Who is this?

1. Who is this? And why is she so important?

2. The US Economy and the Federal Reserve 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)

3. Monetary policy in a nutshell…. Commercial banks have more money that they want, so they lend that money out to businesses The Fed purchases bonds from the marketplace with newly printed money Those new dollars find their way into commercial banks Expanded business means more jobs as businesses increase hiring Businesses borrow this money to expand their operations

4. From a supply/demand perspective, this is what it would look like… Wages Unemployment Labor Supply (Workers) Current market wage Labor Demand (Firms) If the Fed does nothing, the market should correct itself through falling wages Employment People looking for work Job openings

5. From a supply/demand perspective, this is what it would look like… Wages Labor Supply (Workers) Current market wage Labor Demand (Firms) However, by increasing the money supply, interest rates fall, businesses borrow, and labor demand rises – note that the wages don’t change. Employment People looking for work Job openings

6. From a supply/demand perspective, this is what it would look like… Wages Labor Supply (Workers) Current market wage The goal is to return us to “full employment” – otherwise known as NAIRU (Non Accelerating Inflation Rate of Unemployment) Employment People looking for work Job openings =

7. From a supply/demand perspective, this is what it would look like… Wages Labor Supply (Workers) Current market wage However, if we keep interest rates low for too long, wages begin to rise and another process begins Employment People looking for work Job openings =

8. As workers wages rise, they start buying more goods and services. Higher demand for goods and services raises prices As businesses see their labor costs rising, they pass that cost along to the consumer in the form of higher prices OR Demand Pull Inflation Cost Push Inflation

9. Monetary policy in a nutshell… Current market wage If unemployment is above NAIRU, keep interest rates low “Natural rate of unemployment” otherwise known as NAIRU (Non-Accelerating Inflation Rate of Unemployment) Current market wage If unemployment is at or below NAIRU, raise interest rates up (INFLATION IS A CONCERN)

10. 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. QE3 QE2 QE1

11. 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

12. From the latest employment report (8/01/2014) "Now joblessness isn't just for philosophy majors.“ – Kent Brockman For the month of July, 2014: Unemployment Rate =6.2% Jobs created: 209,000 “Unemployment is capitalism's way of getting you to plant a garden." - Orson Scott Card

13. 10.1% Has this policy by the Federal Reserve worked? QE1 QE2 6.2% It’s taken us 5 years to work our way down from our high of 10.1% Current “Recovery” Last Recession

14. Monthly change in payrolls Average = 156,000/mo. 209,000 in July Average = -361,000/mo. 8 million jobs gained during the recovery 8 million jobs lost during the recession

15. 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. Eligible population = 107M 1.5% x 107M = 1.60M Entering the workforce 1.60M 1.60M retiring Now (2014) 16 years ago (1998) 45 years ago (1969) 61 Years ago (1953) 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. Monthly change in payrolls Average = - 361,000/mo. Average = 156,000/mo. 156,000 Jobs created - 123,000 to satisfy population growth 33,000 lost jobs recovered per month To get back to “normal” 8,000,000 33,000 = 242 months 8 million jobs lost during the recession (~20 years)

17. Let’s look at the last time we hit 10% unemployment 10.8% (1982) 10.1% (2010) Average = 5.8%

18. During the recovery following the 81-82 recession, we created almost twice as many jobs per month Average = 265,000 Average = -177,000

19. 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 To get back to “normal” 3,000,000 142,000 = 21 months Average = -177,000 (~2 years) Average = 265,000 3,000,000 jobs lost

20. Lets compare the current recession/recovery to the last few 2 years

21. 10.8% (1982) 10.1% (2010) It took 2 years to go from 10.8% to 6.7% It took 5 years to go from 10.1% to 6.2% Average = 5.8% How can the unemployment rate drop so quickly with so few jobs being created?

22. The labor force participation rate is currently at a 35 year low and continues to fall… Start of recession ‘81-’82 Recession

23. Let’s look at the statistics during the great recession • December 2009 • Eligible Population: 235M • Labor Force: 154M • Not in Labor Force: 81M • Labor Force Participation: 65% • Employed: 138M • Unemployed: 16M • Unemployment Rate: 10% • January 2008 • Eligible Population: 232M • Labor Force: 154M • Not in Labor Force: 78M • Labor Force Participation: 66% • Employed: 146M • Unemployed: 8M • Unemployment Rate: 5% • 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%

24. Now, lets look at the statistics during the recovery • December 2009 • Eligible Population: 235M • Labor Force: 154M • Not in Labor Force: 81M • Labor Force Participation: 66% • Employed: 138M • Unemployed: 16M • Unemployment Rate: 10% • 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%

25. Partly, what’s happening is this…. The Fed purchases bonds from the marketplace with newly printed money Because banks have more cash on hand than they want, they this extra money out Those new dollars find their way into commercial banks Banks deposit their extra money at the Fed The DJIA has risen from $9,441 in 2009 to $17,026 now Businesses are borrowing this money to refinance existing debt and buy back stock

26. Reserve balances of commercial banks at the Federal Reserve QE3 Billions of Dollars QE2

28. Two types of unemployment Cyclical Structural The 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. Note: The Fed can’t do anything about structural unemployment…only cyclical unemployment

29. “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” Speech to labor unions, Feb. 2013 What does this mean?

30. We have two possible labor markets in the US… Unemployment Rate = 6.3% Wages Unemployment Rate = 6.3% Wages Labor Supply (Workers) Qualified Labor Supply (Workers) Current market wage Current market wage Natural Rate = 5% Labor Demand (Firms) Labor Demand (Firms) Employment People looking for work Job openings Employment People looking for work Job openings Cyclical Structural

31. Janet believes the unemployment we have is cyclical … No fear of inflation You are here 6.2% NAIRU ~ 5% Inflation becomes a worry here

32. Suppose that it is structural… No fear of inflation NAIRU = 7-8% Inflation a concern You are here 6.2% Janet’s Target = 5-6% Inflation a BIG concern

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

34. Without wage pressures, inflation hasn’t been a problem….yet! Annual percentage Fed’s target

35. 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”

36. 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”