Janet Yellen: Surprisingly resilient American consumers blocked a recession—and now the Fed could keep interest rates higher for longer

Despite record inflation, soaring interest rates, and geopolitical conflicts, Yellen expressed optimism for the US economy in an interview at Fortune’s CEO Initiative conference.

The strong labor market and resilient US consumer contributed to a soft landing, Yellen told Fortune CEO Alan Murray. She gave her predictions on what the Federal Reserve could do next with interest rates, and how booming artificial intelligence could impact the economy.

Yellen also said she doesn’t believe the U.S. should de-couple from China, and that it’s urgent Congress allocate funds for Ukraine.

See a full transcript of the interview below.

Inflation, recession, and economic outlook

Alan Murray: So good to see you. I really, really appreciate you being here. So, you had a wild weekend. 

Janet Yellen: We’re waiting to see whether the government would stay open or shut down.

Alan Murray: And really all that happened was they kicked the ball down the road 45 days and Moody’s is threatening to downgrade US debt. So, I guess the first question for you is, is this mess going to change the relative optimism you had about the US economic outlook?

Janet Yellen: Look, I’m very optimistic about the US economic outlook, short term. Inflation is coming down in the context of an extremely strong labor market, what people would normally call a soft landing,

Alan Murray: Which is amazing, by the way, it hardly ever happened.

Janet Yellen: Correct. And it’s great, because, of course, we want to see inflation come down, it’s been burdening Americans. But we want to maintain the good strong labor market that we have. And we seem to be on that kind of path and medium term, we are now engaging in a very substantial program of investments, to strengthen our economy, to boost our productive capacity to boost productivity growth, to draw more American workers into the labor market, and to address long standing structural problems, like climate change and inequality across people, races, and places.

Alan Murray: I want to talk about that. But before I do, I suppose I should let this group in on a little secret about our past. Yeah, which I hesitate to do, because it highlights my age, and may then also highlight me. But I have a master’s degree in economics, which I got at the London School of Economics for which was the one year that Secretary Yellen taught there. So, she taught me what little I know about macroeconomics, I learned from Janet Yellen. I have wonderful memories of you drawing ISLM curves and Phillips on that big Blackboard, three tools. So, I asked this question. With that in mind, the people who almost hung us up this weekend are concerned about government spending. We have a budget deficit of one and a half trillion dollars. If I had said to you back when we were at the London School of Economics that we were going to end up in that place, I think you would have used your curves to show me that’s not a good scenario. So how is it that that’s okay?

Janet Yellen: Okay. That’s a great question. And as Treasury Secretary, I feel it’s my job to worry about fiscal sustainability. So, I do think it’s critical that we establish spending and revenue targets that put us on a path where fiscal policy is sustainable, and a path that’s consistent with solid growth. And I believe now, we’re on such a path. So, one way to judge it, because our economy is now all about big numbers. And a trillion is certainly a big number in half. Our economy has a large GDP and so forth. I think the metric that I think is most relevant to judging fiscal sustainability is the amount that we’re spending to service the debt, real net interest payments as a share of GDP, how much of our GDP goes to service the debt? And the answer over the next 10 years in the mid-session review, which is the most recent budget forecasts that the administration prepared? The answer is 1%.

So real net interest as a share of GDP is about 1%. That’s historically, completely normal. Some guidelines would say, try to keep it under 2%. But it’s 1%. For the next decade. Now, I will say that that budget does assume meaningful deficit reduction over the next 10 years, there were $3 trillion of deficit reduction incorporated into it, along with a significant program of investments in our economy, but ones that are financed by collecting greater revenues in the way that we think is it fair where the burden largely falls on corporations and very high-income taxpayers.

Alan Murray: And I do want to come back to the investment piece of it. But before I do, I mean, the other thing that that assumption depends on is how long do interest rates, which is a big issue, not just for the government, but for any company that’s carrying a substantial amount of debt, how long? Or how long? Are we going to, you know, are we going to have to roll over all our debt at rates that are double what we initially had? 

