This is a very good speech by Janet Yellen, the vice chair of the Federal Reserve.
Yellen’s core question is simple: “deeper recessions are usually followed by stronger-than-average recoveries.” But “this recovery has been significantly weaker than past experience would have predicted.” Why?
As all great orators do, Yellen begins with a chart. “The dashed line in exhibit 1 shows how real GDP would have been expected to increase in this recovery, based on the experience of the United States and other advanced economies and given the depth and duration of the Great Recession,” she says.
Yellen’s innovation in this speech is that rather than focusing on what’s holding this recovery back, she focuses on the forces that have driven past recoveries — the “tailwinds,” as she calls them — that have been absent from this one.
Tailwind #1: Fiscal policy. “History shows that fiscal policy often helps to support an economic recovery,” Yellen says. But that’s not been the case in this recovery. “In the year following the end of the recession, discretionary fiscal policy at the federal, state, and local levels boosted growth at roughly the same pace as in past recoveries, as exhibit 3 indicates. But instead of contributing to growth thereafter, discretionary fiscal policy this time has actually acted to restrain the recovery.”
Tailwind #2: Housing. “Before the Great Recession, housing investment added an average of 1/2 percentage point to real GDP growth in the two years after each of the previous four recessions, considerably more than its contribution to growth at other times. During this recovery, in contrast, residential investment, on net, has contributed very little to growth since the recession ended.”
Tailwind #3: Faith. “Another important tailwind in most economic recoveries is one that tends to be taken for granted–the faith most of us have, based on history and personal experience, that recessions are temporary and that the economy will soon get back to normal,” says Yellen. “Even during recessions, households’ expectations for income growth tend to be reasonably stable, which provides support for overall spending. In the most recent recession, however, surveys suggest that consumers sharply revised down their prospects for future income growth and have only partially adjusted up their expectations since then.”
Yellen has been among the members of the Fed pushing the central bank to do more to alleviate unemployment. And so she ends her speech by defending her underlying view that “a broad-based cyclical shortage of demand is the main cause of today’s elevated unemployment rate,” which means the Federal Reserve can help.
In recent months, however, Yellen and her allies have won. The Fed is doing more to fight unemployment. It’s doing about as much as Yellen has asked it to do, in fact. But it’s not been nearly enough. And so the glaring omission in Yellen’s speech is what she believes would be enough. My guess is that Yellens’ view is that the Fed has done all it can do to keep interest rates low. What’s needed now is for Congress to step up and take advantage of those low interest rates.
Indeed, Congress could help put all three tailwinds back into play. They control fiscal policy, and so they could take advantage of the low interest rates to, say, rebuild the nation’s infrastructure or pass a massive tax cut, or both. They have broad power over the housing market, and so they could pass legislation — like that proposed by Sen. Jeff Merkley (D-Ore.) — to make it easier for homeowners to take advantage of low interest rates and refinance.
And while the nation’s grim mood isn’t entirely Congress’s fault, the gridlock, doomsaying and brinkmanship that has come to define Washington in recent years certainly isn’t making Americans more confident in the future.