Yellen: Big Spending Could Require Interest Rate Hikes

Treasury Secretary Janet Yellen speaks during a virtual roundtable event on Feb. 5.

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Acknowledging that President Joe Biden’s ambitious government spending proposals could have ripple effects on the economy, U.S. Treasury Secretary Janet Yellen said she could foresee the need to raise benchmark interest rates to prevent overheating.

"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,” Yellen said when asked about the degree of government spending that Biden, her boss, has proposed. “So it could cause some very modest increases in interest rates to get that reallocation."

Yellen was interviewed on Monday by Ron Brownstein, senior editor at The Atlantic, and the magazine aired the interview during a live-streamed economic summit it hosted on Tuesday.

Later in the day, at a separate live-streamed summit hosted by the Wall Street Journal, Yellen—the former chairwoman of the Federal Reserve—clarified that she was neither predicting nor recommending the Federal Reserve raise its target for the benchmark fed funds rate, suggesting her earlier comments were meant only to point out that the Fed has the power to control inflation if that’s needed.

"Let me be clear, it's not something I’m predicting or recommending. If anybody appreciates the independence of the Fed, I think that person is me, and I know the Fed can be counted on to do whatever is necessary to achieve their dual mandate objectives,” she said in answer to a question from Gerald Seib, a Wall Street Journal editor. “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."

The Federal Reserve has maintained the target for the fed funds rate at virtually zero since the start of the COVID-19 pandemic and doesn’t foresee raising it until at least 2024.  As recently as last week’s meeting of the Fed’s Federal Open Market Committee, Fed Chairman Jerome Powell reassured the public the central bank wasn’t planning to change course, even as it acknowledged inflation is on the rise and the economy is strengthening. An increase in the rate would mean higher household borrowing costs for homes, cars, and everyday items.

Even before Yellen’s comments, some economists suggested government spending, coupled with supply chain bottlenecks, could trigger an inflation problem, and in turn, push the Fed to raise interest rates sooner than expected.

The economy this year has surged, benefiting from the rollout of COVID-19 vaccines as well as a massive infusion of government aid. After two relief packages, including the $2.2 trillion CARES Act, were approved by Congress under the Trump administration, Biden's $1.9 trillion American Rescue Plan was passed, authorizing additional stimulus checks and extending benefits like a federal supplement to weekly state-administered unemployment insurance. 

Now Biden’s administration is proposing another roughly $4 trillion in spending under the American Jobs Plan and the American Families Plan, calling for huge investments in roads and bridges, child care subsidies, universal preschool, and more. 

Proposed tax increases on corporations and the wealthy, as well as measures to tamp down tax evasion, should help pay for the programs on the table, and the time is ripe to invest in the country, Yellen said.

“We’ve gone for way too long letting long-term problems fester in our economy,” she said.

“We have a reasonable amount of fiscal space because we are in an environment—have been for a long time, and probably will be for a long time to come—an environment of low rates,” she said. 

“These are investments our economy needs to be competitive and to be productive,” she said. “I think that our economy will grow faster because of them.”