Yellen’s Freudian slip?

The Federal Open Market Committee raised the target for the Federal funds rate for the first and only time in 2016. It now stands at 0.5% to 0.75%. The Fed Open Market Committee Members have – through their summary of economic projections – indicated that there could be three more rate hikes next year. I doubt if the U.S. economy can take more than two. We will see. These are all futuristic statements.

According to Goldman Sachs commentary on the decision, Ms. Yellen compared the current situation to 2007. This is what Goldman wrote:

Chair Yellen went further in the press conference, saying: “we are roughly comparable to 2007 levels when we thought there was a normal amount of slack in the labor market. The labor market was in the vicinity of maximum employment”.

If it truly reflects the FOMC’s views, this is a telling statement. In 2007, the unemployment rate averaged 4.6%, three tenths below the Board staff’s real-time estimate of the structural unemployment rate or NAIRU of 4.9%. Measures of the output gap for that year offer a similar message: the Board’s real-time output gap series as well as the current estimate from the Congressional Budget Office (CBO) are both +0.4% (implying output above long-run potential). Chair Yellen mentioned that broader measures of utilization point to some remaining slack, and she pushed back against suggestions that policy was “behind the curve”. But she did appear to say that the economy was, in effect, at full employment.

That is interesting. Then, the Federal Reserve was too late. They did not tighten but maintained a hawkish tone (bias to tighten). Unbeknownst to them, the economy was weakening and was inching towards the edge of the cliff. They had to cut rates drastically in July – September 2007.

Much a similar story can repeat itself in 2017 too.

Perhaps, that was a Freudian slip on her part yesterday!


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