Fed’s Yellen: A View of the Economic Crisis

The U.S. economy may be about to “turn the corner” and the recession will end later this year, San Francisco Federal Reserve Bank President Janet Yellen said on Tuesday to the Commonwealth Club of California. Fed’s Yellen also said U.S. benchmark lending rates could stay near zero for a couple of years based on the amount of slack now in the economy. Here are some excerpts from her speech:

From the SF Fed:

We’ve seen encouraging signs lately that the economy is poised to turn the corner…I expect the recession will end sometime later this year. That would make it the longest and probably deepest downturn since the Great Depression.
…
I expect that we will turn the growth corner sometime later this year, but I am not optimistic that the economy will spring back to normal anytime soon. What’s more, I expect the unemployment rate to remain painfully high for several more years.

That’s a dreary prediction, but there is also some risk that things could turn out worse. High on my worry list is the possibility of another shock to the still-fragile financial system. Commercial real estate is a particular danger zone. Property prices are falling and vacancy rates are rising in many parts of the country. Given the weak economy, prices could fall more rapidly and developers could face tough times rolling over their loans. Many banks are heavily exposed to commercial real estate loans. An increase in defaults could add to their financial stress, prompting them to tighten credit. The Fed and Treasury are providing loans to investors in securitized commercial mortgages, which should be a big help. But a risk remains of a severe shakeout in this sector.

Turning her attention to inflation she said:

Just a short time ago, most economists were casting a wary eye on the risk of deflation—that is that prices might drop, perhaps falling into a downward spiral that would squeeze the life out of the economy. Now, though, all I hear about is the danger of an outbreak of high inflation.

I’ll put my cards on the table right away. I think the predominant risk is that inflation will be too low, not too high, over the next several years. I take 2 percent as a reasonable benchmark for the rate of inflation that is most compatible with the Fed’s dual mandate of price stability and maximum employment.

… With unemployment already substantial and likely to rise further, the downward pressure on wages and prices should continue and could intensify.  For these reasons, I expect core inflation will dip to about 1 percent over the next year and remain below 2 percent for several years.

If the economy fails to recover soon, it is conceivable that this very low inflation could turn into outright deflation. Worse still, if deflation were to intensify, we could find ourselves in a devastating spiral in which prices fall at an ever-faster pace and economic activity sinks more and more.  But I don’t view this as likely.

emphasis added

Addressing the matter whether the Fed’s resolve is firm enough to tighten policy when the time comes to do so, Yellen said the Fed “won’t hesitate to withdraw the extraordinary stimulus we have put in place”, when necessary. “If anything, I’m more concerned that we will be tempted to tighten policy too soon, thereby aborting recovery.”