Janet L Yellen: Shaping the future of the macroeconomic policy mix
Remarks by Ms Janet L Yellen, Chair of the Board of Governors of the Federal Reserve
System, at the Panel Discussion on "Shaping the Future of the Macroeconomic Policy Mix",
International Symposium of the Bank of France "Central Banking: The Way Forward?", Paris,
7 November 2014.
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I would like to thank the Banque de France for inviting me to take part in what I expect will be a
lively discussion.
The suddenness and severity of the global financial crisis forced policymakers to respond
rapidly and creatively, employing a wide range of macroeconomic tools - including both
monetary and fiscal policies - to arrest a steep economic downturn and restart the global
economy. Given the slow and unsteady nature of the recovery, supportive policy remains
necessary.
Today I would like to briefly review the evolution of monetary and fiscal policies following the
global financial crisis both in the United States and in other advanced economies, since we
have faced similar experiences and employed similar policy responses. I will try to draw some
lessons and provide some thoughts on the policy mix going forward.
Policy before the crisis
Prior to the global financial crisis, inflation rates in the United States and other advanced
economies were near their target levels and most of these economies appeared to be operating
close to their potential. Policy interest rates were similarly in the vicinity of levels considered to
be normal.
Fiscal deficits also appeared to be under control before the crisis. According to the Organisation
for Economic Co-operation and Development (OECD), general government deficits in 2007
were less than 4 percent of GDP in the United States and the United Kingdom, about 2 percent
in Japan, and less than 1 percent, on average, in the euro area. Still, given relatively buoyant
economic conditions, governments probably should have been doing more to prepare for the
long-term challenge of aging populations, which will boost pension obligations and health-care
expenditures in coming years. Moreover, government debt levels were already high in Japan
and in some European economies and not particularly low elsewhere. In addition, some
euroarea countries that appeared to have strong fiscal positions going into the crisis depended
partly on revenue from housing booms that soon went bust.
The policy response to the crisis
When the crisis hit, its global scope and severity were exceptional. Central banks in the United
States and other countries responded by rapidly and sharply reducing their policy interest rates,
lowering them in many cases to near zero. In addition, in their role as lenders of last resort,
central banks acted rapidly to provide liquidity to help stabilize the financial system and support
the flow of credit to households and businesses, in some cases creating new lending facilities.
These extraordinary and creative responses showed that monetary policymakers had
internalized the lessons of the Great Depression.
Initially, fiscal policy also provided significant stimulus. A portion of this stimulus reflected the
operation of automatic stabilizers - higher unemployment benefits, for example, and a decline
in tax payments due to lower incomes - and some came through cuts in tax rates and
increases in discretionary spending. Expansive fiscal policy served to raise deficits in most
countries, some of which faced further costs from stabilizing financial institutions, pushing
deficits even higher. Sharp increases in deficits led in turn to escalating levels of government
debt.
Policy during the recovery
The combination of increasing debt and depressed output led to rising ratios of debt to gross
domestic product (GDP) in many advanced economies and heightened concern about whether
the growth in debt could be sustained without unsettling financial markets. As a result, early in
the recovery governments began to withdraw fiscal stimulus, and, in most cases, fiscal policy
became a net drag on economic growth. This outcome was most evident in the euro-area
periphery, where skyrocketing bond yields and deepening concerns about default left
governments with little choice about whether to rein in stimulus. In Spain, for example, the
OECD estimates that fiscal consolidation has subtracted an average of 1-1/2 percentage points
from GDP growth each year since 2009. But fiscal policy also turned contractionary in countries
facing less market pressure, such as the United Kingdom and the United States. Governments
in both countries embarked on fiscal consolidation programs over the past four years, sharply
reducing their structural deficits, and, as a consequence, creating headwinds that slowed the
recovery.
With fiscal drag weighing on growth and with private-sector deleveraging also holding back
consumption and investment, monetary policy bore the brunt of supporting the economy. With
policy rates at or approaching zero, central banks of necessity turned to unconventional policy
tools such as large-scale asset purchases and enhanced forward guidance about the future
path of policy rates. These unconventional tools have, in my view, served to support a recovery
in domestic demand and, as a consequence, global economic growth.
Even so, the recovery in most advanced nations has proceeded more slowly than policymakers
would have hoped. This sluggishness has been due in part to the severity of the financial shock
associated with the crisis and the persistent headwinds to recovery in its aftermath. But the lack
of fiscal support for demand in recent years also helps account for the weakness of this
recovery compared with past recoveries.1 In the United States, fiscal policy has been much less
supportive relative to previous recoveries. For instance, at a comparable point in the recovery
from the 2001 recession, employment at all levels of government had increased by about
800,000 workers; in contrast, in the current recovery, government employment has declined by
about 650,000 jobs.
Lessons
What lessons can we draw from this experience? The first is that governments need to address
long-term challenges and significantly improve their structural fiscal balances during good times
so they have more fiscal space to provide stimulus when times turn bad. When poor economic
conditions drive policy interest rates close to the zero lower bound, fiscal stimulus may be more
effective than usual in boosting aggregate demand because it will not have the usual effect of
raising real interest rates, thereby crowding out private demand.2
A second lesson is that, while even if it is appropriate for fiscal policy to play a larger role when
policy rates are near zero, policymakers nevertheless may face constraints in implementing
fiscal stimulus. This means that central banks need to be prepared to employ all available tools,
including unconventional policies, to support economic growth and to reach their inflation
targets.
A third critical lesson pertains to the importance of having a sound and resilient financial sector
with strong capitalization and prudent risk management, supported by effective regulation and
supervision. The recent crisis has appropriately increased the focus on financial stability at
central banks around the world. At the European Central Bank (ECB), the recent
comprehensive assessment is an important step toward building confidence in euro-area
banks. I wish the ECB great success as it takes on its new responsibilities at the center of the
single supervisory mechanism. At the Federal Reserve, we have devoted substantially
increased resources to monitoring financial stability and have refocused our regulatory and
supervisory efforts to limit the buildup of systemic risk. This macroprudential approach to
promoting financial stability will be an important complement to our other tools for promoting a
healthy economy.
Looking ahead
In advanced economies, the current macroeconomic policy mix generally remains one of
extraordinary monetary policy stimulus and somewhat contractionary fiscal policy. Considering
the headwinds that continue to weigh on growth, employment, and prices, this situation is
hardly ideal. Policymakers face difficult choices as they seek to balance the need for long-term
fiscal sustainability with the need to support their economies in the near term.
Even so, I continue to anticipate that the headwinds associated with the financial crisis will
wane. As employment, economic activity, and inflation rates return to normal, monetary policy
will eventually need to normalize too, although the speed and timing of this normalization will
likely differ across countries based on differences in the pace of recovery in domestic
conditions. This normalization could lead to some heightened financial volatility. But as I have
noted on other occasions, for our part, the Federal Reserve will strive to clearly and
transparently communicate its monetary policy strategy in order to minimize the likelihood of
surprises that could disrupt financial markets, both at home and around the world. More
importantly, the normalization of monetary policy will be an important sign that economic
conditions more generally are finally emerging from the shadow of the Great Recession.