Yellen: Fed is perplexed by chronically low inflation

CLEVELAND -- Federal Reserve Chair Janet Yellen acknowledged Tuesday the Fed is puzzled by the persistence of unusually low inflation, and it might have to adjust the timing of its interest-rate policies accordingly.

Speaking to a conference of economists, Yellen touched upon key questions the Fed is confronting as it tries to determine why inflation has remained chronically below its target of 2 percent annually. The Fed chair said officials still expect the forces keeping inflation low to fade eventually. But she conceded the Fed may need to adjust its assumptions.

In noting the persistence of low inflation, Yellen suggested the Fed will take care not to raise rates too quickly. But she also said the central bank should avoid raising rates too slowly. Moving too gradually, she suggested, might eventually force the Fed to have to accelerate rate hikes and thereby elevate the risk of a recession.

Most analysts expect the central bank to raise rates in December, for a third time this year, in a reflection of economic improvement. But the Fed has said its rate hikes will depend on incoming data.

In her speech in Cleveland to the annual conference of the National Association for Business Economics, Yellen went further than she has before in suggesting the Fed could be mistaken in the assumptions it is making about inflation.

"My colleagues and I may have misjudged the strength of the labor market, the degree to which longer-run inflation expectations are consistent with our inflation objective or even the fundamental forces driving inflation," Yellen said.

The Fed seeks to control interest rates to promote maximum employment and stable prices, which it defines as annual price increases of 2 percent. While the Fed has met its goal on employment, with the jobless rate at 4.4 percent, near a 16-year low, it has continued to miss its inflation target.

Chronically low inflation can depress economic growth because consumers typically delay purchases when they think prices will stay the same or even decline.

Inflation, which was nearing the 2 percent goal at the start of the year, since then has fallen further behind and now is rising at an annual rate of just 1.4 percent.

Yellen previously has attributed the miss on inflation this year to temporary factors, including a price war among mobile-phone companies. She and other Fed officials have predicted inflation soon would begin rising toward the Fed's target, helped by tight labor markets that will drive up wage gains.

In her remarks Tuesday, Yellen said this outcome of a rebound in inflation is still likely. But she said the central bank needed to remain alert to the possibility other forces not clearly understood might continue to keep inflation lower than the Fed's 2 percent goal.

The Fed chair cautioned if the central bank moved too slowly in raising rates, it inadvertently could allow the economy to become overheated and thus have to raise rates so quickly in the future, it could push the country into a recession.

"It would be imprudent to keep monetary policy on hold until inflation is back to 2 percent," Yellen said.

During a question-and-answer session, Yellen said the Fed would be "looking at inflation very carefully" to determine the timing of upcoming rate hikes. But she said the data is likely to be difficult to assess, in part because of the effects of the recent devastating hurricanes, which have forced up gasoline prices.

Yellen's remarks came a week after Fed officials left their benchmark rate unchanged but announced they would start gradually shrinking their huge portfolio of Treasury and mortgage bonds. Those holdings had grown from purchases the Fed made over the past nine years to try to lower long-term borrowing rates and help the U.S. economy recover from the worst downturn since the 1930s.

The Fed did retain a forecast showing officials expect to boost rates three times this year. So far, they have increased their benchmark lending rate twice, in March and June, leaving it at a still-low range of 1 percent to 1.25 percent.

Last week, the Fed said the reductions in its bond holdings would begin in October by initially allowing a modest $10 billion in maturing bonds to roll off the $4.5 trillion balance sheet each month.

Asked about how long-term loan rates might respond to reductions in the Fed's bond portfolio, Yellen cited a study that estimated the increase in its bond holdings had lowered such rates by about 1 percentage point.

But she said the reduction in the holdings likely wouldn't raise rates by as much as a percentage point given the Fed intended to keep the size of its balance sheet significantly higher than it was before the financial crisis. She said any upward pressure on rates likely would be gradual and take place over several years.

Later on Tuesday, Yellen toured a job-training center operated by Cuyahoga Community College and participated in a roundtable with students, faculty and potential employers.

Yellen, who has visited a number of job centers during her time as Fed chair, told the group job training was especially important now as employers find it harder in a tight labor market to find workers with the necessary skills.

Crutsinger reported from Washington.