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For release on delivery
9:10 a.m. EST
December 1, 2010

Fiscal Responsibility and Global Rebalancing

Remarks by
Janet L. Yellen
Vice Chair
Board of Governors of the Federal Reserve System
2010 International Counterparts Conference
Sponsored by the Committee for Economic Development
New York, New York

December 1, 2010

Good morning. Thank you for inviting me to be with you today. The Committee
for Economic Development has a long and distinguished record in identifying and
addressing crucial issues related to our nation’s economic growth and productivity. And
today’s conference on fiscal sustainability and the global economy fits squarely within
that tradition. My remarks will focus on the challenges faced by U.S. policymakers as
they confront the need to put fiscal policy on a sustainable track in the long term while
providing support to the economy in the near term. I will also offer some thoughts on the
recent actions undertaken by the Federal Reserve and on the implications of our nation’s
fiscal and monetary policy choices for the global economy. 1
The Challenge of Achieving Fiscal Sustainability in the United States
Charting a sensible course for the federal budget is an essential but formidable
task for U.S. policymakers. Since the onset of the recent recession and financial crisis,
the federal budget deficit has soared as the weak economy has depressed revenues and
pushed up expenditures and as necessary policy actions have been taken to help ease the
recession and shore up the financial system. At 9 percent of gross domestic product
(GDP), the budget deficit in fiscal year 2010 was a little lower than it had been a year
earlier, but it was still considerably above the average of 2 percent of GDP during the
pre-crisis period from fiscal 2005 to 2007. As a result of the recent deficits, federal debt
held by the public has increased to around 60 percent of GDP--a level not seen in 60


My remarks reflect my own views and not necessarily those of my colleagues on the Federal Open
Market Committee (FOMC).

-2For now, the budget deficit seems to have topped out. So long as the economy
and financial markets continue to recover, the deficit should narrow relative to GDP over
the next few years as a growing economy boosts revenues and reduces safety-net
expenditures and as the policies put in place to provide economic stimulus and promote
financial stability wind down. That said, the budget situation over the longer run presents
some very difficult challenges, in part because the aging of the U.S. population implies a
sizable and sustained increase in the share of the population receiving benefits from
Social Security, Medicare, and Medicaid. Currently, there are about five individuals
between the ages of 20 and 64 for each person aged 65 and older. This ratio is projected
to decline to around three by the time most of the baby boomers have retired in 2030, and
further increases in average life expectancies may push this ratio down a little more in the
years after that. Moreover, the demographic pressures on the budget appear likely to be
compounded by continued large increases in per capita spending on health care.
Admittedly, the ability of budget analysts to forecast the trajectory of health-care
spending is limited, but it is prudent to assume that federal health spending per
beneficiary will continue to rise faster than per capita GDP for the foreseeable future.
In a nutshell, the problem is that, in the absence of significant policy changes, and
under reasonable assumptions about economic growth, demographics, and medical costs,
federal spending will rise significantly faster than federal tax revenues in coming years.
As a result, if current policy settings are maintained, the budget will be on an
unsustainable path, with the ratio of federal debt held by the public to national income
rising rapidly.

-3A failure to address these fiscal challenges would expose the United States to
serious economic costs and risks. A high and rising level of government debt relative to
national income is likely to eventually put upward pressure on interest rates, thereby
restraining capital formation, productivity, and economic growth. Indeed, once the
economy has recovered from its downturn, fiscal deficits will crowd out private spending.
Large fiscal deficits will also likely put upward pressure on our current account deficits
with the rest of the world; the associated greater reliance on borrowing from abroad
means that an increasing share of our future income will be required to make interest
payments on federal debt held abroad, thereby reducing the amount of income available
for domestic spending and investment. A large federal debt will also limit the ability and
flexibility of policymakers to address future economic stresses and other emergencies, a
risk that is underscored by the critical fiscal policy actions that were taken to buffer the
effects of the recent recession and stabilize financial markets in the wake of the crisis.
And a prolonged failure by policymakers to address America’s fiscal challenges could
eventually undermine confidence in U.S. economic management.
I do not underestimate the difficulty of crafting a long-range budget plan that will
both garner sufficient political support and have sound economic foundations. The
reactions to the proposals offered by members of the President’s National Commission on
Fiscal Responsibility and Reform, as well as to those offered by other prominent groups,
provide ample evidence of the differences that must be bridged. Nonetheless, I am
encouraged that the debate seems to be moving forward and is starting to touch on some
broad principles that--if followed--would improve economic growth and make achieving
sustainable fiscal policies at least somewhat easier. Perhaps the most fundamental

