Proceeding cautiously with interest rates
Yellen believes the ability to deal with economic shocks is asymmetric. Because interest rates are near zero, she believes it's easier to respond to positive shocks by lifting rates than negative ones by cutting rates. She said:
I consider it appropriate for the Committee to proceed cautiously in adjusting policy. This caution is especially warranted because, with the federal funds rate so low, the FOMC's ability to use conventional monetary policy to respond to economic disturbances is asymmetric.
Yellen added: If economic conditions were to strengthen considerably more than currently expected, the FOMC could readily raise its target range for the federal funds rate to stabilize the economy. By contrast, if the expansion was to falter or if inflation was to remain stubbornly low, the FOMC would be able to provide only a modest degree of additional stimulus by cutting the federal funds rate back to near zero.
Risks to economic growth
One concern was a slowdown in the global economy, which is heavily influenced by China. Yellen said:
There is much uncertainty, however, about how smoothly this transition will proceed and about the policy framework in place to manage any financial disruptions that might accompany it. These uncertainties were heightened by market confusion earlier this year over China's exchange rate policy.
A second concern relates to oil prices. Low oil prices were likely to boost economic activity in the US over the next few years, Yellen said. However she said: "The apparent negative reaction of financial markets to recent declines in oil prices may in part reflect market concern that the price of oil was nearing a financial tipping point for some countries and energy firms."
"In the case of countries reliant on oil exports, the result might be a sharp cutback in government spending; for energy-related firms, it could entail significant financial strains and increased layoffs."
Inflation in the US, once energy and food prices have been excluded, has picked up this year. As measured by the so-called personal consumption expenditures index, it rose to 1.7 per cent in January and remained there last month. Yet Yellen expects to fall again before recovering next year.
Core PCE inflation, which strips out volatile food and energy components, was up 1.7 percent in February on a 12 month basis, somewhat more than my expectation in December. But it is too early to tell if this recent faster pace will prove durable.
"Even when measured on a 12-month basis, core inflation can vary substantially from quarter to quarter and earlier dollar appreciation is still expected to weigh on consumer prices in the coming months," she said.
"For these reasons, I continue to expect that overall PCE inflation for 2016 as a whole will come in well below 2 percent but will then move back to 2 percent over the course of 2017 and 2018, assuming no further swings in energy prices or the dollar."
The tough start to the year for financial markets and the economy led to the Federal Reserve toning down its projections for how quickly interest rates would rise. Financial markets have started pencilling in a slower upward path for rate hikes, and this change in expectations has, by itself, cushioned the economy.
"Financial market participants appear to recognize the FOMC's data-dependent approach because incoming data surprises typically induce changes in market expectations about the likely future path of policy, resulting in movements in bond yields that act to buffer the economy from shocks," Yellen said. She added:
This mechanism serves as an important "automatic stabilizer" for the economy. As I have already noted, the decline in market expectations since December for the future path of the federal funds rate and accompanying downward pressure on long-term interest rates have helped to offset the contractionary effects of somewhat less favorable financial conditions and slower foreign growth.