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November 29, 2011

Aggregate Demand and the Global Economic Recovery

Remarks by
Janet L. Yellen
Vice Chair
Board of Governors of the Federal Reserve System
at
“Asia’s Role in the Post-Crisis Global Economy”
Asia Economic Policy Conference Sponsored by
the Federal Reserve Bank of San Francisco
San Francisco, California

November 29, 2011

Good morning. I’m delighted to return “home” to the Federal Reserve Bank of
San Francisco and honored to kick off the Bank’s second Asia Economic Policy
Conference.
In my remarks this morning I will underscore the urgency of strengthened
international policy cooperation to attain strong, sustainable and balanced growth in the
global economy--a theme that received emphasis at the Group of Twenty (G-20) Leaders’
Summit in Cannes earlier this month. The global economy is facing critical challenges.
The recovery in the United States and other advanced economies has been proceeding too
slowly to provide jobs for millions of unemployed people. There have also been clear
signs of slowing growth in emerging market economies over the past year. In effect, we
face a dearth of aggregate demand, not just among the advanced economies, but also for
the global economy as a whole.1
In ordinary times, policymakers in the advanced countries would address such a
demand shortfall with expansionary fiscal and monetary policies. But these are no
ordinary times. Central banks in a number of advanced economies, including the United
States, have brought short-term interest rates close to zero, so that further monetary
accommodation can be provided only through unconventional tools, such as securities
purchases and forward policy guidance. Meanwhile, the scope for fiscal stimulus is
limited by concerns about sizable budget deficits and longer-term sustainability.
At the G-20 summit earlier this month in Cannes, the United States and other
advanced economies--including France, Germany, Italy, Japan, Spain, and the United
1

I am indebted to Federal Reserve Board staff members Shaghil Ahmed, Eric Engen, William English,
Joseph Gruber, Steven Kamin, Michael Leahy, Andrew Levin, Trevor Reeve, and David Wilcox for their
assistance in preparing these remarks.

-2Kingdom--agreed to pursue fiscal consolidation plans to place public finances on a
sustainable course over the medium term while sustaining the near-term recovery.
Indeed, in the current environment of weak demand, near-term fiscal consolidation could
threaten the economic recovery, which in turn may undermine the success of the fiscal
strategy. In such circumstances, economies with the capacity to stimulate global
growth--namely, countries with large current account surpluses and the potential to
expand domestic demand--must take a leading role in adopting policies to rebalance and
sustain the global economy. This commitment was made by all of the G-20 leaders,
including those from China, Indonesia, South Korea, and other emerging markets.
In the remainder of my remarks, I will point out some key factors that have been
restraining the pace of U.S. economic growth, and I will discuss the need for fiscal
adjustments to place our federal budget on a sustainable path over the medium term
without impairing the economic recovery. I will then turn to a consideration of the
crucial role of the Asian economies in fostering a stronger global recovery. Of course,
these remarks solely reflect my own views and not necessarily those of others in the
Federal Reserve System.
U.S. Economic Growth
Since the middle of 2009, the U.S. economy has been recovering from the most
severe recession and financial crisis to afflict our country since the Great Depression.
However, the pace of the economic recovery has been less vigorous than desired or
expected, and the unemployment rate has declined only about 1 percentage point over the
past two years. Indeed, the number of jobs in the private sector remains more than 6
million below the peak level reached in early 2008--a distressing development made all

