Janet Yellen said if inflation continues to rise, interest rates may need to increase to keep the economy from overheating.  (iStock)

With the threat of inflation on the horizon, Treasury Secretary Janet Yellen said interest rates may need to rise to combat the potential risk. 

"It may be that interest rates will have to rise somewhat to make sure that our economy doesn't overheat, even though the additional spending is relatively small relative to the size of the economy," Yellen said at a virtual event hosted by The Atlantic. "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 [and] I think that our economy will grow faster because of them."

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Yellen was formerly the head of the Federal Reserve under former Presidents Donald Trump and Barack Obama. In this role, she was responsible for guiding the direction of interest rates and had overseen several rate hikes from the Federal Reserve before the pandemic-induced recession. 

When COVID-19 hit, the Federal Reserve quickly dropped interest rates down to zero in an attempt to stimulate the economy. Now, as the economy recovers, Yellen said interest rate hikes may be necessary in order to keep it from overheating. 

However, when asked about her comments later, Yellen downplayed the inflation concern and said she was not suggesting that the Fed raise rates. 

"If anybody appreciates the independence of the Fed, I think that person is me," Yellen said. "I don't think there’s going to be an inflationary problem. But if there is, the Fed will be counted on to address them."

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Even the slowest recovering sector of the economy, the labor market, could be fully recovered as early as next year, Yellen previously stated. 

The U.S. Bureau of Labor Statistics released its latest jobs report Friday showing the U.S. economy gained 559,000 jobs in May. And while President Joe Biden voiced his optimism over the report, economists were much less enthusiastic. 

The report showed the unemployment rate declined by 0.3 percentage points to 5.8% in May. Earlier that week, a report generated using ADP’s employment data showed the market could expect to add close to 1 million jobs in May. But despite this month’s disappointing numbers, Yellen said the labor markets will soon make a full recovery. 

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Yellen previously said she expects the labor market to completely recover by 2022, thanks to the $1.9 trillion stimulus package passed by the Biden administration. 

"We expect the resources [in the bill] to really fuel a very strong economic recovery," Yellen told MSNBC in March. "I’m anticipating, if all goes well, that our economy will be back to full employment — where we were before the pandemic — next year."

With the economic recovery in full swing and a complete recovery expected as soon as 2022, fears have begun to rise that the economy is heating up too fast. If inflation becomes a problem, the Federal Reserve could look at raising interest rates to combat an overheating economy. 

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