US Federal Reserve Chair Janet Yellen offered an upbeat assessment of the US economy, signaling that further rate hikes are in store for 2017. But will the Fed also reduce the size of its balance sheet?
In her semiannual Congressional testimony this week, Yellen was positive on the economy’s growth prospects and outlined the considerable progress that’s been made toward the Fed’s dual goals of employment and price stability.
JOB GAINS AND INFLATION CONTINUE TO IMPROVE IN 2017
Testifying on behalf of the Federal Reserve Open Market Committee (FOMC), Yellen noted that the strong average job gains in the second half of 2016 are continuing in early 2017. As a result, the jobless rate of 4.8% is now in line with the FOMC’s estimate of long-run full employment.
Yellen also noted that key inflation measures have moved closer to the committee’s 2% objective. However, the official Consumer Price Index (CPI) is already well above the 2% mark. In January, the CPI was up 2.5% from its level a year ago—the fastest annual gain since 2012. That gain, along with the Fed’s positive outlook on growth and labor markets, should make officials more confident that inflation will range around 2% or higher for a while.
The combination of “considerable progress” toward the FOMC’s dual objectives and ongoing improvement in the economy would, in Yellen’s words, “warrant further gradual increases in the federal funds rate.” Yellen reiterated what she said back in December 2015: “waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession.”
ON THE HORIZON: THREE RATE HIKES LIKELY, MAYBE MORE
Based on current Fed projections, the FOMC’s central view is for three official rate hikes in 2017. But some committee members think there could be more. This week, Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, said “we [the FOMC] may need more than three rate hikes this year.”
Lacker added that the FOMC should start to scale down its balance sheet. Yellen, responding to a question during her testimony, stated that the FOMC plans to reduce the balance sheet in an orderly way and that policymakers will be discussing a “balance sheet strategy” in coming months.