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This was added on 4/11/11

To read the speech, go to

Please note that I agree with much of what Janet Yellen says with regard to correcting perceptions about what is going on these days, but I disagree about some other things.  I point those out below.  The disagreements are very important. 

"Some observers have attributed the recent boom in commodity prices to the highly accommodative stance of U.S. monetary policy, including the marked expansion of the Federal Reserve's balance sheet and the maintenance of the target federal funds rate at exceptionally low levels. Such an interpretation of recent developments naturally leads to the conclusion that the Federal Open Market Committee (FOMC) should move promptly toward firmer monetary conditions. Indeed, some have even raised the specter of a return to the high inflation of the 1970s in arguing for the urgency of monetary policy tightening.

"Increases in energy and food prices are, without doubt, creating significant hardships for many people, both here in the United States and abroad. However, the implications of these increases for how the Federal Reserve should respond in terms of monetary policy must be considered very carefully. In my remarks today, I will make the case that recent developments in commodity prices can be explained largely by rising global demand and disruptions to global supply rather than by Federal Reserve policy."

Janet Yellen is right - the recent price increases are commodity price increases, not price increases due to accommodative monetary policy. 

"Moreover, empirical analysis suggests that these developments, at least thus far, are unlikely to have persistent effects on consumer inflation or to derail the recovery." 

I won't comment on the first part of the statement right here - but I will comment on the second.  The economic recovery will be derailed, by the real estate crisis or national debt problem or renewed high gas prices or some combination of these three. 

"Critically, so long as longer-run inflation expectations remain stable, the increases seen thus far in commodity prices and headline consumer inflation are not likely, in my view, to become embedded in the wage and price setting process and therefore are not likely to warrant any substantial shift in the stance of monetary policy. An accommodative monetary policy continues to be appropriate because unemployment remains elevated, and, even now, measures of underlying inflation are somewhat below the levels that FOMC participants judge to be consistent, over the longer run, with our statutory mandate to promote maximum employment and price stability."

The increases in commodity prices and headline consumer inflation will not become embedded in the wage and price setting process this time - we are at a completely different point in the Kondratieff wave now.  The embedding in the wage and price setting process is what happens during the stagnation phase of the Kondratieff wave - the 1970's in our case, especially toward the end of the phase as the phase develops.  The Fed is fighting the last battle. 

As for unemployment remaining elevated at a time when measures of underlying inflation are even somewhat below the levels that FOMC participants judge to be consistent, over the longer run, with their statutory mandate to promote maximum employment and price stability, that is exactly what I would expect at this stage of the Kondratieff cycle, especially in light of the manipulation by the Keynesians along the way over the years in their effort to keep the system going.  They have managed to postpone the high unemployment and low inflation that is dangerously close to deflation, but we have now gotten there.  The high unemployment and low overall inflation will persist until we get to a point where a deflationary depression gets underway. 

"While I continue to anticipate a gradual economic recovery in the context of price stability, I do recognize that further large and persistent increases in commodity prices could pose significant risks to both inflation and real activity that could necessitate a policy response. The FOMC is determined to ensure that we never again repeat the experience of the late 1960s and 1970s, when the Federal Reserve did not respond forcefully enough to rising inflation and allowed longer-term inflation expectations to drift upward. Consequently, we are paying close attention to the evolution of inflation and inflation expectations."

The FOMC does not have to worry about repeating the experience of the late 1960's and 1970's - that was the late part of the Kondratieff growth phase (when consumer price inflation first picks up during the Kondratieff wave), the transition to the stagnation phase (late 1960's/early 1970's), and the stagnation phase (rest of the 1970's), which is characterized by high consumer price inflation especially if the currency is disconnected from its reference point early in the stagnation phase (which happened in our case in August 1971), but which does not turn into hyperinflation (it does not go anywhere near that high).  The Fed is fighting the last battle - our problem this time is declining inflation leading to deflation, overall, not increasing overall inflation

"Let me now turn to a discussion of the sources of the recent increase in commodity prices. In my view, the run-up in the prices of crude oil, food, and other commodities we've seen over the past year can best be explained by the fundamentals of global supply and demand rather than by the stance of U.S. monetary policy."


