RTTNews - San Francisco Federal Reserve President Janet Yellen said late Tuesday that she expects the recession to end sometime later this year. While speaking at the Commonwealth Club of California, Yellen said growth is likely to come from multiple avenues such as increased federal government spending resulting from the stimulus measures. However, the Fed president cautioned that it would take more than mere fiscal policy to take the economy to growth path.
Yellen said, We now come to the present-the third act-in which the economy hopefully recovers. Right now, we're like a patient in intensive care whose condition has stabilized and whose fever is just starting to come down. She struck a simile between the current economic turmoil and a play with three acts and added that at present we are into the final act-one that is defined by economic recovery.
Citing the example of the auto industry, which has seen production cuts and consequently, a decline in inventories, Yellen suggested that GDP boost is likely come from inventory shrinkage. She expressed confidence that the housing sector will recover like the phoenix from the ashes. The sector has to eventually see an increase in house construction in tandem with the increase in the number of households, as the nation works off the massive overbuilding of the boom years.
At the same time, Yellen expressed caution regarding the pace of recovery. She said, I expect the pace of the recovery will be frustratingly slow. While noting that the Fed had the leeway to lower interest rates during the earlier downturns, giving an impetus to growth, Yellen said federal funds rate could not be taken any lower this time around. Answering queries by the media following the speech, Yellen reportedly said maintaining the main rate near zero for several years is certainly not outside the realm of possibilities.
Although the Fed is acting through novel programs, the Fed President is of the view that they are not as potent as large rate cuts. Therefore, she believes that monetary policy alone cannot do much to stimulate a rapid recovery this time. Additionally, downturns engendered by problems at the financial sector will take time to heal.
The recovery could also be hampered by the global scale of the recession and the sorry state of affairs in the job market, which suggests that it may be a long time before the economy can return to full employment.
Yellen did not rule out the possibility of things taking a turn for the worse. She feels that another shock to the still-fragile financial system could make matters worse. On inflation, Yellen is of the view that too low inflation will be more of a risk than too high inflation. Yellen expects the core inflation rate to dip below 1% over the next year and remain below 2% over the next several years, given the weakness in the job market, which is expected to exert downward pressure on spending and in turn prices.
Yellen also said there is a possibility of this low inflation environment turning into deflation if growth does not recover soon enough. However, inflation expectations aren't likely to worsen significantly, given the public's confidence in the central bank maintaining a stable inflation environment.
Allaying fears that the Fed's massive funding program will stoke inflation, Yellen said the Fed has tools to tighten policy and head off future inflation. She noted that many of the emergency credit to the financial system are already tapering off as market conditions improve. The Fed has the ability to raise fed funds rate by raising interest rates it pays to banks on the reserve balanced they hold with it, thereby helping to tighten credit conditions without shrinking its balance sheet.
Yellen also shrugged off the concern that higher fiscal deficit could fuel inflationary pressures by suggesting that in countries with advanced financial systems and histories of low inflation there is no such connection. Yellen also suggested that the Fed could be resolute when it comes to fostering recovery while maintaining price stability. She said the central bank would not hesitate when it is necessary to withdraw the extraordinary stimulus it has put in place.
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