Janet Yellen Holds Forth (and does so exceptionally clearly)

April 16th, 2014 at 5:42 pm

I enjoyed the chair’s speech today, assessing the state of the economy and holding forth on the Fed’s macro policy.  Here are some bullets, along with an observation about an important way that life has gotten harder—maybe significantly harder—for the Fed in recent years.

–As is her wont, Yellen focused on the slack that remains in the job market.  The number 6.5% as an unemployment benchmark was not in the speech.  Clearly, and appropriately, the Fed no longer wants to signal that number as a meaningful threshold, focusing instead on “full employment” which for them is around 5.4%.

–In this regard, she referred to the gap between the current unemployment rate and this target as a significant shortfall, one that could take “…more than two years to close.”

–Let’s say that’s right, and I doubt it’s pessimistic.  Let’s also stipulate, though I’ve got some issues with this assertion, that the unemployment rate was at full employment in 2007.  That means a nine-year stretch—2007-2016—of slack job markets.  And they accuse Japan having suffered through a lost decade.

–Numerous times in both her speech and Q&A, the chair noted low and decelerating inflation (core PCE) as a challenge.  If I’m Yellen, I’m a little unsettled by such low inflation, even as there’s been some tightening and a bit of nominal wage growth (see figure three here).  A key point she made is this, and it’s one I’ll return to in a moment: “…during the recovery, very high levels of slack have seemingly not generated strong downward pressure on inflation. We must therefore watch carefully to see whether diminishing slack is helping return inflation to our objective.”

–She again emphasized this critical point: “I believe that long-term unemployment might fall appreciably if economic conditions were stronger.”  I think Yellen believes, as do I, that a stronger job market could not just lower long-term unemployment, suggesting a significant cyclical component remains in the jobless rate, but even more importantly, stronger growth could pull some folks who’ve left the labor force back in.  I think of that as “reverse hysteresis” and it’s a very big deal regarding both living standards and macro growth.

So, what’s this troubling problem I referenced above?  It is this: I think that while inflation has become less responsive to slack and thus to Fed actions that target slack, market reactions and even global capital flows have grown considerably more elastic to Fed moves.

It is pretty widely agreed that the Phillips curve has flattened in recent years, as I cover here.  For full employment types, like Dean Baker and I, that’s good news in that you can worry less about price pressures as the jobless rate falls.  For inflation hawks, on the other hand, it means the Fed could find it tougher than it thinks to slow faster price growth.

But at the same time, and here I’m admittedly in anecdotal mode, it seems like financial markets and capital flows are increasingly sensitive to the slightest unexpected Fed actions, even when those actions should really be expected, with last summer’s “taper-tantrum” being exhibit number one.

This raises the stakes for forward guidance/expectations management.  Both Yellen and before her, Bernanke, were pretty clear that their main client is the real economy, which is as it should be.  But if it’s true that financial markets have grown more sensitive to Fed moves than inflation, that poses a challenge the Fed can’t ignore.

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8 comments in reply to "Janet Yellen Holds Forth (and does so exceptionally clearly)"

  1. Larry Signor says:

    I have real problems with the Phillips Theorem in todays economy. When the growth in wages stalls for the majority of workers for an extended period of time and the managers experience the wage growth, we can have deflation (due to over-saving by rentiers) and rising median wages (due to extreme rents by managers). Does this sound familiar? Ms. Yellen surely realizes this and is carefully trying to turn this ship. Full employment is part of the answer to solving economic inequality. She must be careful how she phrases that concept. (In a properly distributive and balanced economy, I have no problem with the Phillips Curve. Those conditions do not exist today.)

  2. Robert Buttons says:

    Janet said we will price fix interest rates below market levels for the foreseeable future. Translation: The leeches did not cure the patient, bring on more leeches.

  3. doverby says:

    There seems to be a growing number of people who think that the long term unemployed are going to stay unemployed for structural reasons and that there is nothing that we can do about it. A study by three Princeton economist found that only 11% of the long term unemployed will ever regain employment:


    The study also seems to make a broad assumption that businesses will only hire from a limited pool of short-term unemployed folks, therefore increasing inflation and raising prices.

    I tend to agree with Yellen and yourself, however. As the economy continues to add jobs, it seems unlikely to me that businesses will have the luxury of picking and choosing only qualified, short-term unemployed people. These folks will start to be in short supply (pun intended).

    • Perplexed says:

      -“There seems to be a growing number of people who think that the long term unemployed are going to stay unemployed for structural reasons and that there is nothing that we can do about it.”

      -“That’s because the relative exclusion of the long-term unemployed means that employers must choose from among a limited supply of workers. That trend could push up prices.”

      Those “structural reasons” are otherwise known as the 1914 Clayton Act which exempts “labor” from anti-trust protections available to producers of any other product or commodity. This is know as “unequal protection under the law,” and there is indeed something we could do about it: enforce Constitutional rights to equal protection. If the companies that excluded these workers (or any other group of workers) from the so called “labor market” faced the treble damages, criminal prosecutions, and jail time specified by the Clayton Act the practice would stop almost immediately. The Framers went to a great deal of trouble to prevent tyranny of the majority when writing the Constitution as they rightly predicted U.S. citizens would be at great risk of being victimized by it. Obviously they fell short by not providing a mechanism to insure enforcement.

  4. Perplexed says:

    -“It is pretty widely agreed that the Phillips curve has flattened in recent years…”

    At least its clear to those who believe in “labor market” theology. If, on the other hand, “labor markets” are myth and you just focus on those accepted to the cartels, the Phillips Curve appears alive & well:

    The now 100 year old Clayton Act assures that these cartels can operate unimpeded by the “Equal Protection under the Law” problems that would apply to real markets:


  5. marcel says:

    For full employment types, like Dean Baker and I, … “

    Good god man, what would your grammar say if she heard you talking like this?

    • doverby says:

      It’s a blog post, not a column. You’d have a difficult time finding a blogger that doesn’t make mistakes every now and then since blogs are typically written quickly.

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