Fed chief Yellen's news conference after FOMC meeting

The rate hike reflects the committee's confidence that the economy will continue to strengthen. The economic recovery has clearly come a long way, although it is not yet complete, Janet Yellen said.

Washington: The following are highlights from Federal Reserve Chair Janet Yellen`s press conference on Wednesday following the end of a two-day meeting of the U.S. central bank's policy-setting committee.

Yellen on the rate hike and the recovery

It reflects the committee's confidence that the economy will continue to strengthen. The economic recovery has clearly come a long way, although it is not yet complete. Room for further improvement in the labour market remains, and inflation continues to run below our longer-run objective. But with the economy performing well, and expected to continue to do so, the committee judged that a modest increase in the federal funds rate target is now appropriate, recognising that even after this increase, monetary policy remains accomodative.

Yellen on some cyclical weakness remaining

The unemployment rate at 5 percent in November is down 6/10ths of a percentage point from the end of last year, and is close to the median of FOMC participants` estimates of its longer-run normal level. A broader measure of unemployment that includes individuals who want and are available to work, but have not actively searched recently, and people who are working part time but would rather work full time, also has shown solid improvement. That said, some cyclical weakness likely remains. The labour force participation rate is still below estimates of its demographic trend. Involuntary part time employment remains somewhat elevated. And wage growth has yet to show a sustained pickup.

Yellen on outlook for economy, risks balanced

The committee currently expects that with gradual adjustments in the stance of monetary policy, economic activity will continue to expand at a moderate pace, and labour market indicators will continue to strengthen.

Although developments abroad still pose risks to U.S. economic growth, these risks appear to have lessened since last summer. Overall the committee sees the risk to the outlook for both economic activity and the labour market as balanced.

Yellen on raising rates despite low inflation

With inflation currently still low, why is the committee raising the federal funds rate target? As I`ve already noted, much of the recent softness in inflation is due to transitory factors that we expect to abate over time, and diminishing slack in labour and product markets should put upward pressure on inflation as well. In addition, we recognise that it takes time for monetary policy actions to affect future economic outcomes. Were the FOMC to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly at some point to keep the economy from overheating and inflation from significantly overshooting our objective.

Such an abrupt tightening could increase the risk of pushing the economy into recession.

Yellen on decision to keep balance sheet steady for now

Maintaining our sizable holdings of longer-term securities should help maintain accommodative financial conditions and should reduce the risk that the federal funds rate might return to the effective lower bound in the event of future adverse shocks.

Yellen on gradual rate hikes because of low neutral rate

The federal funds rate is likely to remain for some time below levels that are expected to prevail in the longer run.

This expectation is consistent with a view that the neutral nominal federal funds rate defined as the value of the federal funds rate that would be neither expansionary nor contractionary if the economy were operating near potential, is currently low by historical standards, and is likely to rise only gradually over time.

Yellen on neutral not being a policy goal

Neutral is not a policy goal. It is an assessment... Neutral is essentially a stance of policy, a level of short-term rates, which if the economy were operating near its potential -- and we are reasonably, not quite at that, but reasonably close to it -- it would be a level that would maintain or sustain those conditions.

Yellen on timing of rate hike

We decided to move at this time because we feel the conditions that we set out for a move - namely, further improvement in the labour market and reasonable confidence that inflation would move back to 2 percent over the medium term - we felt that these conditions had been satisfied.

We have been concerned, as you know, about the risks from the global economy, and those risks persist. But the U.S. economy has shown considerable strength. Domestic spending that accounts for 85 percent of aggregate spending in the U.S. economy has continued to hold up; it`s grown at a solid pace. And while there is a drag from net exports from relatively weak growth abroad, and the appreciation of the dollar, overall, we decided today that the risks to the outlook for the labour market and the economy are balanced.

Yellen on inflation and further rate hikes

We really need to monitor over time actual inflation performance to make sure that it is conforming, it is evolving, in the manner that we expect. So it doesn`t mean that we need to see inflation reach 2 percent before moving again, but we have expectations for how inflation will behave.

Were we to find that the underlying theory is not bearing out, that it is not behaving in the manner that we expect, and that it doesn`t look like the shortfall is transitory and disappearing with tighter labour markets, that would certainly give us pause. And we have indicated that we are reasonably close, not quite there, but reasonably close to achieving our maximum employment objective.

But we have a significant shortfall on inflation.

Yellen on oil prices and inflation

I have been surprised by the further downward movement in oil prices. But we do not need to see oil prices rebound to higher levels in order for the impact on inflation to wash out. So all they need to do is stabilise.

