The Economic View: Yellen and rates

Further clarification from Fed Chair Janet Yellen around the Fed’s ‘gradual rate rise’ pathway has brought to light the central bank’s contentious forecasting of inflation.

The Federal Open Market Committee's 2 per cent inflation target has been a constant constraint for returning the Federal funds rate back to the neutral cash rate – at no point in the last five years has trimmed mean or headline inflation reached the magical 2 per cent level.

However, according to Yellen and Co., inflation forecasting has been impacted by the eccentric nature of external factors, such as food, energy and import pricing. Slack in the market has also been a factor, and one they concede has caused contention.

Yet, it’s strength in the overall labour market, wealth and economic growth that is allowing the Fed to consider rate rise as a ‘financial stability’ mechanism, countering the risk of overheating.

Yellen was at pains to point out that market conditions could indeed hamper or reverse its gradual rate rise program. But, in the main, despite an inflation figure 30 basis points under target, financial conditions warrant further increases to the Fed funds rate to maintain financial stability.