WASHINGTON — Treasury Secretary Janet Yellen said that the economy could be at risk of overheating if the Biden administration’s spending proposals are approved, raising the prospect that the Federal Reserve could have to raise interest rates to address future inflation.
Her comments, which aired Tuesday and briefly spooked investors, reignited fears raised by some economists and business leaders that trillions of dollars in new spending that the government has authorized since March 2020 could lead the Federal Reserve to take steps that cool off the economy.
In an interview with The Atlantic, Yellen defended the Biden administration’s proposed spending programs but said that if approved they may require the central bank to raise interest rates to prevent the economy from expanding too rapidly. The Federal Reserve — not the Treasury Department — sets interest-rate policy, but Yellen has a unique vantage point, having led the Fed at the end of the Obama administration and beginning of the Trump administration. Raising interest rates slows the pace of economic growth by increasing the cost of borrowing.
’'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, but these are investments our economy needs to be competitive and to be productive.’'
Later on Tuesday, Yellen said she was not predicting or recommending interest-rate increases when remarking about the impact of fiscal spending on the US economy.
“It’s not something I’m predicting or recommending,” Yellen said during an online event hosted by The Wall Street Journal. “If anyone appreciates the independence of the Federal Reserve I think that person is me.”
Yellen, herself a former Fed chair, said she didn’t anticipate a bout of persistently higher inflation — but that if one occurred the central bank has the tools to deal with it.
“The Fed can be counted on to do whatever is necessary to achieve their dual mandate objectives,” she said.
Questions about Yellen’s earlier comments had prompted White House press secretary Jen Psaki, at her daily briefing, to say, “Secretary Yellen certainly understands” the Fed’s independence.
The Biden administration has not suggested that it is rethinking any of its spending plans in the face of inflationary price pressures. And there are a number of factors that appear to be driving prices higher in certain sectors. Some of them have nothing to do with the government’s spending.
For example, the sudden restart of the US economy and continued problems in global supply chains has led to a shortage on a range of items — from computer chips to rental cars — and is raising prices sharply.
Yellen’s remarks created further pressure on the S&P 500, which added to its losses for the day before recovering. The tech-heavy Nasdaq ended up down more than 2 percent.
Yellen’s comments were the most forward-leaning by a senior White House official so far on the issue of inflation, though the administration did not try to instantly distance itself from the treasury secretary.
’'We take inflationary risk incredibly seriously,’' Psaki said.
Yellen’s comments suggest that the Biden administration could look to the Federal Reserve, which Yellen once led, to cool down the economy if their agenda is completely adopted by Congress. Former president Donald Trump pressured the Fed to lower interest rates to combat economic fallout from his trade agenda.
Inflation in recent months has emerged as a potential concern among leading economists, prompting an extensive White House review. Analysts have also noted the delicate balance the Biden administration is trying to find.
The federal government has pumped trillions of dollars in emergency spending into the US economy since last year, including Biden’s $1.9 trillion stimulus package, which passed in March. Some analysts fear that this surge in cash will lead consumer demand to overpower supply, raising prices in a way that hurts many Americans.
The Federal Reserve does have ways to address inflation, but there have not been major concerns about it for decades. Fed chair Jerome Powell has not indicated that near-term government spending increases could suddenly lead to a big inflation 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.
If inflation rises rapidly and prices get too high, the Fed could move to raise interest rates to essentially slow the economy. 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 percent 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.
Material from Bloomberg News was used in this report.