Janet Yellen’s Superb Speech
Ask and you shall receive. Here’s your double dose of Rosie for the evening. From today’s daily letter:
San Francisco Fed President Janet Yellen delivered a superb speech last night that really resonated with us — a true reality check for a stock market which has galloped ahead by 54% from the lows, purely on a record eight point expansion of the P/E multiple. The move in equity valuation suggests that stock market investors are anticipating 4% real GDP growth in the coming year. Janet Yellen has proven to be one of the more astute economic forecasters at the Federal Reserve and so we thought it prudent to re-print part of her sermon.
First, the good news
“I’m happy to report that the downturn has probably now run its course. This summer likely marked the end of the recession and the economy should expand in the second half of this year.”
A slow motion recovery lies ahead
“But I regret to say that I expect the recovery to be tepid. What’s more, the gradual expansion gathering steam will remain vulnerable to shocks. The financial system has improved but is not yet back to normal. It still holds hazards that could derail a fragile recovery. Even if the economy grows as I expect, things won’t feel very good for some time to come. In particular, the unemployment rate will remain elevated for a few more years, meaning hardship for millions of workers. Moreover, the slack in the economy, demonstrated by high unemployment and low utilization of industrial capacity, threatens to push inflation lower at a time when it is already below the level that, in the view of most members of the Federal Open Market Committee (FOMC) best promotes the Fed’s dual mandate for full employment and price stability.”
Sorry, but the credit crisis is not over
“Unfortunately, more credit losses are in store even as the economy improves and overall financial conditions ease. Certainly, households remain stressed. In the face of high and rising unemployment, delinquencies and foreclosures are showing no sign of turning around. The delinquency rate on adjustable-rate mortgages is now up to about 18 percent, and, on fixed-rate loans, it’s about 6 percent. Delinquencies on both types of loans have increased sharply over the past year and are still rising. This trend is consistent across other major loan categories, and is affecting high- and low-quality borrowers alike. Even recent-vintage loans are experiencing rising delinquency rates …
…As I said, financial conditions are better, but not back to normal. And the likelihood of continuing losses by financial institutions will add new fuel to the credit crunch. In particular, small and medium-size banks could experience damaging losses on commercial real estate loans. Thus far, the largest losses have been on loans for construction and land development. Going forward, however, rising loan losses on other commercial real estate lending is likely because property values are falling, office vacancy rates are rising, and credit remains tight or nonexistent for those many property owners that will need to refinance mortgages over the next few years. Financial contagion from this sector is one of the most important threats to recovery.”
Severe consumer headwinds
“The chances are slim for a robust rebound in consumer spending, which represents around 70 percent of economic activity. Of course, consumers are getting a boost from the fiscal stimulus package. But this program is temporary. Over the long term, consumers face daunting issues of their own. In fact, it’s easy to draw a comparison between the financial state of households and that of financial institutions. For years prior to the recession, households went on a spending spree. This occurred during a period that economists call the “Great Moderation,” about two decades when recessions were infrequent and mild, and inflation was low and stable. Credit became ever easier to get and consumers took advantage of this to borrow and buy. Stock and home prices rose year after year, giving households additional wherewithal to keep spending. In this culture of consumption, the personal saving rate fell from around 10 percent in the mid-1980s to 1½ percent or lower in recent years. At the same time, households took on larger proportions of debt. From 1960 to the mid-1980s, debt represented a manageable 65 percent of disposable income. Since then, it has risen steadily, with a notable acceleration in the last economic expansion. By 2008, it had doubled to about 130 percent of income.
It may well be that we are witnessing the start of a new era for consumers following the traumatic financial blows they have endured. The destruction of their nest eggs caused by falling house and stock prices is prompting them to rebuild savings. The personal saving rate is finally on the rise, averaging almost 4½ percent so far this year. While certainly sensible from the standpoint of individual households, this retreat from debt-fueled consumption could reduce the growth rate of consumer spending for years. An increase in saving should ultimately support the economy’s capacity to produce and grow by channeling resources from consumption to investment. And higher investment is the key to greater productivity and faster growth in living standards. But the transition could be painful if subpar growth in consumer spending holds back the pace of economic recovery.”
Soft labour market underbelly
“Weakness in the labor market is another factor that may keep the recovery in low gear for a while … my business contacts indicate that they will be very reluctant to hire again until they see clear evidence of a sustained recovery, and that suggests we could see another so-called jobless recovery in which employment growth lags the improvement in overall output. What’s more, wage growth has slowed sharply … when the array of problems facing consumers is considered, it is hard to see how we can avoid sluggish spending growth.”
Inventories the major impetus to growth
“Putting the whole puzzle together, the main impetus to growth in the second half of this year will be inventory investment. The boost it provides will be a big help for a while, but we will need to look to other sectors to sustain growth. The fact that the largest sector of the economy — consumer spending — is likely to be lackluster implies a less-than-robust expansion. Even the gradual recovery we expect will be vulnerable to shocks, especially from the financial sector.”
Deflation the principal risk, not inflation
“The slow recovery I expect means that it could still take several years to return to full employment. The same is true for capacity utilization in manufacturing. It will take a long time before these human and capital resources are put to full use.
My personal belief is that the more significant threat to price stability over the next several years stems from the disinflationary forces unleashed by the enormous slack in the economy. The 1980s provides a useful historical comparison. During that period, fears about burgeoning federal deficits and an unsustainable fiscal situation were widespread, as they are today. Moreover, the Fed was under significant political pressure, and some worried whether it would be able to safeguard its independence. But those circumstances didn’t ignite a renewed bout of inflation …
…Of course, that period differed from ours in one critical respect. Then, inflation was coming down from unacceptably high levels. Monetary policy was designed to be tight enough to bring inflation down to price stability, a goal we accomplished and have maintained for two-and-a-half decades. Today, we are starting with very low inflation. Core PCE price inflation has averaged just under 1½ percent over the past twelve months, which is already below the 2 percent rate that I and most of my FOMC colleagues consider an appropriate long-term price stability objective. With slack likely to persist for years, it seems likely that core inflation will move even lower, departing yet farther from our price stability objective …
…I can assure you that we will be ready, willing, and able to tighten policy when it’s necessary to maintain price stability. But, until that time comes, we need to defend our price stability goal on the low side and promote full employment. Thank you very much.”
Janet Yellen and Alan Blinder: The Fabulous Decade: Macroeconomic Lessons from the 1990s
Tags: credit crisis, david rosenberg, deflation, economy, federal reserve
credit crisis, deflation, economy, fed |
Subscribe