Janet Yellen, the Vice-Chair of the San Francisco Federal Reserve, gave this speech yesterday at NYU. There has been much discussion within the FOMC regarding the reasons for the slow growth in employment during the recovery. Some argue that we have substantial structural unemployment that cannot be resolved through monetary policy. They would like the Fed to bring interest rates up to their traditional levels. Yellen disagrees with that view and provides her reasons in this speech. She argues that unemployment has been widespread across sectors. Labor force immobility due to "house lock" is also not a factor since renters have the same mobility rate. Therefore, structural factors in unemployment are less of a cause than cyclical factors.
Yellen describes several headwinds that are slowing down economic growth. The major factor is weak demand for new homes. Growth in demand for new homes has been the engine that has driven recoveries from our recent recessions but new home sales have not recovered for several reasons. High unemployment, tighter credit standards for mortgages and the selling off of excess inventory have constrained the sale of new homes.
Fiscal factors have also slowed the recovery. State and local governments have cut spending and the federal stimulus has wound down. The cap that was put on federal spending going forward is also pro-cyclical. Exports to Europe have also slowed due to economic headwinds in Europe.
Since core inflation has been below the target rate of 2%, and because inflation expectations have been normalized, she is more concerned with the employment mandate than she is with elevated inflation. She favors the continuation of near zero short term interest rates until the end of 2014. Unemployment is expected to return to 5.25% by that time.
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