Janet Yellen: The answer is, I don’t know. It’s a great question. And it’s one that’s very much on the administration’s mind. You know, when the administration came in during the pandemic, we had had a decade of interest rate, short term interest rates with zero long term interest rates higher but very much lower than today’s interest rates. And the interest burden was almost nonexistent at that point. Now, the forecasts we’ve made assume that interest rates will rise toward more normal levels. But we are seeing, especially over the last several months, a pretty significant increase in not only tenure, nominal yields, but also real yields. And there’s a question mark, just why is that?

Alan Murray: Why are we going back to something that looks more like the history prior to 10 years ago than the last 10 years? 

Janet Yellen: That’s a very important question. One view is that it may take a longer period of somewhat higher interest rates to control inflation to keep it down. But in the medium term, interest rates will go back to more normal levels. It’s also possible that longer term interest rates will be higher than we thought. But I would point out that for many decades, the level of real interest rates not only in the United States, but in many advanced economies had been moving down. Yeah. And it was felt by most economists that there were strong structural reasons why that occurred.

Alan Murray: You know, this is why I loved you as a teacher way back when, because you could explain to me both sides of the equation, but what do you think, give us? What do you think we’re going to go back to extraordinarily low interest rates? Or do you think we’re going to be living with this for a long time?

Janet Yellen: So, I think the structural forces that lead us to believe interest rates would be low. Yeah, they’re alive and well. And we’re talking about aging populations, high propensities to save globally weak investment opportunities. Now, you know, there are a lot of investment opportunities associated with climate change. You could imagine a world where we get very serious about investment in, in climate related investments. And if investment were generally stronger, both private and government could push up real interest rates. I’m not sure we’re on that path. Although in the United States, we are seeing full increases.

AI technology and the job market

Alan Murray: And I am going to get to that, I promise. But the other thing we’ve been talking about here today is the extraordinarily quick adoption of generative AI technology. I think Erik Brynjolfsson said earlier that most waves of technology take like 10 years before you start to see him in the productivity numbers, he thinks this one’s going to be much faster. We’ve seen lots of anecdotal evidence of huge productivity gains. If I studied my books correctly, way back then a big increase in productivity could make a huge difference to all the things we’re talking about growth, inflation, etc. Do you think we’re on the verge of a? We’ve had disappointing productivity for the last decade, are we on the verge of something significantly better?

Janet Yellen: So, I will say, I’m not an expert in AI. From what I understand, as you just said, the progress in this area is unbelievably rapid. And I think it could make a significant difference. Isn’t administration as a country, we’re also working on a whole set of investments, that should be productivity boosting over the medium term. We’re addressing the problem of crumbling roads and highways and infrastructure that really hasn’t been appropriately designed for a modern economy, we have a huge, you know, we passed really a trifecta of legislation, the bipartisan infrastructure bill, the chips, and semiconductor act, and then the Inflation Reduction Act. So, we’re investing in R&D in ways we haven’t in decades, restoring us Leadership in Science and Technology. We have a huge program of incentives.

Alan Murray: Maybe a significant increase in productivity.

Janet Yellen: Yes, but let me be careful, because productivity growth, usually a 10th or two here is regarded as a big a big thing. So, I don’t want to pull numbers out of a hat or understand the uptick. I think there will be a payoff because I don’t want to exaggerate.

Semiconductors, clean energy, and China

Alan Murray: So, let’s talk about the investment agenda. You’ve because you’ve focused on it. investment of infrastructure, obviously, that’s important to the economy needs to happen and kudos on making that happen. Investment in R&D. We’ve seen how that pays off, we wouldn’t. That’s where the Internet came from, right? Government R&D but we’re also doing something that in my career we’ve never done before, which is really a big move towards industrial policy, you know, what the, what we’re doing with semiconductors, what we’re doing on batteries, what we’re doing on solar trying to recreate those industries in the United States. 

I guess my question for you is, theoretically, I get the case for that. But that is not something we have much experience or skill at doing. We don’t have the institutions to do it. We don’t have a political system that can support it over the long term. I mean, we don’t know what’s going to happen. And in the next election, it could be an administration that’s opposed to all those programs. So how can you give this group confidence that those things will work?