"In particular, a rapid pace of expansion of the emerging market economies (EMEs), which played a major role in driving up commodity prices from 2002 to 2008, appears to be the key factor driving the more recent run-up as well."


"Although real activity in the EMEs slowed appreciably immediately following the financial crisis, those economies resumed expanding briskly by the middle of 2009 after global financial conditions began improving, with China--which has accounted for roughly half of global growth in oil consumption over the past decade--again leading the way."


"By contrast, demand for commodities by the United States and other developed economies has grown very slowly." 


"In contrast, the arguments linking the run-up in commodity prices to the stance of U.S. monetary policy do not seem to hold up to close scrutiny. In particular, some observers have pointed to dollar depreciation, speculative behavior, and international monetary linkages as key channels through which accommodative U.S. monetary policy might be exacerbating the boom in commodity markets. Let me address each of these possibilities in turn.

"First, it does not seem reasonable to attribute much of the rise in commodity prices to movements in the foreign exchange value of the dollar. Since early last summer, the dollar has depreciated about 10 percent against other major currencies, and of that change, my sense is that only a limited portion should be attributed to the Federal Reserve's initiation of a second round of securities purchases. By comparison, as I noted earlier, crude oil prices have risen more than 70 percent over the same period, and nonfuel commodity prices are up roughly 40 percent. Put another way, commodity prices have risen markedly in all major currencies, not just in terms of U.S. dollars, suggesting that the evolution of the foreign exchange value of the dollar can explain only a small fraction of those increases."


"A second potential concern is that U.S. monetary policy is boosting commodity prices by reducing the cost of holding inventories or by fomenting "carry trades" and other forms of speculative behavior. But here, too, the evidence is not compelling. Price increases have been prevalent across a wide range of commodities, even those that are associated with little or no trading in futures markets. Moreover, if speculative transactions were the primary cause of rising commodity prices, we would expect to see mounting inventories of commodities as speculators hoarded such commodities, whereas in fact stocks of crude oil and agricultural products have generally been falling since last summer."


"A third concern expressed by some observers is that the exceptionally low level of U.S. interest rates has translated into excessive monetary stimulus in the EMEs. In particular, even though their economies have been expanding quite rapidly, many EMEs have been reluctant to raise their own interest rates because of concerns that higher rates could lead to further capital inflows and boost the value of their currencies. Some argue that their disinclination to tighten monetary policy has in turn resulted in economic overheating that has generated further upward pressures on commodity prices.

"I do not think this explanation accounts for much of the surge in commodity prices, in part because I believe that the bulk of the rapid economic growth in EMEs mainly reflects fundamental improvements in productive capacity, as those countries become integrated into the global economy, rather than loose monetary policies. Irrespective of monetary conditions in the advanced foreign economies, it is clear that the monetary and fiscal authorities in the EMEs have a range of policy tools to address any potential for overheating in their economies if they choose to do so. Indeed, in light of the relatively high levels of resource utilization and inflationary pressures that many EMEs face at present, monetary tightening and currency appreciation might well be appropriate for those economies."


"Turning now to the outlook for U.S. consumer prices, I anticipate that the recent surge in commodity prices will cause headline inflation to remain elevated over the next few months. However, I expect that consumer inflation will subsequently revert to an underlying trend that remains subdued, so long as increases in commodity prices moderate and longer run inflation expectations remain reasonably well-anchored."

This is the usual schmaltzy language from the Fed with regard to further inflation.  First, they assume that price increases will not continue at all - but there is no guarantee of that.  Second, they take advantage of the definition of inflation - which is an increase in prices.  They are saying that they do not expect such increases to continue.  I can assure you that at least with respect to oil prices, and probably with regard to the prices of most other individual consumer items as well, if the price does not come back down, people will complain even if it does not go up more.  My claim is that the prices may continue to go up more for the time being - but when they get high enough (and I am not talking about hyperinflation here), I think people will cut back on their spending and that is when, in an economy that is 2/3 dependent on consumer spending, the deflationary depression will start (if people are not buying, prices will come down). 

