Fed’s Yellen Recovery Model to Be Put to Test With Rate Hike

Janet Yellen is guiding the Federal Reserve towards its first rate rise in a decade armed with traditional economic models that some economists worry could fail her in a world of massive money printing and near zero rates.

The 69-year-old economist argues the time is coming for a rate-lift-off even though inflation has yet to accelerate, trusting decades of studies that suggest a tight labor market eventually creates inflationary pressures.

It is a risky wager considering that global inflation is at historic lows and many central banks remain in an easing mode as their economies struggle to get any traction.

If she is right, Yellen, who has already presided over the end of the Fed’s bond-buying stimulus program, will cement her reputation and that of her “dashboard” that relies on long-established relationships between jobs, wages and prices.

If she is wrong, the Fed could join the European Central Bank and the central banks of Sweden, Israel and Canada, which have all tried, but failed, to escape the drag of zero rates in the wake of the 2007-09 financial crisis.

There are reasons to doubt conventional economic theory. Many economists predicted a spiral of falling prices when the U.S. jobless rate soared during the crisis and then thought inflation would rise when unemployment plunged. Neither happened, though Yellen has maintained this year that the Fed was on course for rate increases, which would be “data dependent,” likely gradual, and with no pre-set path.

via SOURCE

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