Yellen on tolerating inflation shortfalls

So yes, we have tolerated inflation shortfalls that we thought would disappear over the medium term, just as we did overshoots of inflation that we also judged to be transitory. But we do need to monitor inflation very carefully, because if energy prices and the dollar were to stabilise...our expectation is that both headline and core inflation would move up. And if we failed to see that occurring in the manner that we expect, of course we would need to take further action to reconsider the outlook and to put in place appropriate policy.

Yellen on recession chances

The underlying health of the U.S. economy I consider to be quite sound. I think it`s a myth that expansions die of old age. I do not think that they die of old age. ... There is a significant odd probability in any year that the economy will suffer some shock that we don`t know about, that will put it into recession.

So I`m not sure exactly how high that probability is in any year, but maybe at least on the order of 10 percent.

Yellen on balance sheet policy

We would reduce the size of the balance sheet to essentially whatever size we needed to manage monetary policy ... in an effective and efficient way.

Now, a lot has changed since prefinancial crisis in terms of the financial system, and we are studying, we are engaging in a project at this time to consider what our long-run operating framework should look like. So I can`t tell you exactly what size of balance sheet we will determine is the best to operate in an efficient and effective manner. It might be somewhat larger than the very tiny quantity of reserves that we had in precrisis. We have not determined that.

We have also said that ... we expect to reduce the size of our balance sheet over time by diminishing or ceasing entirely reinvestments. And beyond that, we haven`t given additional guidance, other than to say that the timing of reductions in reinvestment will depend on economic and financial conditions.

Yellen on rate hike as a show of confidence

So, I think the first thing that Americans should realise is that the Fed`s decision today reflects our confidence in the U.S. economy, that we believe we have seen substantial improvement in labour market conditions, and while things may be uneven across regions of the country, and different industrial sectors, we see an economy that is on a path of sustainable improvement.

Yellen on financial market resilience

I would say that I think we have a far more resilient financial system now than we had prior to the financial crisis, and highly capital banks that are well situated to support corporate lending.

I`d also point out that many corporations during these years have reduced their interest payments and extended their debt profiles. I think that should help to mitigate spillovers. But we will be evaluating this carefully.

Yellen on potential need to reverse rate hike if too early

It is true that some central banks have raised rates and later turned around. Not in every case is that reflective of a policy mistake. Economies are subject to shocks. Sometimes when they have raised rates, it hasn`t been the wrong thing to do, but conditions have changed in a way that they have had to reverse policy to respond to shocks. I`m not denying that there are situations where central banks have moved too early.

We have considered the risk of that, we have weighed that risk carefully in making today`s decision. I don`t believe we will have to do it.

Yellen on risks to growth

We want to be careful about downside risks. But consumers are in much healthier financial condition. Their income prospects have improved. We see them buying a lot of cars. Housing has been recovering very slowly, but the demographics would point to considerable upside for residential investment.

My main line forecast is for gradual recovery, but there is upside risk there. We have seen that the decline in drilling has been depressing investment spending, but there is upside risks too.

There are many countries that are undergoing very difficult adjustments or slowing growth, especially with declining commodity prices. But even recently, we have seen growth in emerging markets strengthen.

Yellen on inflation models

We have many people who are studying inflation models. I`ve tried to, let me express some humility about them. I do not think that they are perfect. ...We throw out models that are persistently not working. We are always trying to develop better models. I`m not aware, I will say, of a different model of inflation that would be superior to the one that we employ.

Yellen on wages

So, my expectation is that in a strengthening labour market, that we would see faster wage growth. And I believe there is, with a 2 percent inflation objective, space for wage growth to be higher than it`s been.

We may be seeing some incipient signs of faster wage growth. We have seen a pickup in measures of hourly compensation, and some slight firming in recent months in average hourly earnings.

I hesitate to say that this is a firm trend. We have been disappointed in the past. Wage growth is not - there are many factors that affect it. It is not definitive in any sense in determining our policy. But it does have a bearing on the inflation outlook. It also has a bearing on assessing how much slack there is in the labour market, and I think a number of my colleagues looking at the slow pace of wage growth ... you have seen that their estimates of the longer run normal unemployment rate have come down.

Yellen on emerging markets

We have made a commitment to emerging market policymakers that we would do our best to communicate as clearly as we could about our policy intentions to avoid spillovers that might result from abrupt or unanticipated policy moves. I think this move has been expected and well communicated, at least I hope that it has.

My general view is that many emerging markets are in a stronger position than they would have been in the 1990s, for example...On the other hand there are vulnerabilities there ... so we will monitor this very carefully.