BOSTON (MNI) – The following is the second section of the remarks
of Federal Reserve Vice Chair Janet Yellen prepared Wednesday for the
Boston Economic Club:
The figure also shows the central tendency of the unemployment
projections that my FOMC colleagues and I made at our April meeting:
Those projections reflect our assessments of the economic outlook given
our own individual judgments about the appropriate path of monetary
policy. Included in the figure as well is the central tendency of FOMC
participantsf estimates of the longer-run normal unemployment rate,
which ranges from 5.2 percent to 6 percent. Like private forecasters,
most FOMC participants expect the unemployment rate to remain well above
its longer-run normal value over the next several years. Of course,
considerable uncertainty attends this outlook: The shaded area provides
an estimate of the 70 percent confidence interval for the future path of
the unemployment rate based on historical experience and model
simulations.4 Its width suggests that these projections could be quite
far off, in either direction. Nevertheless, the figure shows that labor
market slack at present is so large that even a very large and favorable
forecast error would not change the conclusion that slack will likely
remain substantial for quite some time.
Turning to inflation, figure 3 summarizes private and FOMC
forecasts. Overall consumer price inflation has fluctuated quite a bit
in recent years, largely reflecting movements in prices for oil and
other commodities. In early 2011 and again earlier this year, prices of
crude oil, and thus of gasoline, rose noticeably. Smoothing through
these fluctuations, inflation as measured by the price index for
personal consumption expenditures (PCE) averaged near 2 percent over the
past two years. In recent weeks, however, oil and gasoline prices have
moderated and are now showing through to the headline inflation figures.
Looking ahead, most FOMC participants at the time of our April meeting
expected inflation to be at, or a bit below, our long-run objective of 2
percent through 2014; private forecasters on average also expect
inflation to be close to 2 percent. As with unemployment, uncertainty
around the inflation projection is substantial.
In the view of some observers, the stability of inflation in the
face of high unemployment in recent years constitutes evidence that much
of the remaining unemployment is structural and not cyclical. They
reason that if there were truly substantial slack in the labor market,
simple accelerationist gPhillips curveh models would predict more
noticeable downward pressure on inflation. However, substantial
cross-country evidence suggests that, in low-inflation environments,
inflation is notably less responsive to downward pressure from labor
market slack than it is when inflation is elevated. In other words, the
short-run Phillips curve may flatten out.5 One important reason for this
non-linearity, in my view, is downward nominal wage rigidity– that is,
the reluctance or inability of many firms to cut nominal wages.
The solid blue bars in figure 4 present a snapshot of the
distribution of nominal wage changes for individual jobs during the
depth of the current labor market slump, based on data collected by the
Bureau of Labor Statistics.6 For comparison, the dashed red line
presents a hypothetical distribution of wage changes, using a normal
distribution that approximates the actual distribution of wage changes
greater than zero. The distribution of actual wage changes shows that a
relatively high percentage of workers saw no change in their nominal
wage, and relatively few experienced modest wage cuts. This pile-up
phenomenon at zero suggests that, even when the unemployment rate was
around 10 percent, many firms were reluctant to cut nominal wage rates.
In the absence of this barrier, nominal gains in wages and unit labor
costs would have likely been even more subdued given the severity of the
economic downturn, with the result that inflation would probably now be
running at a lower rate.
Anchored inflation expectations are another reason why inflation
has remained close to 2 percent in the face of very low resource
utilization. As shown in figure 5, survey measures of longer-horizon
inflation expectations have remained nearly constant since the mid-1990s
even as actual inflation has fluctuated. As a result, the current slump
has not generated the downward spiral of falling expected and actual
inflation that a simple accelerationist model of inflation might have
predicted. Indeed, keeping inflation expectations from declining has
been an important success of monetary policy over the past few years. At
the same time, the fact that longer-term inflation expectations have not
risen above 2 percent has also proved extremely valuable, for it has
freed the FOMC to take strong actions to support the economic recovery
without greatly worrying that higher energy and commodity prices would
become ingrained in inflation and inflation expectations, as they did in
the 1970s.
While my modal outlook calls for only a gradual reduction in labor
market slack and a stable pace of inflation near the FOMCfs longer-run
objective of 2 percent, I see substantial risks to this outlook,
particularly to the downside. As I mentioned before, even without any
political gridlock, fiscal policy is bound to become substantially less
accommodative from early 2013 on. However, federal fiscal policy could
turn even more restrictive if the Congress does not reach agreement on
several important tax and budget policy issues before the end of this
year; in fact, the CBO recently warned that the potential hit to gross
domestic product (GDP) growth could be sufficient to push the economy
into recession in 2013. The deterioration of financial conditions in
Europe of late, coupled with notable declines in global equity markets,
also serve as a reminder that highly destabilizing outcomes cannot be
ruled out. Finally, besides these clearly identifiable sources of risk,
there remains the broader issue that economic forecasters have
repeatedly overestimated the strength of the recovery and so still may
be too optimistic about the prospects that growth will strengthen.
Although I view the bulk of the increase in unemployment since 2007
as cyclical, I am concerned that it could become a permanent problem if
the recovery were to stall. In this economic downturn, the fraction of
the workforce unemployed for six months or more has climbed much more
than in previous recessions, and remains at a remarkably high level.
Continued high unemployment could wreak long-term damage by eroding the
skills and labor force attachment of workers suffering long-term
unemployment, thereby turning what was initially cyclical into
structural unemployment. This risk provides another important reason to
support the recovery by maintaining a highly accommodative stance of
monetary policy.
The Conduct of Policy with Unconventional Tools
Now turning to monetary policy, I will begin by discussing the
FOMCfs reliance on unconventional tools to address the disappointing
pace of recovery. I will then elaborate my rationale for supporting a
highly accommodative policy stance.
As you know, since late 2008, the FOMCfs standard policy tool, the
target federal funds rate, has been maintained at the zero lower bound.
To provide further accommodation, we have employed two unconventional
tools to support the recovery–extended forward guidance about the
future path of the federal funds rate, and large-scale asset purchases
and other balance sheet actions that have greatly increased the size and
duration of the Federal Reservefs portfolio. These two tools have
become increasingly important because the recovery from the recession
has turned out to be persistently slower than either the FOMC or private
forecasters anticipated. Figure 6 illustrates the magnitude of the
disappointment by comparing Blue Chip forecasts for real GDP growth made
two years ago with ones made earlier this year. As shown by the dashed
blue line, private forecasters in early 2010 anticipated that real GDP
would expand at an average annual rate of just over 3 percent from 2010
through 2014. However, actual growth in 2011 and early 2012 has turned
out to be much weaker than expected, and, as indicated by the dotted red
line, private forecasters now anticipate only a modest acceleration in
real activity over the next few years.
-more- (2 of 4)
** MNI **
[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$]
