Yellen: Fed faces unpleasant mix on prices, growth

by Ros Krasny

CHICAGO (Reuters) – San Francisco Federal Reserve Bank President Janet Yellen said on Friday that the U.S. central bank faces an “unpleasant combination” of risks to inflation and growth in setting interest rate policy.

“The U.S. economy is particularly exposed to downside risks from the unwinding of the housing bubble and disruptions in financial markets,” Yellen said in remarks prepared for Banque de France’s symposium on globalization and monetary policy in Paris.
“There is some slack now in the U.S. labor market and, if these downside economic risks materialize, quite a bit more slack could emerge,” she said, which would tend to dampen inflation.

The dove position: OK to cut now because inflation coming down later anyway.

Still, Yellen said inflation risks were “roughly balanced” and that the Fed “cannot afford to take for granted that inflation expectations will remain well-anchored.”

The hawk position: if you let inflation expectations elevate (and there are signs this is happening), it’s too late, and a much larger output gap is needed to bring it back down.