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Highlights from SF Fed President Yellen's Speech

Anthony Randazzo
July 2, 2009, 5:15pm

Federal Reserve Bank of San Francisco President Janet Yellen spoke at the Commonwealth Club of California on Tuesday about the progress of economic recovery. There has been some speculation that she might succeed Ben Bernanke as Fed Chairman when his term ends next year. She expects a slow recovery, but recovery nonetheless. Here are highlights from her speech:

I am not going to go into detail about the alphabet soup of Fed programs created during this period [fall of 2008]. But I want to stress that these policies—in some cases improvised in very short order—did succeed in averting a full-blown meltdown. The panic of 2008 subsided.  Increasingly, banks and corporations have been able to raise funds on reasonable terms. Confidence in the financial system is slowly returning...

The news during the past few months has been encouraging. Even though house prices are continuing to fall in most markets, housing sales and new construction appear to have stabilized. Consumers have recovered some spirit and their spending has also stabilized, thanks in part to government stimulus programs. Payrolls are still shrinking at an awful pace, but the momentum of job losses has slowed considerably in the past two months.

Financial markets are in much better shape today than we ever would have dreamed six months ago. Investors have gone from disregarding risk, to being paralyzed by it, to once again being willing to take on a reasonable bit. The stock market has rallied and investor appetite for corporate bonds and other assets has rebounded, restoring access to capital for healthy companies. Even so, I am concerned that mortgage rates, which have risen of late, could place a drag on a still very sick housing market, potentially driving home prices still lower and pushing more borrowers into foreclosure. The recent run-up in oil prices may also reflect greater confidence in the global outlook...

I expect the recession will end sometime later this year. That would make it the longest and probably deepest downturn since the Great Depression. Growth will come from a variety of sources. One is federal government spending resulting from the stimulus program passed by Congress earlier this year. This package provides tax cuts that leave more cash in consumers’ pockets, as well as direct government spending increases that add to payrolls and boost economic output. But it will take more than fiscal policy to really get the economy moving forward...

History also teaches us that it often takes a long time to recover from downturns caused by financial crises. In particular, financial institutions and markets won’t heal overnight.  Our major banks have made excellent progress in establishing the capital buffers needed to continue lending even through a downturn that is more serious than we anticipate. But they are still nursing their wounds and credit will remain tight for some time to come...

If the economy fails to recover soon, it is conceivable that this very low inflation could turn into outright deflation. Worse still, if deflation were to intensify, we could find ourselves in a devastating spiral in which prices fall at an ever-faster pace and economic activity sinks more and more.  But I don’t view this as likely. The vigorous policy actions of the Fed and other central banks, combined with sizable fiscal stimulus here and abroad, have sent a clear message that deflation won’t be tolerated. Based on measures of inflation expectations, the public appears confident that the Fed will adopt policies that will maintain a low, positive rate of inflation.

Anthony Randazzo is Director of Economic Research

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