by Calculated Risk on 9/10/2007 11:44:00 AM

UPDATE: On Bloomberg Video: Yellen Sees `Significant Downward Pressure' on Economy. (hat tip Anne)

Click image for video.

Federal Reserve Bank of San Francisco President Janet Yellen speaks about the U.S. credit and housing markets, and their impact on the overall economy and Fed monetary policy. Yellen speaks at the National Association for Business Economics annual meeting in San Francisco. (Source: Bloomberg)

From San Francisco Fed President Janet Yellen: Recent Financial Developments and the U.S. Economic Outlook. As usual, Dr. Yellen's speech is worth reading. Here are a few excerpts (emphasis added):

Even with corrections to credit underwriting standards, it still may turn out that these innovations don’t actually spread risk as transparently or effectively as once thought, and this would mean—to some extent—a more or less permanent reduction of credit flowing to risky borrowers and long-lasting shifts in patterns of financial intermediation. It also could mean an increase in risk premiums throughout the economy that persists even after this turbulent period has passed.

On housing and consumption:

Beyond the housing sector’s direct impact on GDP growth, a significant issue is its impact on personal consumption expenditures, which have been the main engine of growth in recent years. The nature and extent of the linkages between housing and consumer spending, however, are a topic of debate among economists. Some believe that these linkages run mainly through total wealth, of which housing wealth is a part. Others argue that house prices affect consumer spending by changing the value of mortgage equity. Less equity, for example, reduces the quantity of funds available for credit-constrained consumers to borrow through home equity loans or to withdraw through refinancing. The key point is that, according to both theories, a drop in house prices is likely to restrain consumer spending to some extent, and this view is backed up by empirical research on the U.S. economy.

And the risks to the economy could be 'significant':

To sum up the story on the outlook for aggregate demand, I see significant downward pressure based on recent data indicating further weakening in the housing sector and the tightening of financial markets. As I have indicated, a big issue is whether developments in the relatively small housing sector will spread to the large consumption sector, perhaps through declines in house prices. Should the decline in house prices occur in the context of rising unemployment, the risks could be significant.