “The short answer, I believe, is ‘no.’”

There are reports of difficulties in filling jobs for certain occupations, but this is “not evidence that the economy as a whole is experiencing a serious worker shortage,” she said.

A “strong labor market” should help lift inflation to the 2 percent goal over the next couple of years, she said.

Trump has promised to support economic policy reforms that boost economic growth, but in a cautionary note, Yellen said, “I think that allowing the economy to run markedly and persistently ‘hot’ would be risky and unwise.”

“I consider it prudent to adjust the stance of monetary policy gradually over time.”

Though uncertainty in policy changes lay ahead, Yellen stressed that “rules should not be followed mechanically, since doing so could have adverse consequences for the economy.”

Taylor, a senior fellow at SIEPR and the Hoover Institution, was among the many scholars who attended the event. During a cordial question-and-answer exchange, Yellen said that the Taylor rule “has always informed my thinking” but at the same time, “I believe very strongly in the independence of monetary policy.”

Yellen, a professor emerita at the University of California, Berkeley, took leave from the school for five years starting in 1994 and served as a member of the Fed’s Board of Governors through February 1997. She left the Fed to lead the Council of Economic Advisers through August 1999. 

She also chaired the Economic Policy Committee of the Organization for Economic Cooperation and Development from 1997 to 1999. And she served as chief of the Federal Reserve Bank of San Francisco for six years starting in 2004 before returning to the Fed’s Board of Governors as vice chair in 2010. 

Yellen was appointed to a four-year term as chair of the Fed’s Board of Governors in 2014.

Yellen was welcomed to Stanford by Mark Duggan, the Trione Director of SIEPR and Wayne and Jodi Cooperman Professor of Economics. 

“She’s brought with her a deep academic background in monetary policy, and represents the strong and important connection between scholarship and economic policy, which is our focus here at SIEPR,” Duggan said in his opening remarks.

Though Trump has hinted that he might not reappoint her as chair in 2018, Yellen could remain as a governor until her 14-year term expires in 2028.