Yellen: 'Gradual' Rate Increases Will Be Needed to Sustain Economic Expansion -- 2nd Update

By Nick TimiraosFeaturesDow Jones Newswires

The Federal Reserve will need to keep gradually raising its benchmark interest rate over the next few years, but that rate won't need to rise to levels seen in previous cycles, Fed Chairwoman Janet Yellen said in congressional testimony Wednesday.

Ms. Yellen also updated lawmakers on the Fed's plans to start slowly shrinking its $4.5 trillion portfolio of bonds and other assets acquired during and after the 2008 financial crisis. Ms. Yellen said officials expected to set those plans into motion this year, but she wasn't more specific about the timing.

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"The committee currently expects that, provided the economy evolves broadly as anticipated, it will likely begin to implement the program this year," Ms. Yellen said in five pages of prepared testimony.

Fed officials next meet July 25-26. At their meeting last month, officials raised rates for the third time in as many quarters to a range between 1% and 1.25% and penciled in one more rate increase this year. Ms. Yellen gave no indication about the timing of its next increase in her testimony Wednesday.

Ms. Yellen was set to begin two days of testimony, starting with the House of Representatives on Wednesday and the Senate on Thursday, in what are likely to be her final appearances on Capitol Hill before her term expires next February. The White House is beginning the process of considering who should be the next Fed chair. While Ms. Yellen isn't expected to be reappointed, President Donald Trump hasn't ruled it out.

Ms. Yellen's tenure as Fed chairwoman began in early 2014, as the Fed began to slow its purchases of Treasury and mortgage securities, the conclusion of the latest -- and broadest -- effort to spur household and business investment by pushing down long-term interest rates.

The Fed stopped adding to its holdings, also known as its balance sheet, in October 2014, but it has continued to reinvest the proceeds of maturing assets to maintain the portfolio's size. Since then, central bankers in Europe and Japan have ramped up similar bond-buying experiments, and the Fed slowly moved to raise interest rates from near zero.

Statements from Fed officials in recent weeks have highlighted a debate over whether a slowdown in inflation should lead them to hold back on additional rate increases for now. But even those who want to go slower on raising rates because of their doubts about inflation have shown no such qualms about announcing plans to implement the portfolio runoff in the next few months.

Excluding volatile food and energy categories, the Fed's preferred inflation gauge slowed to a gain of 1.4% over the year ended May, versus 1.8% in February. In her testimony, Ms. Yellen said the inflation slowdown partly reflects unusual one-off declines and officials would monitor inflation developments "closely" in the months ahead. "There is...uncertainty about when -- and how much -- inflation will respond to tightening resource utilization," she said.

More broadly, Ms. Yellen said the economy's performance was likely to warrant "gradual increases in the federal-funds rate over time" to achieve the Fed's goals of maximum sustainable employment and stable prices, measured relative to a 2% annual inflation target. Inflation has fallen below that target for most of the last five years.

"Additional gradual rate hikes are likely to be appropriate over the next few years to sustain the economic expansion and return inflation to our 2% goal," Ms. Yellen said.

Under the balance sheet plan announced last month, the Fed will allow its holdings to decline gradually by allowing a predetermined amount of bonds to mature every month without reinvestment. Allowing some of the holdings to run off could push up long-term rates, but markets haven't shown a significant reaction so far.

The Fed doesn't plan to use its portfolio as an active tool of monetary policy during normal times, Ms. Yellen said Wednesday. But it would be "prepared to resume reinvestments if a material deterioration in the economic outlook were to warrant a sizable reduction in the federal-funds rate," she said.

Ms. Yellen characterized the Fed's benchmark short-term rate as "somewhat below" its neutral level, one in which the Fed is neither trying to speed up or slow down the economy. Because that level is currently low by historical standards, "the federal-funds rate would not have to rise all that much further to get to a neutral policy stance," she said.

Ms. Yellen's outlook on the economy was little changed from the assessment she offered at a news conference last month after the Fed announced its most recent rate increase. The unemployment rate, at 4.4% in June, is near its lowest levels in 16 years.

Ms. Yellen said the labor market "has continued to strengthen," and the pace of 180,000 average monthly job gains this year remains "well above the pace we estimate would be sufficient, on average, to provide jobs for new entrants to the labor force."

While global growth prospects have improved this year, Ms. Yellen said, "a number of our trading partners continue to confront economic challenges." She judged the economy faces roughly the same likelihood of performing stronger than the Fed's current forecasts as performing weaker, a change from recent years when the risks have been tilted more heavily to the downside.

Some Fed officials in recent weeks have said easier financial conditions, including stocks at record highs and a decline in the dollar, could justify further rate increases this year. Ms. Yellen didn't mention financial conditions in her prepared testimony.

Ms. Yellen is likely to face questions over financial regulation at Wednesday's hearing. While she has largely defended the postcrisis financial-regulatory architecture created by the Dodd-Frank Act, Ms. Yellen and other Fed officials have signaled openness to changing some of those rules.

On Tuesday, the White House formally nominated Randal Quarles, a former Treasury official in Republican administrations, to serve on the Fed's seven-member board of governors and as the vice chair of bank supervision, a new post created by the 2010 Dodd-Frank financial-regulatory overhaul. The Fed has two other vacancies on its board, giving Mr. Trump an early opportunity to put his stamp on the central bank.

Write to Nick Timiraos at

(END) Dow Jones Newswires

July 12, 2017 10:17 ET (14:17 GMT)