Janet Yellen: So, I believe, although throughout my career, it’s not as though I’ve been a strong believer in industrial policy generally. I think if you look at the semiconductor industry, and the way in which it’s evolved globally, over decades, what you see your enormous government interventions in virtually every country that plays a significant role, and the United States is set back on its hands and allowed other countries to, through massive subsidies to, you know, real, really build their own capacity in semiconductors. And I think this is an issue with real national security concerns. And there are technology spillovers, and interactions that we’re fooling ourselves if we think that abandoning for all practical purposes, semiconductor manufacturing, is a smart, smart strategy for the United States.

Alan Murray: And how many areas like that are there? Mark Warner was on the stage earlier this morning. And he was talking about a pretty big expansion from the ones I’ve already mentioned, he was talking about biotechnology and mentioned several other categories. He thinks we have to get in this game in a big way.

Janet Yellen: So, you mentioned two in those are the two that I think we’re focused on semiconductors, in part because it’s critical role, both national security and to other technological developments, that I think that’s justified. And in the case of clean, clean energy. You know, partly, I think we have developed a huge over dependence on China, as a supplier in these areas, and trying to subsidize its industry. We had a solar panel manufacturing industry in the United States that was essentially put out of business. You know, maybe we’ll talk about China. I’m not sure if that’s where you want to go. But I’m a believer that we should stay involved. Yes. 

I don’t believe we should decouple it all from China. But I do think we have; we need to lower risks in the sense that we have over dependence on China in areas that are critical to our national well-being. And I think clean energy is among those. So, you know, this the subsidies the tax subsidies in the Inflation Reduction Act, they provide huge incentives, both to do things in the United States to increase is our own domestic capacity, by the way, creating really some good jobs, especially for people who’ve been losing out in this economy, people who don’t have a college education. We’ve seen $500 billion in manufacturing investments that have been announced, because of these three, these three pieces of legislation.

Alan Murray: People who are in this room today. So, I want to open this up. I have a lot of questions, but I don’t want to monopolize your time if other people are out there who have questions. We have one right here.

Bond vigilantes

Audience Member: How concerned are you about the return of the bond vigilantes and the market dictating your borrowing rate versus the Fed?

Janet Yellen: Well, I mean, I take it that markets did determine bond rates. The bond vigilantes, I think I first came in, heard that term back in the early 1990s, when inflation was high. And interest rates were moving up in 94, and 95. And nominal, you know, 10-year yields kept rising higher and higher, suggesting that the Fed’s work wasn’t done, and they weren’t doing enough. And the concern was that the bond markets were driving the Fed’s behavior, and that they would continue pushing the Fed to the point where the economy would fall into a recession. Now, I don’t honestly think that that’s the case. Now. I think the markets are trying to figure out what the Fed and other central banks are going to need to do to make sure that inflation stays low. I don’t want to comment from my current perch on details of monetary policy. 

But, you know, I think I think we’ll see; some people have been surprised that the US economy has shown so much resilience, consumer spending remains strong, investment spending is solid, housing is usually clobbered by tight monetary policy. And this has been but it’s stabilized and seems to be moving up. And so, I think people are trying to figure out exactly what it’s going to take to keep inflation moving down. And the economic resilience that they see may suggest higher for longer, but we’ll see. And I think it’s by no means a given.

Speaker McCarthy and government shutdown

Alan Murray: Last question, and we can do this quickly. It’s a yes or no kind of question. Speaker McCarthy kept the shutdown from happening this weekend, he now stands to lose his position because of a grip of renegades in his own party. Should the Democrats in the House help him keep his job? Is it a yes, or no? 

Janet Yellen: I am going to say neither yes nor no. You know, it’s for the Republicans and Democrats in the House to figure that out. I’m pleased that they were able to keep the governor glad he did. Yes. We have a lot more to do. We have until mid-November to pass appropriations bills as a continuing resolution. It’s urgent that the Congress allocate funds for Ukraine. That hasn’t been done. That’s really our focus. exactly whether the speaker survives or who’s speaker and how that how that happens. I’m going to leave, it’s not the remit of the Secretary of the Treasury. No, it’s not.