NEW YORK - Federal Reserve Vice Chair Janet Yellen Wednesday night said years of high unemployment and 2%-or-less inflation lie ahead and if not, it's "completely appropriate" to modify the 2014 language of the Fed's conditional commitment if necessary.
Speaking to the Money Marketeers of New York University, Yellen said she is prepared to either ease more or tighten sooner and acknowledges there could be upside surprises with GDP and downside surprises, particularly if world events trigger a big oil price spike.
A labor economist, Yellen used extensive charts as well as parenthetical comments presented as footnotes to a lengthy text to cast doubt on several common assumptions while making clear unemployment is her primary concern, not inflation.
Extended jobless benefits may have an effect in prolonging job searches, but only temporarily. Most of current unemployment seems to be cyclical, she said, not structural. But she said there remains a risk that long-term unemployment could become structural. She doubts that "house lock" is depressing job mobility or that there is a significant mismatch between job openings and available skills.
"The labor market has shown welcome signs of improvement," she said. "Even so, the economy remains far from full employment. Furthermore, the improvement in labor market conditions has outpaced the seemingly moderate growth of output."
On price stability, she said, "While the jump in energy prices is pushing up inflation temporarily, I anticipate that subsequently inflation will run at or below the Committees 2 percent objective for the foreseeable future."
She skipped some of the early pages in delivering an abridged version of her prepared text, including a recounting of the Federal Open Market Committee's latest quarterly forecast.
She emphasized that the seeming recent progress in hiring "must be kept in perspective" and the overall view is that "these job gains still leave us far short of where we need to be."
Private payrolls "remains nearly 5 million below its pre-recession peak, and the unemployment rate stands well above levels that I, and most analysts, judge as normal over the longer run," she said.
Her speech was illustrated by a long series of charts, several of which showed the modest progress made from the steep trough of the 2008 crisis.
The part of the unemployment picture that is structural in nature "is uncertain," she said, "but I read the evidence as supporting the view that the bulk of the rise in unemployment that we saw in recent years was cyclical, not structural."
Indeed, she added, "measures of the dispersion of employment changes across industries did not increase more than past experience would have predicted given the depth of the recession."
She also said that so-called house lock, the reluctance or inability of homeowners to sell as house prices drop or when underwater on their mortgages, "is not having a significant effect on the level of structural unemployment." Homeowners and renters show the same reduction in mobility, even in areas where house prices have declined the most.
The relationship between unemployment and job vacancies, the Beveridge curve, tends to reinforce the view that most unemployment is cyclical, she said.
However, what indications there are that unemployment has been declining less than it should, considering job vacancies, could reflect "increases in the maximum duration of unemployment benefits."
"The influence of these benefits will dissipate as they are phased out and the economy recovers," she said. Meanwhile, "vacancies typically adjust more quickly than unemployment to changes in labor demand, causing counterclockwise movements in vacancy-unemployment space that can look like shifts in the Beveridge curve."
Yellen said she is concerned that those unemployed for long periods "could become less employable as their skills deteriorate," an outcome that "does not appear to have occurred in the wake of previous U.S. recessions."
"The risk that continued high unemployment could eventually lead to more-persistent structural problems underscores the case for maintaining a highly accommodative stance of monetary policy," she said.
Even a "very large and favorable forecast error would not change the conclusion that slack will likely remain substantial for quite some time," she said. "I anticipate that growth in real gross domestic product (GDP) will be sufficient to lower unemployment only gradually from this point forward, in part because substantial headwinds continue to restrain the recovery."
The overhang of vacant housing, dampening new construction, and the effect of high unemployment on housing demand, restricted mortgage credit and uncertainty over the direction of house prices all make up a headwind slowing the recovery, she said.
"A second headwind comes from fiscal policy," she said, that is squeezing budgets at all level of government while federal stimulus grants phase out.
"A third factor weighing on the outlook is the sluggish pace of economic growth abroad" and despite policy actions taken by European authorities, still elevated risk premiums on sovereign debt and other securities that signal persistent strains in global financial markets.
She also acknowledged an inconsistency between growth and employment which poses a problem for policymakers. "Unemployment has declined significantly over the past year even though growth appears to have been only moderate," an "unanticipated decline in the unemployment rate" that "presents something of a puzzle."
If that puzzle "was largely the result of such a catch-up in hiring, I would expect progress on the unemployment front to diminish unless the pace of GDP growth picks up." Catch-up, she said, "can go on for only so long."
The puzzle could resolve itself in other ways, "For example, GDP could have risen more rapidly over the past year than current data indicate."
She also acknowledged the risk to the inflation outlook posed by oil prices. "Prices of crude oil, and thus of gasoline, have turned up again," she said. Because the Fed acted "forcefully" inflation expectations did not move lower during the recession "driving down both wages and prices in a self-reinforcing spiral."
"I anticipate that slack in the labor market will continue to restrain growth in labor costs and prices," she said. "And, given the stability of inflation expectations, I expect that the latest round of gasoline price increases will also have only a temporary effect on overall inflation."
"Indeed, if crude oil prices were to follow the downward-sloping path implied by current futures contracts, energy costs would serve as a restraining influence on overall inflation over the next several years," she added.
She said that what she called simple monetary policy rules leave out some important considerations. "While the Taylor (1999) rule can serve as a useful policy benchmark, its prescriptions fail to take into account some considerations that I consider important in the current context," she said. "In particular, this rule does not fully take into account the implications of the zero lower bound on nominal interest rates and hence tends to understate the rationale for maintaining a highly accommodative stance of monetary policy under present circumstances."
The FOMC, she said, "has considerable latitude to withdraw policy accommodation if the economic recovery were to proceed much faster than expected or if inflation were to come in higher."
If the recovery faltered in inflation drifted down, "the Committee could provide additional stimulus using its unconventional tools, but doing so involves costs and risks."
"It would be imprudent to adhere mechanistically to the prescriptions of any single policy rule," she said. "Such rules can serve as useful benchmarks for facilitating monetary policy deliberations and communications, but a dose of good judgment will always be essential as well."
"I expect the economic recovery to continue -- indeed, to strengthen somewhat over time," she said. "Even so, over the next several years, I anticipate that we will fall far short in achieving our maximum employment objective, and I expect inflation to remain at or below the FOMCs longer-run goal of 2 percent."
"I consider a highly accommodative policy stance to be appropriate in present circumstances," she continued. "But considerable uncertainty surrounds the outlook, and I remain prepared to adjust my policy views in response to incoming information."
"In particular," she concluded, "further easing actions could be warranted if the recovery proceeds at a slower-than-expected pace, while a significant acceleration in the pace of recovery could call for an earlier beginning to the process of policy firming than the FOMC currently anticipates."
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