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.”

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2 Comments on Fed’s Yellen: A View of the Economic Crisis

  1. It seems like an inevitable downward spiral: unemployment, downward pressure on wages and prices and low inflation that could turn into deflation. If the U.S. economic upward turn doesn’t benefit the job market, where does that leave the rest of us. Turning to spiritual guidance may be the next step, which would curb the distinction between church and state but possibly lead to a more informed public. I just hope this “transitional moment” doesn’t lead to the two becoming totally intertwined.

  2. Let’s be clear – deflation is a horrible thing, and we’re certainly slowly heading towards the conditions necessary for it, but no one is saying we’re anywhere near it or that the prospects of falling into it are especially high right now.

    Checking the consumer price indices since the financial crisis hit last fall, we have month to month changes in inflation of {0%, -2%, -3%, -2%, +1%, 0%, -1%, 0%, 0%, +2%}, hardly what I’d call persistently negative numbers.

    Dr. Yellen put it very well, pointing out that we’re looking at sub 2% inflation (disinflation), making the right conditions for but not necessarily precipitating deflation (it makes it conceivable if and only if the effects of high unemployment drive wages and prices down).

    My point: There’s a difference between necessary and sufficient causes of deflation, so let’s not go crazy speculating here.

    That said, does anyone else see the good news in this? Yellen independently asserts what Bernanke and the FOMC has been saying for months – we know when the recession is ending – it’s ending in Q3 FY09 (followed by unemployment topping off in Q2 FY10 – Yellen didn’t mention unemployment, but the FOMC has).

    The Administration’s most conservative estimates have GDP going positive in Q4 FY09 and unemployment maxing out a year later in Q4 FY10. The always thougtful Mark Zandi estimates positive GDP growth at least by Q4 FY09 and unemployment turning around in Q3 FY10.

    The bottom line is: the recession is ending THIS YEAR, and unemployment is turning the corner NEXT YEAR. It will be a jobless recovery, but doesn’t it make you feel good to know to know that there’s an evidence-based consensus building on exactly how bad it’ll be and when we should expect it to end?

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