Some paragraphs then follow in Yellen's speech that I do not comment on, having to do with definitions of different ways of measuring inflation, and then she says this

"I want to emphasize that this focus on core and other inflation measures that may exclude recent increases in the cost of gasoline and other household essentials is not intended to downplay the importance of these items in the cost of living or to lower the bar on the definition of price stability. The Federal Reserve aims to stabilize inflation across the entire basket of goods and services that households purchase, including energy and food. Rather, we pay attention to core inflation and similar measures because, in light of the volatility of food and energy prices, core inflation has been a better forecaster of overall inflation in the medium term than overall inflation itself has been over the past 25 years."

So the Fed has finally cleared that up more explicitly - it has confused many people for a long time, but I have known the above for a long time already. 

"In my view, the marked decline in these trend measures of inflation since the intensification of the crisis largely reflects very low rates of resource utilization. Strong productivity gains have also played a role in holding down inflation because, together with low wage inflation, they have markedly restrained the rise in firms' production costs. With resource slack likely to diminish only gradually over the next few years, it seems reasonable to anticipate that underlying inflation will remain subdued for some time, provided that longer-term inflation expectations remain well contained."

I agree with the view that the marked decline in the trend measures of inflation since the intensification of the crisis largely reflects very low rates of resource utilization - but I do not agree that they can be increased a lot again.  The Fed often, in recent times, has talked in terms of "anticipating a gradual return to more normal levels of resource utilization in the context of price stability."  This is a Keynesian way of thinking - and is simply impossible to accomplish at this stage of the Kondratieff wave (at least in terms of getting back to "normal," meaning from the point of view of the Fed and most other people who do not know the Kondratieff wave well, much higher, levels of resource utilization), and that is why it is simply not going to happen.  That is also why it is not really happening so far. 

But, yes, strong productivity gains also played a role - but that simply means companies learned to do more with fewer people and so they do not need as many people anymore.  That does not help the unemployment problem at all.  And, yes, it also holds down inflation - in fact, it contributes to deflation. 

As for resource slack being likely to diminish only gradually over the next few years, it does indeed seem reasonable to anticipate that underlying inflation will remain subdued for some time, provided that longer-term inflation expectations remain well contained - but that is looking at the situation from a Keynesian point of view and putting a (unjustified) positive spin on it.  The Keynesians don't want to accept that resource utilization goes down over the course of the later part of a long-term economic up-cycle and into the subsequent downturn - and so they talk in terms of "resource slack being likely to diminish only gradually over the next few years," which is actually just an acknowledgement of current conditions at this very late stage of the long-term economic up-cycle - resource utilization is not going up much or quickly, compared to past recoveries in recent decades - but expresses the hope that it will eventually go up to much higher levels, and notes that given current conditions, inflation is likely to stay low.  Again, the Keynesians are fighting the last battle, deflation will be the problem in the future. 

"Real consumer spending--which had been rising at a brisk pace in the fall--slowed somewhat around the turn of the year,"

Yep, right after the Christmas shopping season. 

"and measures of consumer sentiment declined in March."

Yep, right about the time gas prices went way back up. 

"Those developments may partly reflect the extent to which higher food and energy prices have sapped households' purchasing power."


"More generally, however, as the improvement in the labor market deepens and broadens, households should regain some of the confidence they lost during the recession, providing an important boost to spending." 

The labor market is still very thin - and people know it - so I think this is a very optimistic statement. 

"Nonetheless, a sharp rebound in economic activity--like those that often follow deep recessions--does not appear to be in the offing."

No kidding - and that is why I think the above statement is very optimistic. 

In fact, the very slow recovery this time is very consistent with the very late stage we are at in the Kondratieff wave.  The recovery will not get much faster. 

"One key factor restraining the pace of recovery is the construction sector, which continues to be hampered by a considerable overhang of vacant homes and commercial properties and remains in the doldrums."

Yep!  And it has been my contention from the very beginning that the construction sector would be a very major drag on the recovery. 

"In addition, spending by state and local governments seems likely to remain limited by tight budget conditions." 

Yep - and it will only get worse!

"Moreover, while the labor market has recently shown some signs of life, job opportunities are still relatively scarce."

Yep - and that is why I think the above statement is so optimistic.  In other words, Janet Yellen contradicts herself in her own speech on this one, trying to be optimistic (to support the law against recessions), but having to be realistic later (to acknowledge reality).

