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Monday, March 30, 2015

Yellen: Fed Funds Rate Hike Will Not Be Predetermined

In a speech at the San Francisco Federal Reserve, Fed Chair Janet Yellen provided insight into the reasoning behind a future interest rate hike, but did not provide additional hints as to when rates will be raised aside from implying that a hike will occur later this year.

Yellen implied that the Fed will go about raising rates differently than in the past, suggesting that the committee will not set off on a predetermined course of incremental tightening that involves “similarly sized rate increases at every meeting,” but will instead be data dependent.

More specifically, Yellen noted several special considerations that will factor into the Fed’s decision to gradually raise rates.
  1. Equilibrium real federal funds rates might not recover as much or as quickly as anticipated, leading to a type of “secular stagnation”, where interest rates would need to stay historically low to keep employment under control and prices stable.
  2. Since the interest rates are already near the zero lower bound, the Fed’s ability to reverse course in the event of a negative market reaction is limited.
Despite the Fed’s perceived cautiousness in raising rates, Yellen noted that moving too slowly to raise rates has its own risks, particularly in causing inflation to rise too quickly due to upward pressure from tight labor markets. Further, prolonged low short-term interest rates could cause an excessive buildup in leverage and erosion in underwriting standards.

Read the Federal Reserve release

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