-3the worse by the fact that new entrants have, of course, continued to come into the labor
force in recent years. The fraction of those now jobless who have been without work for
six months or more stands at a very high level. In addition to those officially
unemployed, many individuals are involuntarily working part time or have dropped out
of the labor force entirely.
The pace of economic growth in the second half of this year has been somewhat
faster than in the first half, reflecting in part a reversal of the temporary factors that had
weighed on growth earlier in the year. Nonetheless, a range of more-persistent factors
also appear to be restraining the recovery. In recognition of these drags, the consensus of
professional forecasters in the survey released earlier this month by the Federal Reserve
Bank of Philadelphia was that unemployment would decline only slightly in the next few
years, to an average rate of 8.4 percent in 2013. Moreover, financial market conditions
have deteriorated, on net, in recent months, intensifying some of the headwinds facing the
economy.
At the onset of the financial crisis, consumer spending contracted sharply and the
personal saving rate began a steep ascent. Exhibit 1 shows that the saving rate rose from
around 2-1/2 percent in 2006 to about 5 percent in the first half of this year. It now
appears that consumer spending is advancing at a moderate pace. In the pre-crisis years,
consumer spending grew rapidly, providing considerable impetus to the expansion. In
contrast, over the next few years, consumer spending seems unlikely to serve as one of
the main engines of growth. The ratio of household debt-to-income remains
exceptionally high, even though over the past few years it has declined slightly from the
post-World War II peak reached prior to the crisis. Although households appear to have

-4made some progress in deleveraging, many still face elevated debt burdens and reduced
access to credit. Moreover, high levels of unemployment and underemployment, slow
gains in wages, and declines in the values of both homes and financial assets have
weighed on household spending and diminished the ability of households to tap home
equity in emergencies or for other purposes. Consumer sentiment dropped markedly over
the summer and remains quite depressed, apparently reflecting households’ concerns
about the broader economy as well as their own financial situations.
A sharp downturn in housing was at the core of the previous recession, and this
sector continues to weigh on the recovery. Robust increases in housing activity have
helped spur recoveries from most U.S. recessions since World War II. This time, in
contrast, residential construction remains depressed by a large inventory of foreclosed
and distressed properties either currently available for purchase or probably soon to
become so, tight credit conditions for construction loans and mortgages, and concerns
about the possibility of further declines in home prices. As a result, new home
construction currently is at only about one-third of its average pace in recent decades. In
addition, homeowners with insufficient equity in their homes have found it difficult to
take advantage of today’s low interest rates by refinancing their mortgages. Recently
announced changes to the federal government’s Home Affordable Refinance Program, or
HARP, are designed to improve the opportunity for homeowners to refinance and I’m
hopeful this program will succeed in reducing household debt service burdens and the
flow of foreclosures. More generally, I see a strong case for additional policies to foster
more-rapid recovery in the housing sector. Indeed, to provide greater support for

-5mortgage markets, the Federal Reserve recently adjusted its program for reinvesting its
securities holdings.
The Federal Reserve continues to provide highly accommodative monetary
conditions to foster a stronger economic recovery in a context of price stability.
Moreover, the scope remains to provide additional accommodation through enhanced
guidance on the path of the federal funds rate or through additional purchases of longerterm financial assets.
Challenges for U.S. Fiscal Policy
Turning now to U.S. fiscal policy, with the onset of the recent recession and
financial crisis, the federal budget deficit widened significantly and has remained wide.
Exhibit 2 shows that, as a result, federal debt held by the public has increased relative to
our national income to a level not seen in the past half-century. These budget
developments have reflected both the weak economy, which has depressed revenues and
pushed up expenditures, and the fiscal stimulus that was implemented to help ease the
recession and support the recovery. So long as the economy continues to recover, the
deficit should narrow over the next several years as a growing economy boosts revenues
and reduces expenditures and as the policies put in place to provide economic stimulus
continue to wind down. Even so, the ratio of debt to gross domestic product (GDP) will
continue to edge higher over the next decade unless the Congress and the Administration
are able to agree on a program of deficit reduction that is more ambitious than the targets
incorporated in last summer’s Budget Control Act. Looking yet further out, it is apparent
that, absent significant policy shifts, budget pressures resulting from the aging of the U.S.
population and fast-rising health-care costs will continue to push the federal debt ratio