"The unemployment rate is down from its peak, but at 8.8 percent, it still remains quite elevated. And even the decline that we've seen to date partly reflects a drop in labor force participation, because people are counted as unemployed only if they are actively looking for work."


"Some observers have argued that the high unemployment rate primarily reflects structural factors such as a longer duration of unemployment benefits and difficulties in matching available workers with vacant jobs rather than a deficiency of aggregate demand. In my view, however, the preponderance of available evidence and research suggests that these alternative structural explanations cannot account for the bulk of the rise in the unemployment rate during the recession. For example, if mismatches were of central importance, we would not expect to see high rates of unemployment across the vast majority of occupations and industries. Instead, I see weak demand for labor as the predominant explanation of why the rate of unemployment remains elevated and rates of resource utilization more generally are still well below normal levels."


"As I have indicated, the recent run-up in commodity prices is likely to weigh somewhat on consumer spending in coming months because it puts a painful squeeze on the pocketbooks of American households. In particular, higher oil prices lower American income overall because the United States is a major oil importer and hence much of the proceeds are transferred abroad. Monetary policy cannot directly alter this transfer of income abroad, which primarily reflects a change in relative prices driven by global demand and supply balances, not conditions in the United States. Thus, an increase in the price of crude oil acts like a tax on U.S. households, and like other taxes, tends to have a dampening effect on consumer spending."

Yep - and in an economy that is 2/3 dependent on consumer spending, that is not good!

"The surge in commodity prices may also dampen business spending. Higher food and energy prices should boost investment in agriculture, drilling, and mining but are likely to weigh on investment spending by firms in other sectors. Assuming these firms are unable to fully pass through higher input costs into prices, they will experience some compression in their profit margins, at least in the short run, thereby causing a decline in the marginal return on investment in most forms of equipment and structures. Moreover, to the extent that higher oil prices are associated with greater uncertainty about the economic outlook, businesses may decide to put off key investment decisions until that uncertainty subsides. Finally, with higher oil prices weighing on household income, weaker consumer spending could discourage business capital spending to some degree."


"Fortunately, considerable evidence suggests that the effect of energy price shocks on the real economy has decreased substantially over the past several decades. During the period before the creation of the Organization of the Petroleum Exporting Countries (OPEC), cheap oil encouraged households to purchase gas-guzzling cars while firms had incentives to use energy-intensive production techniques. Consequently, when oil prices quadrupled in 1973-74, that degree of energy dependence resulted in substantial adverse effects on real economic activity. Since then, however, energy efficiency in both production and consumption has improved markedly." 

I think recent evidence puts the lie to this assertion - very high oil prices killed the economy starting in the summer of 2008, despite the relatively lower dependence on oil compared to the 1970's, and I think that high oil prices may well do the same thing this time, and it won't take oil prices as high as the summer of 2008 (which peaked at nearly $150/barrel) because people are much more sensitive to the issue in the meantime. 

"Consequently, while the recent run-up in commodity prices is likely to weigh somewhat on consumer and business spending in coming months, I do not anticipate that those developments will greatly impede the economic recovery as long as these trends do not continue much further." 

I do not think they have to go much further at all - I think oil prices are already high enough to make a big difference. 

Why do I think that?

Because of the importance of round numbers.  Oil prices had to get downright economically painful in 2008 before people noticed - because the people had had such a perception of good times for several years before then that it took oil prices going way high before they were willing to acknowledge the possibility that it might not continue. 

But this time, the economy is much weaker, having not at all fully recovered from that hit yet - and people have been super-sensitive to high oil prices ever since the oil prices went way up back then.  

So I think that as soon as oil prices went above $100/barrel this time, consumer confidence crashed - the consumer confidence numbers are way down in the meantime, just about at that time.  And then oil kept going up, to more than $110/barrel in the meantime.  I think people have very much noticed - I do not think they were dreaming or sleeping at all this time, like they were doing going into the summer of 2008. 

And, just as monetary policy did not mean diddly-squat anymore once gas prices went high enough in the summer of 2008, I do not think monetary policy is going to mean diddly-squat this time once gas prices go high enough - and I think they have probably done so already, given how fragile the economy is and how sensitive people are to gas prices these days.