USD Briefly Takes Out March High, Surging To Level Last Seen March 2003

Speech Highlights

Thank you to the Economic Club of Washington for inviting me to speak to you today. I would like to offer my assessment of the U.S. economy, nearly six and half years after the beginning of the current economic expansion, and my view of the economic outlook.

The U.S. economy has recovered substantially since the Great Recession. The unemployment rate, which peaked at 10 percent in October 2009, declined to 5 percent in October of this year. At that level, the unemployment rate is near the median of FOMC participants' most recent estimates of its longer-run normal level. The economy has created about 13 million jobs since the low point for employment in early 2010, and total nonfarm payrolls are now almost 4-1/2 million higher than just prior to the recession.

I anticipate continued economic growth at a moderate pace that will be sufficient to generate additional increases in employment, further reductions in the remaining margins of labor market slack, and a rise in inflation to our 2 percent objective. I expect that the fundamental factors supporting domestic spending that I have enumerated today will continue to do so, while the drag from some of the factors that have been weighing on economic growth should begin to lessen next year. Although the economic outlook, as always, is uncertain, I currently see the risks to the outlook for economic activity and the labor market as very close to balanced.

Turning to the factors that have been holding down growth, as I already noted, the higher foreign exchange value of the dollar, as well as weak growth in some foreign economies, has restrained the demand for U.S. exports over the past year. In addition, lower crude oil prices have reduced activity in the domestic oil sector. I anticipate that the drag on U.S. economic growth from these factors will diminish in the next couple of years as the global economy improves and the adjustment to prior declines in oil prices is completed.

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Although developments in foreign economies still pose risks to U.S. economic growth that we are monitoring, these downside risks from abroad have lessened since late summer. Among emerging market economies, recent data support the view that the slowdown in the Chinese economy, which has received considerable attention, will likely continue to be modest and gradual. China has taken actions to stimulate its economy this year and could do more if necessary. A number of other emerging market economies have eased monetary and fiscal policy this year, and economic activity in these economies has improved of late. Accommodative monetary policy is also supporting economic growth in the advanced economies. A pickup in demand in many advanced economies and a stabilization in commodity prices should, in turn, boost the growth prospects of emerging market economies.

A final positive development for the outlook that I will mention relates to fiscal policy. This year the effect of federal fiscal policy on real GDP growth has been roughly neutral, in contrast to earlier years in which the expiration of stimulus programs and fiscal policy actions to reduce the federal budget deficit created significant drags on growth.

Regarding U.S. inflation, I anticipate that the drag from the large declines in prices for crude oil and imports over the past year and a half will diminish next year. With less downward pressure on inflation from these factors and some upward pressure from a further tightening in U.S. labor and product markets, I expect inflation to move up to the FOMC's 2 percent objective over the next few years. Of course, inflation expectations play an important role in the inflation process, and my forecast of a return to our 2 percent objective over the medium term relies on a judgment that longer-term inflation expectations remain reasonably well anchored. In this regard, recent measures from the Survey of Professional Forecasters, the Blue Chip Economic Indicators, and the Survey of Primary Dealers have continued to be generally stable. The measure of longer-term inflation expectations from the University of Michigan Surveys of Consumers, in contrast, has lately edged below its typical range in recent years. However, this measure often seems to respond modestly, though temporarily, to large changes in actual inflation, and the very low readings on headline inflation over the past year may help explain some of the recent decline in the Michigan measure.

Let me now turn to the implications of the economic outlook for monetary policy.

In the policy statement issued after its October meeting, the FOMC reaffirmed its judgment that it would be appropriate to increase the target range for the federal funds rate when we had seen some further improvement in the labor market and were reasonably confident that inflation would move back to the Committee's 2 percent objective over the medium term. That initial rate increase would reflect the Committee's judgment, based on a range of indicators, that the economy would continue to grow at a pace sufficient to generate further labor market improvement and a return of inflation to 2 percent, even after the reduction in policy accommodation. As I have already noted, I currently judge that U.S. economic growth is likely to be sufficient over the next year or two to result in further improvement in the labor market. Ongoing gains in the labor market, coupled with my judgment that longer-term inflation expectations remain reasonably well anchored, serve to bolster my confidence in a return of inflation to 2 percent as the disinflationary effects of declines in energy and import prices wane.

Committee participants recognize that the future course of the economy is uncertain, and we take account of both the upside and downside risks around our projections when judging the appropriate stance of monetary policy. In particular, recent monetary policy decisions have reflected our recognition that, with the federal funds rate near zero, we can respond more readily to upside surprises to inflation, economic growth, and employment than to downside shocks. This asymmetry suggests that it is appropriate to be more cautious in raising our target for the federal funds rate than would be the case if short-term nominal interest rates were appreciably above zero. Reflecting these concerns, we have maintained our current policy stance even as the labor market has improved appreciably.

However, we must also take into account the well-documented lags in the effects of monetary policy. Were the FOMC to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals. Such an abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession. Moreover, holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and thus undermine financial stability.

It is thereby important to emphasize that the actual path of monetary policy will depend on how incoming data affect the evolution of the economic outlook. Stronger growth or a more rapid increase in inflation than we currently anticipate would suggest that the neutral federal funds rate is rising more quickly than expected, making it appropriate to raise the federal funds rate more quickly as well; conversely, if the economy disappoints, the federal funds rate would likely rise more slowly. Given the persistent shortfall in inflation from our 2 percent objective, the Committee will, of course, carefully monitor actual progress toward our inflation goal as we make decisions over time on the appropriate path for the federal funds rate.

For What It's Worth

In the "For What It's Worth" category, that's what Yellen believes.

Q: What's it worth?
A: Absolutely nothing.

A seven-year recovery is quite long by any reasonable measurement stick. Inflation targets are very damaging. In striving to hit those targets the Fed blew huge asset bubbles once again, while bragging about being diligent about "excessive risk taking".

The number of jobs did indeed take out the 2007 high, not because of Fed policy, but primarily because of population growth.

US fiscal policy and deficit spending is a wreck waiting to happen. Inflation expectations are meaningless. And this recovery is the weakest on record. 2% growth has been the norm.

Finally, the idea that a bunch of bureaucrats can divine where interest rates should be is absurd. Bubbles of increasing amplitude over time, for which the Fed has never apologized, are proof enough.

Written By: Mike (Mish) Shedlock