The high unemployment level results from "a broad-based cyclical shortage of demand" and the Fed is correct to target maximum employment as part of its policy stance, Federal Reserve Board Vice Chair Janet L. Yellen said Monday.
"I believe the policy steps we have taken recently are in accord with [a] balanced approach. With employment so far from its maximum level and with inflation currently running, and expected to continue to run, at or below the Committee's 2 percent longer-term objective, it is entirely appropriate for progress in attaining maximum employment to take center stage in determining the Committee's policy stance," she told a conference sponsored by the AFL-CIO, according to prepared text released by the Fed.
Explaining the Fed hasn't changed its longer-term goals, she said, "what has changed is that the FOMC is now providing more information about how it expects to pursue its inflation and employment goals. In particular, we will employ our policy tools, as appropriate, to raise aggregate demand and employment in the context of continued price stability, consistent with our balanced approach. That's good news for workers, because I believe that these steps will increase demand, and more demand means more jobs."
The Fed has addressed with "urgency" the "gulf between maximum employment and the very difficult conditions workers face today," Yellen said. "My colleagues and I are acutely aware of how much workers have lost in the past five years. In response, we have taken, and are continuing to take, forceful action to increase the pace of economic growth and job creation."
Past recoveries, she said, received boosts from fiscal policy, housing, and the belief that that situation is temporary and things will soon return to "normal."
But in this economic slowdown, "discretionary fiscal policy hasn't been much of a tailwind." While government spending helped in the first year after the recession's end, Yellen noted, it then "actually acted to restrain the recovery," as state and local governments cut spending and, in some cases, raised taxes "to deal with revenue shortfalls. At the federal level, policymakers have reduced purchases of goods and services, allowed stimulus-related spending to decline, and have put in place further policy actions to reduce deficits."
While the deal to avoid the fiscal cliff help prevent another recession, Yellen noted, but "a long-term plan is needed to reduce deficits and slow the growth of federal debt."
Turning to housing, Yellen noted, "residential investment, on net, has contributed very little to growth since the recession ended," which is understandable "given the central role that housing played in the Great Recession."
As for consumers' expectations that recessions are temporary, Yellen said, "In the most recent recession, however, surveys suggest that consumers sharply revised down their prospects for future income growth and have only partially adjusted up their expectations since then."
Also, the Fed usually would cut the federal funds rate and keep it low until the economy is on a "solid footing." While the Fed cut rates, "unlike the past, by December 2008 the Committee had reduced the federal funds rate effectively to zero. Because that rate, for practical purposes, cannot be cut further, this level is referred to as the effective lower bound. Without the option of using its conventional policy tool, and with the recession getting worse, the FOMC decided to employ unconventional tools to further ease monetary policy, even though the efficacy of these tools was uncertain and it was recognized that their use might carry some potential costs."
Yellen stated she believes these unconventional tools "have helped, and are continuing to help … and thus shore up aggregate demand." Still low interest rates "may be doing less to increase spending than in past recoveries because of some unusual features of the Great Recession and the current recovery," including "the housing crisis left many homeowners with high loan-to-value ratios and damaged credit records, creating barriers to their access to credit, while the financial crisis led many banks to lend only to borrowers with higher credit scores. As a consequence, the proportion of households that have been able to take advantage of declining rates to refinance their mortgages or to borrow to purchase new homes has probably been lower than in past recoveries. In addition, pronounced uncertainty about economic conditions has weighed on capital spending decisions and may have blunted the normal effect of lower interest rates on business investment."
The recovery has been slowed because of this, she said.