Former Federal Reserve Chair Janet Yellen recently spoke in Washington, D.C., to me and other attendees of Charles Schwab’s IMPACT conference. From the Fed’s recent rate increases and U.S. trade battles with China to prospects for national economic growth and her meetings with President Donald Trump, Ms. Yellen addressed a wide range of topics.
A few highlights:
A recession is neither inevitable nor imminent. Ms. Yellen noted that if U.S. economic growth continues through next June, it will be the longest positive stretch in U.S. history. While she is concerned about a build-up of national debt, Ms. Yellen also said she does not think recession will happen in the near term because she is not seeing strong signs of two drivers of recession: (1) large imbalances in the economy and (2) a too-rapid increase in rates by the Fed. She noted that the current rate of growth in the United States is not sustainable from a demographic perspective. As a result, she said she thinks the Fed needs to continue to raise rates — and that the pace so far has been a good one. The Fed, she added, is taking a more measured approach than it did in 2006.
Interest rates are likely to stay low for a while — and 3% is a reasonable Fed funds target. Demographics are the big driver here. Ms. Yellen said that with an aging population and demand for safe assets, real interest rates (net of inflation) of about 1% are probably reasonable. With inflation at 2%, she thinks the Fed unds rate will need to reach 3% from 2.25% where it currently is today to meet the real target rate of 1%. So, in other words, there is still some room to grow.
Current GDP growth puts the economy at risk of overheating absent improvements in productivity. Continued GDP growth of 3% would eventually eliminate any remaining slack in the labor market. If we are then unable to produce enough goods to satisfy demand, the economy could face a rapid increase in inflation. Viewed through this lens, Ms. Yellen said she sees 2% GDP growth as a more sustainable pace. However, she also said she sees a small possibility that the decrease in taxes on business, if used to increase capital expenditures, could increase productivity and allow for a higher rate of growth.