Who is this?

And why is she so important?

Say hello to the new chairman of the federal reserve system…

Janet Yellen• Born in Brooklyn, NY in 1946• Graduated summa cum laude from Brown University in 1967

(Economics)• PhD. In Economics from Yale in 1971• Assistant Professor at Harvard (1971-76)• Economist at Federal Reserve Board (1977-78)• Lecturer, London School of Economics (1978-80)• Assistant Professor, UC Berkeley (1980-82)• Associate Professor, UC Berkeley (1982-1985)• Professor, UC Berkeley (1985-Present)• Member, Board of Governors of Federal Reserve (1994-97)• Chairman of Council of Economic Advisors (1997-99)• President, Federal Reserve Bank of San Francisco (2004-10)• Vice Chair of Federal Reserve (2010 – 2014)

Note: Janet Yellen is married to George Akerlof (Nobel Prize in Economics, 2001)

The US Economy and the Federal Reserve

Monetary policy in a nutshell….

The Fed purchases bonds from the marketplace with newly printed money

Those new dollars find their way into commercial banks

Commercial banks have more money that they want, so they lend that money out to businesses

Businesses borrow this money to expand their operations

Expanded business means more jobs as businesses increase hiring

From a supply/demand perspective, this is what it would look like…

Employment

WagesLabor Supply (Workers)

Labor Demand (Firms)

Current market wage

People looking for work

Job openings

Unemployment

If the Fed does nothing, the market should correct itself through falling wages

From a supply/demand perspective, this is what it would look like…

Employment

WagesLabor Supply (Workers)

Labor Demand (Firms)

Current market wage

People looking for work

Job openings

However, by increasing the money supply, interest rates fall, businesses borrow, and labor demand rises – note that the wages don’t change.

From a supply/demand perspective, this is what it would look like…

Employment

WagesLabor Supply (Workers)

Current market wage

People looking for work

Job openings

The goal is to return us to “full employment” – otherwise known as NAIRU (Non Accelerating Inflation Rate of Unemployment)

=

From a supply/demand perspective, this is what it would look like…

Employment

WagesLabor Supply (Workers)

Current market wage

People looking for work

Job openings

However, if we keep interest rates low for too long, wages begin to rise and another process begins

=

As workers wages rise, they start buying more goods and services. Higher demand for goods and services raises prices

Demand Pull Inflation

ORAs businesses see their labor costs rising, they pass that cost along to the consumer in the form of higher prices

Cost Push Inflation

Monetary policy in a nutshell…

“Natural rate of unemployment” otherwise known as NAIRU (Non-Accelerating Inflation Rate of Unemployment)

If unemployment is above NAIRU, keep interest rates low

If unemployment is at or below NAIRU, raise interest rates up (INFLATION IS A CONCERN)

Current market wage

Current market wage

Since the recession, the Federal Reserve has been purchasing US Treasuries in an effort to keep interest rates low (Quantitative easing):

The Fed is currently purchasing securities at the rate of around $85B per month.

QE1

QE2

QE3

The Fed has committed itself to the following policy:

Tapering quantitative easing (bond purchases) to zero once the unemployment rate reaches 7% and raise interest rates once it hits 6.5% (or even lower)

The current belief is that interest rates will remain at their current levels until mid 2015

From the latest employment report (8/01/2014)

For the month of July, 2014:

Unemployment Rate =6.2%Jobs created: 209,000

"Now joblessness isn't just for philosophy majors.“ – Kent Brockman

“Unemployment is capitalism's way of getting you to plant a garden." - Orson Scott Card

2008 2009 2010 2011 2012 2013 20140.0

2.0

4.0

6.0

8.0

10.0

12.0

QE3

Last Recession Current “Recovery”

It’s taken us 5 years to work our way down from our high of 10.1%

Has this policy by the Federal Reserve worked?

QE1 QE2

6.2%

10.1%

2008 2009 2010 2011 2012 2013 2014

-1000

-800

-600

-400

-200

0

200

400

600

Average = -361,000/mo.

Average = 156,000/mo.

Monthly change in payrolls

209,000 in July

8 million jobs lost during the recession

8 million jobs gained during the recovery

Let’s do a back of the envelope calculation….population grows at around 1.5% per year. Let’s assume everybody enters the workforce at 16 and retires after 45 years.

Now (2014)45 years ago

(1969)

Eligible population = 107M

1.5% x 107M = 1.60M Entering the workforce 1.60M retiring

Eligible population = 205M

1.5% x 205M = 3.08M Entering the workforce

3.08M – 1.60M = 1.48M / 12 = 123,000 Jobs per month!

16 years ago(1998)61 Years ago

(1953)

1.60M

Monthly change in payrolls

8 million jobs lost during the recession

8,000,000 33,000 = 242 months

To get back to “normal”

(~20 years)

2008 2009 2010 2011 2012 2013 2014

-1000

-800

-600

-400

-200

0

200

400

600

156,000 Jobs created- 123,000 to satisfy population growth 33,000 lost jobs recovered per month

Average = 156,000/mo.Average = - 361,000/mo.

