–More Confident About Economic Recovery But Still ‘Fragile’
By Steven K. Beckner
NEW YORK CITY (MNI) – San Francisco Federal Reserve Bank President
Janet Yellen said Thursday night that with the economy operating below
its potential and inflation not threatening, it is “appropriate” for the
Fed to continue to run an “accommodative” monetary policy.
Yellen, the presumed successor to Donald Kohn as Fed Vice Chairman
in several months, said the Fed will need to make monetary policy less
stimulative “at some point” as the expansion proceeds, but she now
supports the Federal Open Market Committee’s assessment that the federal
funds rate is likely to stay “exceptionally low … for an extended
period.”
The economy is improving, but the recovery remains “fragile,” she
said in remarks prepared for delivery to Financial Executives
International in San Francisco.
Yellen said she expects “muted” job gains that will leave the
unemployment rate at 9.25% at the end of this year and 8% at the end of
next year.
Financial conditions have improved, but credit flows remain
“extremely weak,” she said.
Meanwhile, inflation is not just low but “diminishing,” she said.
Against that backdrop, Yellen made clear she sees no need for the
Fed to raise rates in the foreseeable future.
Noting that the federal funds rate is near zero, she said “such an
accommodative policy is appropriate because the economy is operating
well below its potential, inflation is subdued, and such conditions are
likely to continue for a while.”
“Consistent with that view, the Fed’s main policymaking body, the
Federal Open Market Committee, last month repeated its statement that it
expects low interest rates to continue for an extended period,” she
said, adding, “I agree with this assessment.”
“At some point though, as the economy continues to expand, the Fed
will have to pull back some of this extraordinary stimulus,” she added.
Noting that the Fed recently completed its program of buying Fannie
Mae and Freddie Mac securities, Yellen said “these purchases caused the
Fed’s balance sheet to mushroom to $2.3 trillion.”
But, she said, “we won’t have to shrink our balance sheet when the
time comes to push up short-term interest rates” because the Fed can
raise the interest rate we pay to banks on the reserves they hold at the
Fed.
“A hike in the rate we pay on these reserves will cause other
short-term money market rates to rise for the obvious reason that no
bank is going to lend in the open market at a rate below what it can
earn by parking its money in a secure Fed account.”
Yellen said “it’s logical to expect the Fed’s balance sheet to
eventually shrink toward more normal levels and for the bulk of our
holdings to be Treasury securities, as they were prior to the crisis.”
But she said she expects this to be “a gradual process executed in
a careful and deliberate fashion.”
Yellen began with an upbeat tone, saying “lately we’ve been getting
some pretty encouraging news on the economy.” Indeed, she said, “my own
thinking has recently turned a corner and I am becoming more and more
confident that the economy is on the right track.”
However, Yellen then shifted course.
“Even as we applaud the economic turnaround, it’s important not to
lose sight of just how fragile this recovery is and how far we yet have
to go before things return to normal,” she said, noting that the
unemployment rate of 9.7% is still “terribly high by historic
standards.”
“What’s more, an unusually large proportion of the nation’s jobless
have been without work for extended periods,” she said. “Of those
officially counted as unemployed, 44% percent have been jobless for at
least six months, a far bigger share than in any previous postwar
recession. … When we consider a broader measure of underemployment —
one that counts those who want jobs but have stopped looking because
they are discouraged and those who are working part-time for economic
reasons — the unemployment rate jumps to 16.9%.”
Although there has been a “turnaround in the job market,” Yellen
said she “expect(s) the pace of job creation to be muted, which is
likely to leave unemployment stubbornly high for the next few years.”
Forecasting 9.25% unemployment at the end of this year and 8% at the end
of next year, she said this is “a very disappointing outlook.”
Yellen noted that consumer and business spending have been
increasing, but said predicted “consumer spending will increase at a
moderate rate-not too hot, not too cold.”
Likewise, she forecast business spending “will be gradual.”
My business contacts tell me that they see conditions improving,
but that they remain wary and cost conscious. I suspect that the scars
from the past few years will take some time to heal.
Yellen called the commercial real estate picture “bleak” and said
the housing recovery has been “on-again, off-again course.”
“The continued high rate of foreclosures also creates risks to the
recovery of residential real estate,” she said. “More than three years
after the onset of the housing bust, we’ve seen no let-up in mortgage
delinquencies and foreclosures. … Based on the latest data, I expect
the percentage of loans that are seriously delinquent will continue to
move higher.”
“I am also concerned that we got a temporary reprieve from new
foreclosures from the federal government’s trial loan modification
program,” she added.
Despite improvements in financial markets, Yellen said “there is
little evidence that financial institutions are significantly expanding
the provision of credit and liquidity. Quite the contrary, even with
very low interest rates, credit flows remain extremely weak.”
As for inflation, she said, “inflation pressures are already very
low and they seem to be diminishing further….”
She disputed contentions that inflation is being held down by
housing prices, saying, “I don’t think this is a major factor….”
** Market News International **
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