Yellen Sees Muted Inflation as Unemployment Curbs Wages

Janet Yellen is eyeballing wages for signs of inflationary pressure. She doesn’t see any so far.

“Wage gains continue to proceed at a historically slow pace in this recovery, with few signs of a broad-based acceleration,” the Federal Reserve chair said yesterday in her her first major monetary-policy framework speech.

Yellen said in response to a question from Harvard University economist Martin Feldstein that she expects people who have been out of work for a long time to return to the labor force as job prospects brighten. That will keep a lid on wages and inflation.

“The long-term unemployed are likely to move back more actively into the labor force and into the job market and exert pressure on wages and prices,” she told the Economic Club of New York. “Clearly, we will have to watch unfolding evidence and evaluate it with an open mind.”

Feldstein, who has criticized the Fed for paying too little attention to inflation risks, asked Yellen if she agrees short-term unemployment is an early indicator of rising prices and wages. He cited research to that effect by Alan Krueger, a professor at Princeton University in New Jersey and former head of President Barack Obama’s Council of Economic Advisers.

“It’s premature frankly to jump to that conclusion,” Yellen responded. Still, “there can be surprises.”

She said she “would not rule out the possibility that inflation could rise to levels where we would need to address it before we might expect at this point. That is something we will be quite attentive to. It’s not what I anticipate will happen.”

Long-Term Unemployed

Even with the jobless rate near a five-year low, more than 3.7 million Americans have been unemployed six months or longer. Their share of the total ranks of the jobless exceeded 30 percent for the first time in 2009 and hasn’t fallen below that level since. That gauge stood at 35.8 percent in March, down from a record 45.3 percent in April 2010.

Inflation as measured by the Fed’s preferred personal consumption expenditures price index has remained below its 2 percent goal for almost two years. The gauge dropped to a 0.9 percent year-over-year pace in February, down from 1.2 percent the prior month.

That shortfall, as well as a jobless rate that remains above the central bank’s full employment estimate of 5.2 percent to 5.6 percent, means policy makers must be mindful of how much they are missing both sides of their dual mandate to provide maximum employment and stable prices, Yellen said.

Lower Longer

“The larger the shortfall of employment or inflation from their respective objectives, and the slower the projected progress toward those objectives, the longer the current target range for the federal funds rate is likely to be maintained,” she said in her speech.

The gap, in both cases, is large, with a jobless rate of 6.7 percent more than a percentage point higher than the top end of the Federal Open Market Committee’s estimate of full employment. It will take at least two years for the economy to close in on the Fed’s goals, she said, adding that past forecasts were disrupted by negative surprises, not positive ones.

“She clarified exactly what her views are and what the committee’s views are about what the Fed may do over the next six to 12 months or even the next three years,” said Brian Jacobsen, who helps oversee $241 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin. Her speech “better managed the messages she wanted to get out of the last policy statement.”

Data Driven

Yellen, in her third month leading the U.S. central bank, is encouraging investors to look at the flow of economic data to judge when the benchmark interest rate is likely to rise above zero after the Fed dropped a link to a specific level of unemployment. At the same time, she indicated that the economy needs continued support from the central bank.

“Thus far in the recovery and to this day, there is little question that the economy has remained far from maximum employment,” she said.

Yellen said in her speech wage gains are proceeding at a “historically slow pace,” and the chances of inflation rising above the Fed’s 2 percent goal were “significantly below the chances of inflation persisting below 2 percent.”

The Fed last month scrapped its pledge to keep the main interest rate low at least as long as unemployment exceeds 6.5 percent. Instead, the Fed said it will look at a “wide range of information” when considering the first increase since 2006.

Officials dropped the threshold after unemployment fell to 6.7 percent, even as other indicators showed the job market is still scarred by the deepest and longest recession since the Great Depression.

At the same meeting last month, the Fed released forecasts showing officials expect the federal funds rate to rise faster than they previously predicted. Treasuries fell in response, and selling continued when Yellen said the rate might start to climb “around six months” after the Fed ends its bond-purchase program.

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