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Jim Hamiton Listens to Janet Yellen of the SF Fed on Risks for the U.S. Economy

Janet:

Econbrowser: Janet Yellen on risks and prospects for the U.S. economy: Unfortunately, it appears to me that there are at least three reasons for thinking that housing prices have further to fall... the ratio of house prices to rents... still remains quite high... inventories of unsold homes remain at elevated levels.... futures market for house prices predicts further declines....

The ongoing fall in house prices has important implications for the financial markets.... [T]he market for private-label securitized mortgages of even the highest quality remains moribund. These securities were the primary source of financing for nonconforming residential mortgages.... Jumbo mortgages for prime borrowers are available, but at historically high spreads.... With hindsight, it is clear that [the] originate-to-distribute model suffered severe incentive problems--the originator had insufficient incentive to ensure the quality of the loans.... Before private-label mortgage securitization can recover, financial markets must design mechanisms to align the incentives of originators with the interests of the ultimate investors.... [T]here was a widespread failure of risk management... excessive reliance on what turned out to be flawed assessments of risk by rating agencies.... Investors, even large sophisticated financial institutions, did not take adequate steps to assess risk independently.... The encouraging news is that large commercial banks, investment banks, and mortgage specialists have, to some extent, been able to issue new equity capital and to rebuild capital positions.... My expectation is that market functioning will improve markedly by 2009. But things could get worse before they get better....

[B]ooming economic activity in developing countries has boosted their appetite for commodities... since 2000, world demand for oil has increased by roughly 11 million barrels per day, with China accounting for roughly 30 percent of this increase, and other developing countries accounting for another 60 percent.... On the supply side... major discoveries are increasingly difficult to find.... I am not yet persuaded that speculation, rather than the fundamentals of global supply and demand, has played an important role....

Between September and April, the [Federal Open Market] Committee reduced the federal funds rate by 3-1/4 percentage points to its current rate of 2 percent. With core consumer inflation running at about the same rate, the real funds rate is now around zero.... [R]ecent data... suggest that my biggest fears on the downside have, so far, been avoided.... But maximum sustainable employment is only one of our mandates. The other is low and stable inflation. In the wake of rapid increases in prices for gasoline and food, consumer survey measures of longer term inflation expectations have turned up... [but] other surveys, such as the Survey of Professional Forecasters, show little erosion in long-term inflation expectations... the anecdotes I hear are more consistent with credibility than with an upward wage-price spiral.... I still see inflation expectations as reasonably well anchored.... We cannot and will not allow a wage-price spiral to develop...

I still think that my best moment in the Clinton administration was passing out individual sheets of paper to individual members of the House estimating how many of their constituents would benefit from expanding the Earned Income Tax Credit. But I now think doing the staffwork for getting Janet Yellen into the Federal Reserve was almost as positive a public service.

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