1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 20130.0

2.0

4.0

6.0

8.0

10.0

12.0

Average = 5.8%

10.1% (2010)

10.8% (1982) Let’s look at the last time we hit 10% unemployment

1981 1982 1983 1984 1985

-600

-400

-200

0

200

400

600

800

1000

1200

Average = -177,000

Average = 265,000

During the recovery following the 81-82 recession, we created almost twice as many jobs per month

1981 1982 1983 1984 1985

-600

-400

-200

0

200

400

600

800

1000

1200

Average = -177,000

Average = 265,000

During the recovery following the 81-82 recession, we created almost twice as many jobs per month

265,000 Jobs created- 123,000 to satisfy population growth 142,000 lost jobs recovered per month

3,000,000 142,000 = 21 months

To get back to “normal”

(~2 years)

3,000,000 jobs lost

Lets compare the current recession/recovery to the last few

2 years

1980 1985 1990 1995 2000 2005 20100.0

2.0

4.0

6.0

8.0

10.0

12.0

Average = 5.8%

10.1% (2010)

10.8% (1982)

It took 2 years to go from 10.8% to 6.7% It took 5 years to go from

10.1% to 6.2%

How can the unemployment rate drop so quickly with so few jobs being created?

1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 201357.0

59.0

61.0

63.0

65.0

67.0

69.0

The labor force participation rate is currently at a 35 year low and continues to fall…

‘81-’82 Recession

Start of recession

Let’s look at the statistics during the great recession

January 2008• Eligible Population: 232M• Labor Force: 154M• Not in Labor Force: 78M• Labor Force Participation: 66%

• Employed: 146M• Unemployed: 8M• Unemployment Rate: 5%

December 2009 • Eligible Population: 235M• Labor Force: 154M• Not in Labor Force: 81M• Labor Force Participation: 65%

• Employed: 138M• Unemployed: 16M• Unemployment Rate: 10%

Assuming that the labor participation rate remained constant (66%):• To stay at 5% unemployment, we would need to create 1.5 million jobs• We actually lost 8 million jobs • The unemployment rate would’ve been 12%

July 2014 • Eligible Population: 248M• Labor Force: 156M• Not In Labor Force: 92M• Labor Force Participation: 62%

• Employed: 146.3M• Unemployed: 9.7M• Unemployment Rate: 6.2%

Assuming that the labor participation rate remained constant (66%):• To drop to 6.2% unemployment we needed to create 16 million jobs• We actually created 8 million jobs • The unemployment rate would be 10.7%

December 2009 • Eligible Population: 235M• Labor Force: 154M• Not in Labor Force: 81M• Labor Force Participation: 66%

• Employed: 138M• Unemployed: 16M• Unemployment Rate: 10%

Now, lets look at the statistics during the recovery

Partly, what’s happening is this….

The Fed purchases bonds from the marketplace with newly printed money

Those new dollars find their way into commercial banks

Because banks have more cash on hand than they want, they this extra money out

Businesses are borrowing this money to refinance existing debt and buy back stock

The DJIA has risen from $9,441 in 2009 to $17,026 now

Banks deposit their extra money at the Fed

2004 2009 20140

500

1000

1500

2000

2500

3000

QE1

Billi

ons

of D

olla

rs

Reserve balances of commercial banks at the Federal Reserve

QE2

QE3

Note: The Fed can’t do anything about structural unemployment…only cyclical unemployment

Cyclical StructuralThe result of businesses not having enough demand for labor to employ all those who are looking for work. The lack of employer demand comes from a lack of spending and consumption in the overall economy

There is a fundamental mismatch between the number of people who want to work and the number of jobs that are available.

Two types of unemployment

“If the current, elevated rate of unemployment is largely cyclical, then the straightforward solution is to take action to raise aggregate demand. If unemployment is instead substantially structural, some worry that attempts to raise aggregate demand will have little effect on unemployment and serve only to stoke inflation”

“I see the evidence as consistent with the view that the increase in unemployment since the onset of the Great Recession has been largely cyclical and not structural”

What does this mean?

Speech to labor unions, Feb. 2013

We have two possible labor markets in the US…

Employment

WagesLabor Supply (Workers)

Labor Demand (Firms)

Current market wage

People looking for work

Job openings

Unemployment Rate = 6.3%

Employment

WagesQualified Labor Supply (Workers)

Labor Demand (Firms)

Current market wage

People looking for work

Job openings

Unemployment Rate = 6.3%

StructuralCyclical

Natural Rate = 5%

NAIRU ~ 5%

Janet believes the unemployment we have is cyclical …

You are here6.2%

Inflation becomes a worry here

No fear of inflation

Suppose that it is structural…

NAIRU = 7-8%

You are here6.2%

Janet’s Target = 5-6%

Inflation a concern

Inflation a BIG concern

No fear of inflation

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

Annu

al p

erce

ntag

e ch

ange

In Janet’s defense, notice that hourly compensation is not noticeably increasing (in fact, if anything, its decreasing)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

-2

-1

0

1

2

3

4

5

6

Without wage pressures, inflation hasn’t been a problem….yet!

Fed’s target

Annu

al p

erce

ntag

e

This past weekend , the annual gathering of bankers, finance officials and economic experts hosted by the Kansas City Fed was held at Jackson Hole, Wyoming.

“LABOR MARKET HASN'T FULLY RECOVERED EVEN AMID JOB GAINS”

“THERE'S `NO SIMPLE RECIPE' FOR APPROPRIATE POLICY”

“FOMC SHIFTING TO QUESTIONS ON LEVEL OF JOB-MARKET SLACK”

“GAUGING LABOR-MKT SLACK NEEDS TO BE `MORE NUANCED‘”

“ASSESSMENT OF SLACK DEPENDS ON RANGE OF VARIABLES”

“FASTER PROGRESS ON GOALS MAY BRING RATE RISE SOONER…SLOWER PROGRESS ON GOALS MAY DELAY RATE INCREASE”

Translation:

“We have no idea what’s going on or what we should do about it, but as long as inflation remains low I’m not going to worry too much”