-4question that must be faced concerns the size and scope of the federal government--that
is, how much of the nation's economic resources we will devote to federal programs,
including transfer programs such as Social Security, Medicare, and Medicaid. Crucially,
whatever size of government we choose, taxes must ultimately be set at a level sufficient
to achieve an appropriate balance of spending and revenues.
We should not defer charting a course for fiscal consolidation. Timely enactment
of a plan to eliminate future unsustainable budget gaps will make it easier for individuals
and businesses to prepare for and adjust to the changes. Moreover, the sooner we start
addressing the longer-term budget problem, the less wrenching the adjustment will have
to be and the more control we--rather than market forces or international creditors--will
have over the timing, size, and composition of the necessary adjustments.
That said, it is important to recognize that fiscal tightening, were it to occur
prematurely, could retard an already tepid economic recovery. We need, and I believe
there is 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.
Unfortunately, U.S. economic performance continues to be impaired by the
lingering effects of the financial crisis. The economy remains far from full employment
even though a year and a half has elapsed since the trough of the business cycle. Job
gains have continued to be subpar, and the unemployment rate remains near its highest
level since the early 1980s; moreover, given the slow pace of economic growth,
unemployment is likely to remain high for some time. Meanwhile, measures of
underlying inflation have continued to trend lower and are now below the levels the

-5Federal Open Market Committee (FOMC) judges to be consistent, over the longer run,
with its statutory mandate of maximum employment and price stability.
In this context, the Federal Reserve decided at its November meeting to undertake
additional monetary policy actions to satisfy its dual mandate. After weighing carefully
the uncertainties and risks, the FOMC decided to further expand the Federal Reserve’s
holdings of longer-term Treasury securities. The objective of this action is to reduce
longer-term interest rates, thereby promoting a stronger pace of economic growth. The
purchase of longer-term securities, while in some ways “unconventional,” is actually
quite similar to the Fed’s traditional approach to monetary policy, which involves
lowering the overnight federal funds rate by increasing the supply of reserve balances.
With the federal funds rate now effectively pinned at zero, purchases of longer-term
securities are intended to push down rates further out the yield curve. By bolstering
activity in the United States and mitigating risks that could threaten the recovery, this
policy should also provide support for a sustained expansion of the global economy.
In announcing its intention to purchase an additional $600 billion of longer-term
Treasury securities, the FOMC committed to review the purchase program regularly in
light of incoming information and to make adjustments as needed to meet our objectives.
The Committee, of course, recognizes that at the appropriate time, as the economy more
fully recovers, the Federal Reserve will need to remove this extraordinary monetary
accommodation in order to maintain price stability and keep inflation expectations well
anchored. I am confident that the Federal Reserve has both the commitment and the tools
to achieve this unwinding.

