Thursday, April 24, 2014

Fed Chair Janet Yellen: "there remains considerable slack in the economy"

See Yellen: Economy Still Needs Extraordinary Support. The  Fed thinks that we are still below the full-employment GDP (QF in the graph below). They basically think that we are still at a point like AD1 and need to have policies that will move us to AD2 (AD stands for aggregate demand and SRAS stands for short-run aggregate supply). If we move from AD1 to AD2, we will still have very small price increases while having a big increase in GDP which will help lower the unemployment rate. The Fed discussed similar issues in 2009. See Fed Officials Disagree On Threat Of Inflation.

Now excerpts from this latest article:
"Low interest rates, she said, make buying a home more affordable and make it easier for businesses to expand and hire.

“We are trying to lower the costs of buying a car that can carry a worker to a new job and kids to school, and our policies are also spurring the revival of the auto industry. We are trying to help families afford things they need so that greater spending can drive job creation and even more spending, thereby strengthening the recovery,” Yellen said.

Yellen said she and “most” of her Fed colleagues believe the unemployment rate must fall to between 5.2% and 5.6% before fulfilling the Fed’s mandate of maximum sustainable unemployment. At that point, inflation becomes more of a risk because wages rise as demand for workers sharpens.
Yellen noted inflation is still not a concern because the inflation rate is about half the Fed’s target rate of 2%.

However, simply by mentioning the 5.2%-5.6% range for maximum sustainable employment, it's certain market analysts will speculate interest rates, which have hovered at near-zero for more than five years, will start to move higher when the unemployment rate falls into that range. It currently stands at 6.7%.

“The Federal Reserve takes its inflation goal very seriously,” Yellen said. “One reason why I believe it is appropriate for the Federal Reserve to continue to provide substantial help to the labor market, without adding to the risks of inflation, is because of the evidence I see that there remains considerable slack in the economy and the labor market.”

Slack, she explained, is when there are significantly more people looking for work than there are jobs available.

Yellen suggested the primary issues holding back the job market are ‘cyclical,’ in other words there are simply not enough jobs to employ all those who are looking for work. Accommodative monetary policy – low interest rates, for example – can help create conditions conducive to creating jobs, Yellen explained."

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