Fed's Yellen Underscores That Removing Monetary Accommodation Now is Inappropriate
Janet Yellen, President of the Federal Reserve Bank of San Francisco, stressed that the removal of monetary stimulus at the present time is not appropriate given the fragile status of the economy and the "unacceptably high" unemployment rate of 9.7%. The main argument is that "the economy is operating well below its potential and inflation is undesirably low."
Based on the Congressional Budget Office's estimates of potential real GDP (level of GDP if the economy were operating at full employment), the U.S. economy was operating 6% below its potential in 2009 (see chart 1). For the Fed to consider applying monetary policy brakes in 2010, there should a quick "V" shaped recovery similar to other post-war recoveries prior to 1990. The nature of the deep recession and incoming economic data do not support predictions a very robust recovery in 2010. Therefore, the discount rate hike announced on February 18 is clearly a part of the removal of emergency measures put in place when the financial crisis unfolded in the summer of 2007 and not the beginning of a tightening of monetary policy. Chairman Bernanke's testimony on February 24 should largely echo a similar message.
Chicago Fed Index Advances in January
The Chicago Fed National Activity Index (CFNAI) rose 0.02 in January from -0.58 in December. The 3-month moving average of the index was -0.16 in January vs. -0.47 in the prior month. According to the Chicago Fed, "when the three-month moving average of the CFNAI moves above -0.7 following a period of economic contraction, there is an increasing likelihood the recession has ended." The three-month moving average of the CFNAI has held above -0.70 since November 2009. The January reading of the index implies that economy activity is approaching the long-term trend.
The CFNAI is made up of four major components - (1) consumption and housing, (2) production and income, (3) employment, unemployment and hours, and (4) sales, orders, and inventories. Of these four components, the consumption and housing component shows the weakest performance (see chart 3), while the remaining three components show a more noticeable recovery. These trends should not be surprising in light of the fact that the housing market crisis has been the impetus behind the recession. In addition, the home price bubble supported consumer spending.
