Janet Yellen Emphasizes Policy Flexibility, Inflation, Employment

Janet Yellen’s first major speech on Federal Reserve policy reiterated what she and her predecessor have been saying for some time. The amount of time it the key interest rate will remain close to zero depends entirely on when and how quickly the U.S. economy approaches their targets for employment and inflation.

Yellen says they will respond to economic shifts

The U.S. central bank remains frustrated with how slowly the economy is recovering from the recession. Regulators want to see maximum sustainable employment and 2% inflation, which currently is at just a little over 1%. Yellen stated that the bigger the shortfall of either inflation or employment and the slower the economy moves toward those goals, the longer the key interest rate will remain near zero.

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She did note that it’s been nearly five years since the financial crisis and “the Great Recession” and that more than 8 million jobs added to nonfarm payrolls since 2009, which she said is nearly the number lost in the recession. She also said the housing market “seems to have turned a corner,” although it still has quite a ways to go.

Recovery could take two more years

The Fed chairman said the U.S. recovery could be almost finished within the next two years. She said as of now, the growth of the economy hasn’t changed much since the fall. Yellen then listed some questions they are considering as they determine the pace at which they will raise interest rates.

The first is about “slack in the labor market,” which she said will require “a more nuanced judgment” to judge when the labor market is fully recovered. She noted that there is still a high rate of workers who are working part time but would rather work full time. She thinks that long-term employment will get stronger if the economy becomes stronger.

Measuring inflation

Second, she considered whether inflation really is moving toward 2%. She notes that if inflation continues to remain far below 2%, there could be more risks to the performance of the economy. Also the “real burden of debt” for both households and companies increases if inflation consistently remains far below 2%, according to Yellen.

She said there are two considerations which they are using to assess whether inflation is really heading back to 2%. They believe as the slack in the labor market shrinks, it will stop dragging on inflation. In addition, they assume that expectations for inflation will remain close to 2% and naturally pull it back up to that level. However, they remain prepared to respond if it looks like inflation will move dramatically over 2%.