Treasury secretary suggests higher interest rates, spooks investors

WASHINGTON – Treasury Secretary Janet Yellen insisted Tuesday she is not concerned about the risks of economic overheating hours after her earlier comments about inflation caused a brief panic on Wall Street and invited fresh scrutiny about the White House’s position.

The confusion sparked by the treasury chief showed the delicate situation the Biden administration confronts as it seeks to demonstrate its attention to inflationary pressures without fueling criticism that its spending packages could hurt the economy.

First, in an interview with the Atlantic that aired Tuesday morning, Yellen defended the administration’s new spending proposals and said the central bank could handle inflationary pressures with modest interest rate increases.

The Fed sets interest rate policy, but Yellen has a unique vantage point, having led the central bank at the end of the Obama administration and beginning of the Trump administration.

Raising interest rates can slow the pace of economic growth by increasing the cost of borrowing, a tool for fighting inflation.

“It may be that interest rates will have to rise somewhat to make sure our economy does not overheat, even though the additional spending is relatively small relative to the size of the economy,” Yellen said. “It could cause some very modest increases in interest rates to get that reallocation.”

Her comments briefly led the stock market to dip and seemed to suggest that White House officials were acknowledging that inflationary pressures were a growing concern.

At a separate event with the Wall Street Journal later on Tuesday, Yellen was adamant that she was not concerned about inflation and stressed she was not predicting or recommending an imminent hike in rates.

“I don’t think there’s going to be an inflationary problem, but if there is the Fed can be counted on to address them,” Yellen said.

The confusion over Yellen’s remarks reflect the broader challenge facing Biden administration officials as they try to demonstrate they are carefully assessing the economic consequences of their agenda.

“US policymakers are testing the limits of Goldilocks: They are trying to heat up the economy as fast as possible without generating serious inflation,” economists from Bank of America Global Research wrote in a recent note.

Yellen has only been Treasury secretary for several months, but she has decades of experience as a policy maker and is not known for verbal miscues.

The Biden administration has so far not suggested it is rethinking any of its ambitious spending plans in the face of inflationary price pressures and Yellen said late Tuesday that the proposals were all necessary to help the economy.

While some economists have complained about all the new and proposed government spending adding to inflationary pressures, there appear to be a number of factors that are driving up prices higher in certain sectors.

Some of them have nothing to do with the government’s spending.

For example, the sudden restart of the U.S. economy and continued problems in global supply chains has led to a shortage on a range of items ¯– from computer chips to rental cars – is driving up prices sharply.

Yellen’s initial remarks added to a dip in the stock market, though the impact was negligible by the time markets closed in the afternoon.

Even though Yellen sought to eventually downplay the near-term risks of inflation, another senior White House official made clear Tuesday that the risks posed by rising prices were something the Biden administration was monitoring closely.

“We take inflationary risk incredibly seriously,” White House spokeswoman Jen Psaki said.

During the Trump administration, President Donald Trump pressured the Fed to lower interest rates to juice the economy and help offset in part the economic pressures caused by his trade war.

Yellen’s initial comments on Tuesday, the ones about interest rate increases potentially being necessary, suggested the Fed could be needed for a different purpose, to cool off an economy that was growing too quickly.

Trump was criticized for trying to jawbone the Fed from the White House, and Yellen tried to make clear on Tuesday that she was not trying to sway the central bank in any way.

“If anybody appreciates the independence of the Fed, I think that person is me,” she said at the WSJ event.

Inflation in recent months has emerged as a potential concern among leading economists, prompting an extensive White House review.

The federal government has pumped trillions of dollars in emergency spending into the U.S. economy since last year, including President Joe Biden’s $1.9 trillion stimulus package, which passed in March.

Some analysts fear this surge in cash will lead consumer demand to outstrip supply, bidding up prices in a way that hurts many Americans. But there are a variety of things causing a spike in supply.

The global supply chain for many products remains under strain, and many products or components remain inaccessible or in rare supply, driving up prices.

The Federal Reserve does have ways to address inflation in their toolkit, but they have not had to aggressively act to combat inflation for decades.

The most extreme recent example of this was in the late 1970s and early 1980s, when the Fed raised its main interest rate benchmark to 20% in an effort to address inflation.

High interest rates can also have other affects on the economy, leading to high unemployment and cash-flow problems for businesses.

The economic conditions now are much different from 40 years ago, and Fed Chairman Jerome Powell has not suggested at all that the Fed sees inflation as a near-term concern.

“We’ve been living in a world of strong deflationary pressures – around the world, really – for a quarter of a century, and we don’t think that a one-time surge in spending leading to temporary price increases would disrupt that,” Powell told Congress in March.

The first quarter report on economic growth, released by the Bureau of Economic Analysis last week, said that prices grew at a 3.5% annualized rate in the first quarter and are up 1.7% from a year earlier.

For now, inflation has primarily spiked only in specific sectors, such as the housing and lumber markets, as suppliers struggle to catch up with a surge in consumer demand.

The most commonly measured metric for aggregate inflation has remained in check, at least up to this point.

Biden has proposed more than $4 trillion in additional spending programs that would be infused into the economy over the course of the decade.

The White House says those programs are paid for with new taxes. Those tax hikes could in theory reduce their inflationary impact, because the government would be taking out about as much money out of the economy as it is putting in.

But the administration has proposed levying those taxes on corporations and high-income Americans, meaning the hikes may do little to slow economic demand because the rich spend a smaller proportion of their income than do recipients of the new federal programs.

After contracting sharply last year, the economy appears poised to grow rapidly in 2021. But the economic recovery has been uneven so far.

The stock market is at near-record highs, but millions of Americans remain unemployed, and some parts of the economy are having a hard time snapping back to pre-pandemic levels.

Prices on some commodities have risen sharply, adding to inflation fears, and there is a shortage of computer chips that go into a number of products.