-6higher in coming decades. The dashed line in exhibit 2 shows the Congressional Budget
Office’s long-term projection of the debt-to-GDP ratio through 2035 under current policy
settings, including the effects of the Budget Control Act.
It is crucial that the federal budget be put on a sustainable long-run trajectory, and
we should not postpone charting that course. A failure to put in place a credible plan to
address our long-run budget imbalance would expose the United States to serious
economic costs and risks in the long term and possibly sooner. Timely enactment of a
plan to put the federal budget onto a sustainable trajectory will make it easier for
individuals and businesses to prepare for these adjustments. In addition, the sooner our
longer-term budget problems are addressed, the less wrenching the adjustment will have
to be and the more control that policymakers--rather than market forces or international
creditors--will have over the timing, size, and composition of the necessary adjustments.
At the same time, too much fiscal tightening in the near term could harm the
economic recovery. Significant near-term reductions in federal spending or large
increases in taxes would impose an additional drag on the economy at a time when
aggregate demand is already weak. Indeed, under current law, federal fiscal policy is
slated to impose considerable restraint on the growth of aggregate demand next year. We
need, and I believe we have scope for, an approach to fiscal policy that puts in place a
well-timed and credible plan to bring deficits down to sustainable levels over the medium
and long terms while also addressing the economy’s short-term needs. I do not
underestimate the difficulty of crafting a strategy that appropriately balances short-run
needs with long-run considerations, but doing so would provide important benefits to the
U.S. economy.

-7The Key Role of the Emerging Asian Economies
In light of the various factors weighing on aggregate demand in the United States
and other advanced economies, I believe it is crucial for emerging market economies,
particularly in Asia, to take further steps to boost domestic demand, providing support for
their own growth and that of the global economy. Indeed, such policies are a core
component of the G-20 nations’ commitment to strong, sustainable, and balanced growth.
Of course, emerging Asia has already made an important contribution to
bolstering the global economy in the wake of the financial crisis. The top panel of
exhibit 3 shows that even though the emerging Asian economies were hit quite hard by
the global downturn, they recovered much more quickly than did other parts of the world.
The full extent of the Asian bounceback can perhaps best be appreciated by comparing
the level of output in Asia, shown in the bottom panel of the exhibit, with those in
advanced economies and other emerging market economies. Asia’s output level--the
solid line--has increased substantially from its barely perceptible trough. Output in other
emerging market economies--the dashed line--has also increased significantly. In
comparison, output in the advanced economies--the dotted line--has not yet attained its
pre-crisis peak.
A key factor contributing to the relatively rapid recovery of the Asian emerging
market economies was that, in contrast to many previous episodes of severe stress, these
economies were well-positioned to permit the use of countercyclical fiscal and monetary
policies. Cyclically-adjusted fiscal balances in emerging Asian economies fell noticeably
in 2008 and 2009, reflecting a more expansionary fiscal stance; fiscal stimulus was

-8particularly large in China, India, and Singapore. Monetary policy was also eased
substantially throughout emerging Asia.
Partly as a result of those policy measures, the growth of the emerging Asian
economies over the past several years appears to have relied less on external demand
from the advanced economies. The top panel of exhibit 4 shows that the shares of
exports in nominal GDP in the Asian economies have trended downwards since 2006
following a decade of solid increases. However, trade balances in the region (shown in
the bottom panel of the exhibit) generally remain in surplus, notwithstanding some recent
narrowing in several countries. These surpluses suggest that, on balance, the Asian
economies continue to add more to global supply than to global demand.
Crucially, private consumption as a share of output still remains quite low in
several emerging Asian economies. Exhibit 5 shows that China’s consumption share--the
solid line--which was already well below that of other major economies in 2000, has
fallen steadily over the past decade to about one-third of its GDP.2 Private consumption
shares in other emerging Asian economies--the dashed line--are also significantly below
those in the advanced economies--the dotted line--and have not moved up in the wake of
the global financial crisis.
Measures to boost private consumption would appear to benefit not only the
global economy, but also the emerging Asian economies themselves. China and other
emerging market economies have already taken some steps to promote household
consumption, but the progress on this front has been slow and further measures are
warranted. Indeed, at the G-20 Cannes summit, China pledged to rebalance its demand
2

Output per capita has been growing very rapidly in China, so per capita consumption has also been rising.

