In a speech in 2017, Fed Chair Janet Yellen described the long-run federal funds rate that is consistent with achieving the Fed’s mandate of high employment and price stability as the “neutral rate,” which she estimated to be about 3 percent. Yellen noted, “Waiting too long to begin moving toward the neutral rate could risk a nasty surprise down the road—either too much inflation, financial instability, or both. In that scenario, we could be forced to raise interest rates rapidly, which in turn could push the economy into a new recession.”
a. Why is it potentially a problem for the Fed to “wait too long” to raise its target for the federal funds rate? Can’t the Fed just wait until inflation increases and begin to slowly increase the target at that time?
b. Why might interest rates being too low lead to financial instability?
c. Why might the Fed’s rapidly increasing its target for the federal funds rate push the economy into a recession?