Janet Yellen is wrong that low Fed rates raise recession risks and she knows it


Janet Yellen

REUTERS/Gary Cameron

Federal Reserve Chair Janet Yellen holds a news conference following day two of the Federal Open Market Committee (FOMC) meeting in Washington, U.S., December 14, 2016.

Federal Reserve Chair Janet Yellen told Congress this week the central bank could cause a recession if it waits too long to raise interest rates.

Wait, what? Isn't it the other way around? Yes, according to Janet Yellen's testimony just a year earlier.

In the past, Yellen and her predecessor, Ben Bernanke, have emphasized that, because interest rates are still near zero and inflation has remained persistently below the Fed's 2% target, it is safer for policymakers to err on the side of leaving borrowing costs low for longer.


"The federal funds rate is still near its effective lower bound. If inflation were to remain persistently low or the labor market were to weaken, the Committee would have only limited room to reduce the target range for the federal funds rate," she told Congress in June of last year. "However, if the economy were to overheat and inflation seemed likely to move significantly or persistently above 2%, the FOMC could readily increase the target range for the federal funds rate."

Why the confounding change of tune from a Fed chair who is supposed to speak deliberately given that markets hang on her every word? It is true that the labor market has shown gradual but steady improvement. Still, wages remain depressed and underemployment is widespread. The unemployment rate is 4.8%, whereas it stood at 4.9% in June of 2016. Moreover, the rise of Donald Trump to the US presidency has introduced a whole host of global uncertainties that are clouding the outlook. So it's hard to square Yellen's current push for quickly raising rates in the near future.

The fact is, Yellen appears to again have locked herself into a promise - or at least a strong hint - that she may not be able to keep. Yellen and her colleagues are sticking to their forecast that they will raise interest rates three times this year. In 2016, they began the year talking about four rate increases and barely got one off at the December meeting. A similar pattern already seems to be emerging now.


The argument for the Fed's three rate hike forecast is especially weak in light of mediocre labor market and economic data.

Yellen's predecessor, Bernanke, has been very forceful in explaining that the Fed was not keeping interest rates artificially low and that there's no need to quickly raise rates now.

"The state of the economy, not the Fed, is the ultimate determinant of the sustainable level of real returns. This helps explain why real interest rates are low throughout the industrialized world, not just in the United States," Bernanke wrote in his Brookings Institution blog.


Ex-Minneapolis Fed President Narayana Kocherlakota, now a professor at the University of Rochester, says there could be a few reasons for Yellen's change of heart.

"I think that she sees several changes from last year," he said, including firmer inflation figures and sustained employment growth. But he's also somewhat befuddled about Yellen's logic.

"For reasons that I don't fully understand, Yellen has always been extremely concerned about having to raise rates 'too fast'," he said.


This is an opinion column. The thoughts expressed are those of the author.

NOW WATCH: Marriott's CEO travels 200 days a year - these are his favorite travel hacks