-6I strongly supported the Federal Reserve’s recent action because I believe it will
be helpful in strengthening the recovery. But it is hardly a panacea. Thus, a fiscal
program that combines a focus on pro-growth policies in the near term with concrete
steps to reduce longer-term budget deficits could be a valuable complement to our efforts.
Indeed, some budget experts are exploring the idea of explicitly coupling fiscal stimulus
in the near term, when unemployment is high and resource utilization is low, with
specific deficit-reducing actions that take effect at scheduled future times, when output
and employment are expected to have moved closer to their potential. Although a plan of
this type might be challenging to develop and implement, it could provide an effective
means to support economic activity in the short run while moving toward fiscal
sustainability over time.
International Implications of U.S. Policy Choices
Because the focus of this conference is on fiscal adjustments and the global
economy, let me now try to place this discussion of U.S. fiscal and monetary policies into
the current international context. The process of long-run fiscal consolidation in the
United States would likely entail higher national saving relative to investment, which
should have the direct effect of restraining U.S. imports and shrinking the U.S. trade
deficit. More generally, by lowering interest rates, fiscal consolidation should diminish
net capital inflows into the United States, thereby reducing the current account deficit in
this country and current account surpluses elsewhere. The resulting pattern of
international debt accumulation and capital flows would be more balanced than at
present, promoting a more sustainable pattern of growth in the global economy. Indeed,

-7such a rebalancing program was strongly endorsed by the leaders of the Group of Twenty
at their recent meeting in Seoul.
Although the fiscal consolidation process is just beginning, the weakness of
private demand in the United States and other advanced economies, combined with
robust growth in the emerging market economies, has led to a two-speed global recovery
that already is creating pressures toward rebalancing. The advanced economies started
their recoveries in 2009, but economic growth has barely exceeded the growth rate of
potential output; as a result, the level of output in most advanced economies, including
the United States, is still well below its potential. Forecasts suggest that growth and
resource utilization will remain lackluster in the advanced economies for some time.
Furthermore, inflation pressures in most other advanced countries, as in the United
States, remain quite low, reflecting the existence of substantial economic slack.
In contrast to the subdued pace of recovery in the advanced economies, economic
activity in the emerging market economies has rebounded sharply, and the level of output
in most of those economies now well exceeds pre-crisis levels. The consequence is that
policymakers in emerging market countries have turned their attention to the threat of
rising inflation and have begun tightening monetary policy.
The stronger growth prospects in the emerging market economies, coupled with
the tightening stance of their monetary policies, appear to be contributing to a resurgence
of capital inflows to these economies. Sizeable differentials in expected returns between
advanced and emerging market economies also seem to be reinforcing these flows and
causing emerging market currencies to rise. In light of their increasing concerns about
inflation, a case can be made that emerging market policymakers should welcome

-8currency appreciation because it reduces inflation pressures and, over time, aids global
rebalancing. However, some of them have argued that unduly large and rapid capital
inflows may lead to asset-price bubbles and expose the financial sectors in their
economies to a subsequent reversal of these flows, while rapid currency appreciation
could derail the growth of their export sectors. A number of emerging market economies
have accordingly attempted to counter the effects of financial inflows through a range of
policies, including foreign exchange intervention and capital controls.
The U.S. fiscal program that I discussed earlier might also moderate the pressures
emerging market economies are experiencing at present. Stronger U.S. growth would
boost our demand for foreign goods and reduce the incentives for capital flows to
emerging markets, thereby diminishing some of the upward pressure on emerging market
currencies. Thus, the U.S. fiscal program would lessen for a time the natural mechanisms
pushing the emerging markets to rebalance their economies toward domestic demand,
even as it helped put the global economy as a whole on a more solid footing. However,
such developments would in no way diminish the need for such rebalancing in the
medium term. It is also important for both advanced and emerging market economies to
begin planning now for the structural reforms that will eventually be needed to promote
As I hope I’ve made clear, the challenge for U.S. policymakers will be to craft a
strategy that puts our fiscal policy on a sustainable path in the longer term while helping
support the recovery in economic activity in the near term. These goals are challenging
to achieve but not inconsistent. Moreover, making progress on them would not only

-9provide important benefits to the United States; it would also help foster a stronger world
economy in the near term and a better global balance in spending, production, saving, and
borrowing over time.