NEW YORK – The economy has entered a sustained period of expansion, but its strength and durability remains uncertain, according to Federal Reserve Bank of San Francisco President and CEO Janet L. Yellen.
“The economy’s return to growth after a year and a half of recession marks a major turn and it looks like more than a flash in the pan,” Yellen told the Phoenix Chapter of Lambda Alpha International this morning, according to prepared text of her sppech, which was released by the Fed. “It seems to me that the economy has entered a sustained period of expansion. We’ve seen meaningful upturns in areas as diverse as housing, consumer spending, industrial production, and foreign trade. And, a number of factors bode well for the future, including a better functioning financial system, low mortgage interest rates, a resurgent stock market, a stabilization of house prices, and stronger growth abroad.”
But, she warned, “I am not going to paint an entirely rosy picture for you. The strength and durability of the expansion is in question. Some of the rebound is due to temporary government programs and a swing in inventory investment that will not provide an ongoing source of growth. Financial conditions have improved markedly in some respects, but many financial institutions are still hobbled with bad loans. The outlook for consumer spending is in doubt because households remain burdened with debt, and they have taken enormous hits to their wealth from declines in house and stock prices in recent years. And it’s particularly sobering that labor markets continue to deteriorate badly, leaving many millions of our fellow Americans unable to find jobs.”
While the recession has yet to be officially deemed complete, Yellen said, “a wide array of data suggests that the corner has been turned. In the third quarter, residential investment — which was at the center of the downturn — rose at nearly a 25% rate, albeit from a very low level. Home sales, prices, and housing starts are once again climbing. Meanwhile, manufacturing is also beginning to show signs of strength. This was helped by a rebound in motor vehicle production, boosted by the government’s temporary cash-for-clunkers program. Our exports surged as growth abroad picked up. And, importantly, consumer spending finally is growing”
Turning to the recovery, Yellen said, “With such enormous reservoirs of slack in the form of high unemployment and idle productive capacity, we need a strong rebound to put unemployed people back to work and get underutilized factories, offices, and stores humming again. Unfortunately, my own forecast envisions a less-than-robust recovery for several reasons. As the impetus from government programs and inventories diminishes in the quarters ahead, private final demand will have to fill the breach. The danger is that demand may grow at too anemic a pace to support vigorous expansion.”
Among the problems Yellen cited, were: “it may take quite a while for financial institutions to heal to the point that normal credit flows are restored,” and households are unlikely to be at the forefront of the recovery.
On inflation, Yellen said she believes “economic slack and downward wage pressure are pushing inflation below rates that are consistent with price stability.” But she added, “I believe that the more significant threat to price stability over the next several years stems from enormous slack in the economy that is pushing inflation lower. Today, inflation is already very low. Over the past 12 months, consumer prices as measured by the personal consumption price index actually fell by one-half percent. After removing the effects of volatile food and energy prices, core prices rose by 1¼ percent. That’s below the 2 percent rate that I and most of my fellow Fed policymakers on the Federal Open Market Committee (FOMC) consider an appropriate long-term price stability objective. The public’s inflation expectations, which can independently influence inflation, remain well anchored, which is appropriate given the Fed’s record and its commitment to price stability. And with slack likely to persist for years and wages barely rising, it seems probable that core inflation will move even lower over the next few years.”
As for monetary policy, “This landscape presents clear challenges for monetary policy,” she said. “We face an economy with substantial slack, prospects for only moderate growth, and low and declining inflation. With the federal funds rate already at zero for all practical purposes, the Fed’s traditional policy tool is as accommodative as it can be. To provide more stimulus, the Fed has used unconventional policy tools, including emergency lending programs to promote liquidity and push longer-term interest rates lower. However, many of these programs are winding down or nearing completion. That is why the FOMC stated that `economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period’ following our meeting last week.
“At some point, of course, we will have to tighten policy—and we certainly have the means and the will to do so. We are — and always will be — steadfast in our determination to achieve both of our statutory goals of full employment and price stability. Until that time comes though, we need to provide the monetary accommodation necessary to spur job creation and prevent inflation from falling any further below rates that are consistent with price stability,” she concluded.
