Although recent trends are encouraging, inflation is still a potential threat to the U.S. economy, the president of the Federal Reserve Bank of San Francisco said.
Janet Yellen, who spoke Wednesday to the Arizona Council on Economic Education in Scottsdale, said the labor market remains tighter than would be expected at a time when economic growth is slow, creating the potential for higher inflation.
She called the strength of the labor market in the face of “middling” economic growth “an emerging puzzle,” noting that the national unemployment rate has declined by 1/2 percentage point to 4 1/2 percent in the past year while the gross domestic product has grown at a leisurely annual rate of only 2 1/2 and 2 percent in the past two quarters.
“The ramifications of this puzzle are significant,” she said. “If labor markets are really as tight as the unemployment rate suggests, then there may be reason for concern about building inflationary pressures.”
She said there could be several explanations for the seeming disconnect, including the possibility that the labor market reaction to the economic slowdown may be delayed. In fact, she said the unemployment rate could creep up to about 5 percent nationally during 2007.
There are other indications that inflation is moderating, including a decline in the price of oil, she said. Also she said labor compensation growth appears to be moderate, although the economic data on that point are conflicting.
Overall, Yellen said the rate of inflation, running at an annual rate of about 2 percent, is too high for comfort.
“I find recent inflation readings encouraging, but I also am keenly aware that this pattern has yet to show up in the data on any sort of a sustained basis,” she said. “In particular there are upside risks to my outlook, especially having to do with the situation in labor markets.”
Despite her worries about inflation, Yellen said she supported the Federal Reserve Board’s decision to hold short-term interest rates steady since last August, following 17 quarter-point increases during the prior two years.
Yellen, who is a member of the Fed’s Open Market Committee that sets shortterm rates, said the fed’s interest rate policy appears to be successful in slowing the economy to reduce inflationary pressures while not hitting the brakes hard enough to risk a recession.“Even if policy is now well positioned . . . it will still take some additional time for inflation to unwind due to lags between policy actions and their impact on economic activity and inflation,” she said.
“This means that we have yet to see the full effects of the series of 17 funds rate increases. Some are probably still in the pipeline.”
Yellen said the housing market, which took a strong hit last year from higher interest rates and higher prices, may be near the bottom. She cited a flattening of prices and a decline in long-term interest rates, which should help to stimulate sales. But she added that housing construction remains down and inventories are still high.