WASHINGTON — Federal Reserve Board Vice Chair Janet Yellen said Monday that policymakers continue to face a significant number of headwinds that have stalled often "forceful" efforts by the central bank to jump start an economic recovery.
Fiscal policy, housing, and optimism about the future prospects of the economy have all — in the past — helped to promote an economy recovery following a recession, but not this time, Yellen said. Rather, such typical "tailwinds" have only ended up hurting the economic recovery even further. Couple that with the unusual nature of the "Great Recession," policymakers at the Fed have gone to great lengths to help stimulate the economy, but have only achieved dismal results especially when it comes to the continued elevated rate of unemployment.
"The gulf between maximum employment and the very difficult conditions workers face today helps explain the urgency behind the Federal Reserve's ongoing efforts to strengthen the recovery," Yellen said, in a speech before the AFL-CIO. "We have taken, and are continuing to take, forceful action to increase the pace of economic growth and job creation."
The reason for such a slowed recovery, Yellen explains, is due to the fact that the housing crisis left many American homeowners with high loan-to-value ratios, damaged credit, and banks interested in only lending to borrowers with the highest credit scores.
"As a consequence, the proportion of households that have been able to take advantage of declining rates to refinance their mortgages or to borrow to purchase new homes has probably been lower than in past recoveries," said Yellen. "In addition, pronounced uncertainty about economic conditions has weighed on capital spending decisions and may have blunted the normal effect of lower interest rates on business investment."
Additionally, decisions by state and local governments to cut spending and in some cases raise taxes have not helped efforts by the U.S. central bank either. Federal policymakers have added to the burden also by reducing the purchases of goods and services and have allowed stimulus-related spending to decline. And while action by Congress and the president to temporarily keep the U.S. from going over the fiscal cliff kept the economy from slipping back into recession, further discussions on spending cuts and reducing the government's borrowing will continue to be a headwind for the recovery, Yellen said.
"Negotiations continue over the extent of spending cuts now due to take effect beginning in March, and I expect that discretionary fiscal policy will continue to be a headwind for the recovery for some time, instead of the tailwind it has been in the past," said Yellen.
The Fed has sought to counteract some of this by utilizing two unconventional policy tools, since it reduced the federal funds rate to its lowest bound in 2008. The first vehicle was buying a total of $2.3 trillion in large-scale asset purchases like mortgage-backed securities, agency debt, and Treasury securities to help lower longer-term interest rates, while the second tool has been the Fed's forward guidance on the future path of monetary policy.
"Signaling the future path of the federal funds rate can therefore directly affect interest rates today on auto loans, home mortgages, and bonds issued by companies and state and local governments, even when the current level of the federal funds rate cannot be lowered," said Yellen.
In December, the Federal Open Market Committee said it would keep the main interest rate in a range of zero to 0.25% as long as inflation didn't rise above 2.5% over the next two years and unemployment remains above 6.5%.
Despite such targets, Yellen cautioned that policymakers would not be wedded to them in determining future policy actions.
"These quantitative goals are neither ceilings nor floors for inflation and unemployment, and the committee will take a balanced approach to returning both measures to their objectives over time," said Yellen.
Even with some early signs of improvement in the labor market, it has been slow and will take years to fully recover, she said.
"It will take years before many workers feel like they have regained the ground lost since 2007," said Yellen, adding that the effects of globalization and technology will also add to the challenges for workers in certain industries. "The Great Recession stands out both for the magnitude of the job losses that attended the downturn and for the weak recovery in employment that occurred after the recession ended," she said.
A critical question that policymakers have debated over countless FOMC meeting is whether the current high unemployment rate is the result of cyclical or structural reasons. While members of the committee have debated publicly over this issue, Yellen believes that there is sufficient evidence that points to the fact that the increase in unemployment has been largely cyclical, not structural.
"Job losses in the construction and financial services industry were particularly large — hardly surprising given the collapse in these sectors in 2008 and 2009 — but manufacturing and other cyclically sensitive industries were hit hard as well, and employment in these industries has likewise recovered slowly," said Yellen.
Because research suggests a "broad-based cyclical shortage of demand' as the cause of the current unemployment rate, she said, that means problems troubling the labor market are "likely to be substantially resolved as the broader economy improves and bolsters the demand for labor." She added an improved recovery will also be able to come to the aid of dislocated workers who have been stranded by structural changes in the economy.