-9toward domestic spending through policies to bolster household income and strengthen
social safety nets, and Indonesia and Korea each made similar commitments to facilitate
the process of global rebalancing.
What are some specific policy measures that could be helpful? First, increased
public spending on social services, such as education, health care, and retirement
benefits, could spur consumption by reducing the need for precautionary household
saving. In China, some redistribution of the profits of state-owned enterprises to the
central government through larger dividend payments could provide revenue to support
such spending. Second, government support could be shifted away from manufacturing
toward encouraging service-sector development, which has typically lagged behind in
these economies. Services tend to have a higher non-traded component, so faster growth
of this sector would help rebalance growth toward domestic demand. Third, additional
development spending could be directed toward these countries’ poorest regions; for
example, China has recently strengthened its efforts in this area.
The case for boosting investment rates in Asian emerging economies to support
global demand is less clear-cut. At about 45 percent of GDP, Chinese investment rates
are now so high that the return on new investment may already be quite low in some
sectors. In a number of other countries, however, investment rates are only at about the
average of those in the advanced economies. It seems plausible that, with their lower
capital-to-labor ratios, investment rates should be higher in some emerging Asian
economies. Indeed, some have argued that infrastructure needs remain extremely
pronounced in many emerging market economies, and that a wave of investment may be

- 10 in the offing for the world’s developing economies.3 With low interest rates throughout
the world, this would certainly seem to be a propitious time for countries to pursue
productive capital investment.
Finally, exchange rate adjustments will play a crucial role in boosting emerging
Asia’s contribution to global demand. Indeed, the G-20 leaders welcomed China’s
determination to increase exchange rate flexibility and to carry out its plans to increase
convertibility of the renminbi capital account. Such flexibility is crucial if Asian
domestic demand is to be expanded without exacerbating inflationary pressures.
Exchange rate appreciation channels demand toward foreign products, thereby creating
the scope for policies to expand domestic demand without exacerbating inflationary
pressures. More generally, exchange rate flexibility makes it easier for monetary policy
to respond to domestic considerations and to achieve price stability. Perhaps most
important, since the ultimate goal of economic growth is to improve standards of living,
allowing the currency to appreciate can help ensure that a greater proportion of output is
devoted to household consumption, enabling social welfare to improve at a faster pace.
Conclusion
To sum up, growth in advanced nations, including the United States, faces serious
headwinds. Households are still deleveraging, corporations are reluctant to invest, and
fiscal consolidation is needed over time to place public finances on a sustainable course.
Despite some pickup in growth in the United States during the second half of the year,
the outlook is for unemployment to diminish only slowly, remaining painfully high for

3

See, for example, McKinsey Global Institute (2010). Farewell to Cheap Capital? The Implications of
Long-Term Shifts in Global Investment and Saving. McKinsey and Company, December, available at
www.mckinsey.com/mgi/publications/farewell_cheap_capital/index.asp.

- 11 many years to come. These developments have also affected emerging market
economies, where there are now clear signs of slowing growth. In addition, downside
risks to global growth have increased significantly because of rising financial market
pressures, reflecting an intensification of stress in European banking and sovereign debt
markets as well as broader concerns about the outlook.
These circumstances call for concerted domestic policy actions to boost growth
and create jobs. Indeed, as I already noted, we at the Federal Reserve are moving
vigorously to promote a stronger economic recovery. However, monetary policy is not a
panacea, and it is essential for other policymakers to also do their part. In particular,
there is a strong case for additional measures to address the dysfunctional housing
market. Stronger housing demand has the potential to boost recovery. The Congress and
the Administration also can support the recovery in the near term while simultaneously
putting fiscal policy on a sustainable trajectory in the long term.
As I have emphasized in this talk, there is also an urgent need for policy action
from a number of countries. In Europe, forceful action is essential to address the region's
fiscal and financial stresses, which pose a threat not only to growth but also to global
financial stability. In addition, many emerging market economies, particularly in Asia,
have the scope to bolster domestic demand. Such policies would support stronger, more
balanced, and more sustainable global economic growth; they would enhance social
welfare at home as well. The most profound effect of the Asian miracle of the past
several decades has been to lift hundreds of millions of people out of poverty. Further
actions to boost aggregate demand in Asia will ensure that this miracle is sustained.




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Exhibit 1: U.S. Household Saving Rate

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Exhibit 2: U.S. Federal Debt Held by the Public

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