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US Treasury secretary Janet Yellen warned on Tuesday that interest rates may need to rise over time to keep the US economy from overheating, exacerbating a sell-off in technology stocks before she clarified her remarks later in the day.
The former Federal Reserve chair made the comments in the context of the Biden administration’s plans for $4tn of infrastructure and welfare spending over the next decade, rather than the $1.9tn economic stimulus already enacted this year because of the pandemic.
“It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat, even though the additional spending is relatively small relative to the size of the economy,” she said at an event hosted by The Atlantic magazine.
“So it could cause some very modest increases in interest rates to get that reallocation. But these are investments our economy needs to be competitive and to be productive.”
Yellen’s remarks captured the attention of investors and economists who have been hotly debating whether the trillions of dollars of federal spending planned by Biden, combined with the rapid vaccination rollout, will cause a jolt of inflation that may force the Fed to intervene by tightening monetary policy.
The comments seemed discordant with Yellen’s previous views, shared by other Biden administration officials and the Fed, that any inflationary pressures in the US would be transitory. She also appeared to wade into the arena of monetary policy, which Treasury secretaries typically leave to the Fed.
In a later appearance at The Wall Street Journal’s CEO Council on Tuesday afternoon, Yellen clarified her remarks, saying higher rates were “not something I’m predicting or recommending” and she did not think there was “going to be an inflationary problem”.
“If anybody appreciates the independence of the Fed. I think that person is me,” Yellen added.
Yellen’s initial comments added extra pressure to shares of high-growth companies, whose future earnings look relatively less valuable when rates are higher and which had already fallen sharply early in Tuesday’s trading session. The tech-heavy Nasdaq Composite ended the day down 1.9 per cent, while the benchmark S&P 500 was 0.7 per cent lower.
Market interest rates, however, were little changed, with the yield on the 10-year Treasury at 1.59 per cent.
The Fed is still far from raising interest rates, saying the US economy would have to reach full employment, with inflation hitting 2 per cent and be on track to exceed that level moderately for some time, before the first upward move.
Higher interest rates eventually would be a reflection of the Biden’s administration’s success in fuelling the US recovery. But the fear among some investors is that the Fed might be forced to act sooner and too aggressively if inflation spirals upwards uncontrollably, and inflation expectations become unmoored.
Yellen said she believed the Fed had the “tools” to control inflation effectively if needed and stressed that Biden’s investment plans, if enacted, would be spread over several years and would not add to US deficits in a negative way.
“Those investments will be phased in gradually over time. The proposals we have are for eight to 10 years, and involve more modest increases in spending, and tax increases to largely pay for them,” Yellen said at the WSJ event.
She added she “frankly disagrees” with Larry Summers, the former US Treasury secretary, who warned that the $1.9tn stimulus plan was excessive and too risky from an inflation perspective.
In both appearances, Yellen made the case that Biden’s spending plans would address structural deficiencies that have afflicted the US economy for a long time.
Biden’s $4tn plans would fund investment in infrastructure, child care, manufacturing subsidies and green energy to tackle a swath of issues ranging from climate change to income and racial disparities. Yellen said those investments had been “really short-changed or ignored” for too long.
When asked about her interactions with Jay Powell, the Fed chair, since becoming Treasury secretary, Yellen said they meet roughly on a “weekly basis” when they are both available.
“We have a wide range of issues we talk about, but it is entirely up to the Federal Reserve, how they manage monetary policy. It’s something I’m not going to give opinions about.”
Earlier in the day, Jen Psaki, the White House press secretary, said Biden “certainly agrees with his Treasury Secretary” and inflation concerns were closely watched at both the White House and the Treasury.
“We . . . take inflationary risk incredibly seriously, and our economic experts have conveyed that they think this would be temporary and that the benefits far outweigh the concern,” Psaki said. “I think [Yellen] was simply answering a question and conveying how we balance decision-making here.”