U.S. rates may hike early, says Yellen

Janet Yellen, the U.S. Federal Reserve’s recently appointed Chair, says she’s seeing significant improvements in the American labour market.

More importantly, her comments to a major economic forum suggested U.S. interest rates could rise sooner than expected.

Both statements came during her keynote speech at this year’s central bank symposium in Jackson Hole, Wyoming. “In the five years since the end of the Great Recession, the economy has made considerable progress in recovering from the largest and most sustained loss of employment in the U.S. since the Great Depression,” she says.

“More jobs have now been created in the recovery than were lost in the downturn, with payroll employment in May of [2014] finally exceeding the previous peak in January 2008. Job gains in 2014 have also averaged 230,000 a month, up from the 190,000 a month pace during the preceding two years. The unemployment rate, at 6.2% in July, has declined nearly 4% from its late 2009 peak.”

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But even though these developments are encouraging, she adds they “speak to the depth of the damage” of the recession, since “the labor market has yet to fully recover.”

In a report following the speech, CIBC World Markets economist Avery Shenfeld points out Yellen’s also predicted employment data could improve even faster if the economy starts to grow, and if people start coming out of retirement to boost their post-work incomes.

Still, Yellen concedes, “I expect…our understanding of labor market developments and their potential implications for inflation will remain far from perfect. As a consequence, monetary policy [will] ultimately be conducted in a pragmatic manner that relies not on any particular indicator or model, but instead…[on] our ever-evolving understanding of the [global] economy.”

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This practical approach is one of the main reasons global economists expect many of the world’s central banks will remain out of sync following the symposium. In a report this morning, Associated Press comments on how officials have been pulling in different directions since the 2008 recession due to severe gaps in global growth and volatile labour conditions.

Where’s U.S. monetary policy headed?

Yellen says the Federal Reserve’s goal is to “assess just how far the economy now stands from the attainment of its maximum employment goal. Judging the size of that gap is complicated by ongoing shifts in the structure of the labor market and [by] the possibility that the severe recession caused persistent changes in the labor market’s functioning.”

Regarding monetary policy, she notes, “The Federal Open Market Committee’s current program of asset purchases began when the unemployment rate stood at 8.1%, and [when] progress in lowering it was expected to be much slower than desired. The Committee’s objective was to achieve a substantial improvement in the outlook for the labor market, and as progress toward this goal has materialized, we have reduced our pace of asset purchases and expect to complete this program in October.”

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This has occurred even though “the committee modified its forward guidance [in December 2012] for the federal funds rate.” At that point, the Fed stated “as long as the unemployment rate remains above 6.5%, inflation between one and two years ahead is projected to be no more than a half percentage point above the committee’s 2% longer run goal, and [that] long-term inflation expectations continue to be well anchored.”

That view has changed, however, since FOMC now expects monetary policy changes will occur faster than anticipated “if progress in the labor market continues to be more rapid than anticipated…[and] if inflation moves up more rapidly than anticipated.”

Then, “increases in the federal funds rate target could come sooner.”

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Still, policy decisions won’t be made lightly, adds Yellen, since “the assessment of labor market slack is rarely simple and has been especially challenging recently…A considerable body of research suggests the behavior of…labour market variables has changed since the Great Recession.

“Along with cyclical influences, significant structural factors have affected the labor market, including the aging of the workforce and other demographic trends,” as well as “the reduction in the relative number of middle-skill jobs.”

Even so, says Yellen, “the FOMC’s emphasis is naturally shifting to questions about the degree of remaining [economic] slack, how quickly that slack is likely to be taken up, and, thereby, to the question of under what conditions we should begin dialing back” on economic support.

Read her full speech.

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