© Bloomberg. Janet Yellen at the US Treasury Department in Washington, DC, on Jan. 10.
(Bloomberg) — US Treasury Secretary Janet Yellen said persistently weak inflation is likely to return as a long-term challenge for the economy and policymakers once pandemic-era distortions behind the recent surge subside and prices cool.
“We’re just coming through an unusual and difficult period, but I do not think we’re in any way back to the ’80s and ’70s,” she said in an interview, referring to an era of rising prices and wages.
While central banks still have a long way to go to smother the worst bout of inflation in decades, with prices on the downtrend the debate is now shifting to what happens after this fight is over.
The risks of getting it wrong are high, economically and politically. Yellen, along with Federal Reserve Chair Jerome Powell and many in the US economic establishment, incorrectly predicted in 2021 that the burst of inflation would be “transitory.”
She has since admitted getting that call wrong and supported the Fed’s efforts to rein in prices with aggressive interest rate hikes, which risk pushing the US into a recession.
Unlike in the 1970s and early 1980s, Yellen said the current episode of high inflation hasn’t triggered a wage-price spiral, a dynamic in which workers demand raises in anticipation of higher prices, prompting firms to increase prices. Economists look for signs of such a spiral in inflation expectations.
“Expectations have been well-anchored, and I believe they’re still pretty well anchored,” she said in the interview on Friday in Johannesburg, on the final leg of a three-nation visit to Africa. “So we’re not seeing a wage-price spiral. That’s not happening.”
The annual increase in the consumer price index topped out at 9.1% in June, but has slowed to 6.5% as of last month in response to the Fed’s rate hikes, as well as easing supply chain stresses and sliding oil prices.
Former Treasury Secretary Lawrence Summers and Kenneth Rogoff, an ex-chief economist for the International Monetary Fund, are among those who have warned the world’s economy is entering a period of geopolitical tensions and debt crises that risk making episodes of high inflation and high interest rates more common.
Another former IMF chief economist, Olivier Blanchard, is more aligned with Yellen, arguing today’s inflation will not last and that central banks, including the Federal Reserve, will face a return to an environment where interest rates are uncomfortably close to zero. He’s proposed that central banks lift their inflation targets from 2% to 3% to counter that.
Yellen spent a quarter century at the Fed, including four years as chair from 2014 to 2018. During almost that entire tenure, inflation was historically low thanks to demographics, technology and globalization.
The Fed’s preferred gauge of inflation, the personal consumption expenditures index, rose by an annual average of 1.9% — below the Fed’s current target — from 1992 to 2019. Many policymakers have worried that was actually too low, forcing interest rates close to zero and robbing the central bank of the ability to fight recessions with deep rate cuts.
That streak was shattered by Covid-19, marked by supply-chain disruptions and government aid in the US that jacked up demand, and then Russia’s invasion of Ukraine early last year triggered a spike in energy and food prices. Such jumps since the mid-1980s have tended not to last, she said.
“The pandemic created such unusual disruptions in the economy,” she said. “There were just a lot of supply-chain problems. We really hit the wall in a bunch of different sectors and prices really skyrocketed.”
Yellen didn’t say how long she thought it would take for inflation to return to target, nor did she comment on how the Fed should react if it did.
Federal Reserve Chairman, Janet Yellen expressed caution about US inflation in a speech on Wednesday, indicating that it may pose a more significant long-term challenge than some other issues.
Speaking in London, Yellen expressed concern that inflation could remain too low in the long-term and warned of the potentially negative economic side-effects of low inflation. The Fed has long held its 2% inflation target as a goal, however; inflation has been lower than expected since last year.
Yellen highlighted the difficulty of the Fed in dealing with an inflation rate that remains consistently below the 2% target. She noted that the Fed has to balance the risk of raising inflation too high with the danger of having it persistently remain too low. Yellen also warned that “persistently low inflation potentially undermines public confidence in the central bank’s commitment to its inflation objective and thus can impede the attainment of price stability”
The U.S. economy, sustained by low-interest rates, has improved since the Great Recession, but inflation has remained sluggish. While low inflation can help consumers by keeping prices from rising too quickly, Yellen warned that it can also be dangerous in the sense that it can restrain wage growth and hamper investment.
Finally, Yellen expressed her support for the Fed’s current accommodative policies, arguing that they remain an effective tool in reviving the economy.
Given the challenges that persistently low inflation poses, Yellen concluded her speech by reaffirming the importance of the central bank’s 2% inflation target. She encouraged central banks to continue to monitor inflation and find creative solutions to the challenges posed to them by low inflation.