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Thursday, September 04, 2008

Fed's Yellen: Crisis "ongoing and perhaps deepening"

by Calculated Risk on 9/04/2008 02:38:00 PM

From San Francisco Fed President Janet Yellen: The U.S. Economic Situation and the Challenges for Monetary Policy

Regrettably, the nation's economy has been in rough waters for over a year now. Last summer, a precipitous slide in house prices triggered a crisis in financial markets and a credit crunch that is making it hard for consumers and some firms to borrow. These developments are ongoing and perhaps deepening, as banks and other financial intermediaries are continuing to delever by scaling back their balance sheets and shrinking their lending activity. Indeed, some sources of funding have completely dried up. In the face of these developments, firms and consumers have also been pulling back, causing unemployment to rise.
And on the U.S. outlook:
Turning to the national economy, it was recently reported that growth in the second quarter came in at a fairly robust rate of 3¼ percent.
While one might be tempted to interpret the recent strong numbers as a sign that things are turning around, there are three important reasons to think that the strength will not hold up, and that economic performance will be decidedly subpar in the second half of the year. First, consumer spending in the second quarter came in at only a moderate rate, even though it was boosted by substantial tax rebates. But there are no plans in place to repeat those rebates, so by the fourth quarter, the economy will no longer benefit from that fiscal stimulus.

Second, export growth alone contributed one-half of the total real GDP growth registered in the second quarter. This element has been an important source of strength in our economy for over a year, being buoyed by strong growth abroad and by the weakening of the dollar. However, as I discussed, in recent months the dollar has risen somewhat and economic growth in many of our industrialized trading partners has slowed or even turned negative, suggesting that we can no longer count on exports as an important source of strength.

Third, the problems in the housing markets, financial markets, and labor markets continue to be a drag on growth and employment. Fortunately, the recent fall in commodity prices should help to cushion some of this downward pressure on activity. Overall, I anticipate that real GDP growth in the second half of this year will come in below the growth of potential output which implies that the unemployment rate will rise. On its own, this obviously is not good news. And its interaction with the housing and financial markets raises the potential for worse news—a deepening of the adverse feedback loop I've been describing: more unemployment causing more people to fall behind on their mortgage payments, leading to further delinquencies and foreclosures, tighter credit conditions and further downward pressure on activity and employment. This kind of process represents a downside risk for the economy, especially if it intensifies the sagging consumer and business confidence we've seen.
all emphasis added
Dr. Yellen has probably been the most bearish Fed President, especially on housing. Her focus on unemployment (and exports) and the potential negative adverse feedback loops is very important. "Decidedly subpar" is about as close as a Fed President ever comes to predicting a recession.