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May 22, 2015

The Outlook for the Economy

Remarks by
Janet L. Yellen
Chair
Board of Governors of the Federal Reserve System
at
Providence Chamber of Commerce

Providence, Rhode Island

May 22, 2015

Good afternoon. I am pleased to be with you, and it is good to be back in
Providence. As many of you know, I attended Brown University, and the city I see today
is very different from the one I remember from my time here in the 1960s. Many of
those differences reflect dramatic and, at times, wrenching economic changes in Rhode
Island over those years, especially since the financial crisis and the Great Recession. As
ever, Providence has faced these challenges, and I am impressed by the revival and
renewal evident downtown, encouraged by attractions like Waterfire, which bring visitors
and commerce here and build civic pride.
Today I would like to speak with you about the outlook for the U.S. economy. I
should note at the outset that my remarks today reflect my own views and not necessarily
those of others in the Federal Reserve System.
The Recession and the Recovery So Far
As you all know, the economy is still recovering from the Great Recession, the
worst downturn since the terrible episode of the 1930s that inspired its name. The
recession began more than seven years ago, the result of the collapse in the housing
market and the financial crisis that it sparked. Rhode Islanders are well aware of the
great toll taken by the recession. The unemployment rate hit 10 percent nationally, and it
reached 11.3 percent here in Rhode Island. Nationally, payrolls shrank by some 8-1/2
million, about 6 percent, and the 41,000 jobs lost in Rhode Island represented close to
8 percent of the state’s employment. U.S. economic output fell more than 4 percent
nationally, the most since the Great Depression, and many of the hardest-hit industries,

-2including housing construction and manufacturing, are important to the Rhode Island
economy.1
The Federal Reserve took action to help stabilize the financial system during the
crisis, and we have supported the economic recovery with monetary policy actions
designed to hold down longer-term interest rates. With this help, the economy has made
significant strides. The pace of job gains has gradually strengthened, and payrolls
expanded by more than 3 million in 2014 alone. The unemployment rate has come down
steadily to 5.4 percent in April. One sign of a stronger labor market is that the number of
job openings has risen impressively, and another is that more workers are quitting their
jobs, signaling greater confidence in their ability to find a new job.
Rhode Island is sharing in this recovery, but I am well aware that economic
conditions remain difficult here. Rhode Island’s unemployment rate improved very
slowly during the recovery, and, for a time, it was the highest of any state. The jobless
rate has come down a lot over the past year or so, but at 6.3 percent in March,
unemployment here remains above the national average, and payroll employment has yet
to regain its pre-recession peak.
In recent months, some economic data have suggested that the pace of
improvement in the economy may have slowed, a topic I will address in a moment. And
even with the significant gains of the past couple years, it is only now, six years after the
recession ended, that the labor market is approaching its full strength.

1

For a discussion of recent economic developments in Rhode Island, see Mary A. Burke (2014), “Rhode
Island in the Great Recession: Factors Contributing to Its Sharp Downturn and Slow Recovery,” Federal
Reserve Bank of Boston, Current Policy Perspectives 14-9 (Boston: FRB Boston, December),
www.bostonfed.org/economic/current-policy-perspectives/2014/cpp1409.htm.

-3I say “approaching,” because in my judgment we are not there yet. The
unemployment rate has come down close to levels that many economists believe is
sustainable in the long run without generating inflation. But the unemployment rate
today probably does not fully capture the extent of slack in the labor market. To be
classified as unemployed, people must report that they are actively seeking work, and
many people without jobs say they are not doing so--that is, they are classified as being
out of the labor force. Most people out of the labor force are there voluntarily, including
retirees, teenagers, young adults in school, and people staying home to care for children.
But I also believe that a significant number are not seeking work because they still
perceive a lack of good job opportunities.
In addition to those too discouraged to seek work, an unusually large number of
people report that they are working part time because they cannot find full-time jobs, and
I suspect that much of this also represents labor market slack that could be absorbed in a
stronger economy. Finally, the generally disappointing pace of wage growth also
suggests that the labor market has not fully healed. Higher wages raise costs for
employers, of course, but they also boost the spending and confidence of customers and
would signal a strengthening of the recovery that will ultimately be good for business. In
the aggregate, the main measures of hourly compensation rose at a rate of only around
2 percent through most of the recovery. And in Rhode Island, average hourly earnings
have not risen at all in the past year. Nationally, there are at least some encouraging
signs of a pickup so far this year.2 The fact that some large companies, such as Wal-Mart

2

According to the Bureau of Labor Statistics’ (BLS) employment cost index--which measures both wages
and the cost of employer-provided benefits--hourly compensation in private industry rose 2-3/4 percent
over the year ended in March after having averaged gains of about 2 percent per year during most of the
recovery. However, some other prominent aggregate wage measures have remained softer. For example,

-4and Target, have announced wage increases for their employees also might be a sign that
larger wage gains are on the horizon.
This improvement in the labor market has brought the economy closer to one of
the two goals of monetary policy assigned to the Fed by the Congress--maximum
employment. Less progress has been made toward the other goal, price stability.
Consumer price inflation remains below the Fed’s stated objective of 2 percent. The
notion that inflation can be too low may sound odd, but over time low inflation means
that wages as well as prices will rise by less, and very low inflation can impair the
functioning of the economy--for example, by making it more difficult for households and
firms to pay off their debts. Overall consumer price inflation has been especially low-close to zero--over the past year, as the big fall in oil prices since last summer lowered
prices for gasoline, heating oil, and other energy products. But inflation excluding food
and energy, which is often a better indicator of where overall inflation will be in the
future, has also been low, below the Fed’s 2 percent objective both now and for almost all
of the economic recovery. Inflation has been held down by the continued economic
weakness during the slow recovery and, more recently, by lower prices of imported
goods as well as the fall in oil prices. With oil prices no longer declining, and with the
public’s expectations of future inflation apparently stable, my colleagues on the Federal
Open Market Committee (FOMC) and I believe that consumer price inflation will move
up to 2 percent as the economy strengthens further and as other temporary factors
weighing on inflation recede.

the BLS’s average hourly earnings for all employees on nonfarm payrolls have increased 2-1/4 percent over
the 12 months through April.

-5A number of economic headwinds have slowed the recovery, and to some extent
they continue to influence the outlook. These headwinds include, first, the fact that the
housing crash left many households with less wealth and higher debt, weighing on
consumer spending. Many homeowners lost their homes, and many more ended up
“underwater,” owing more on their mortgages than their homes were worth. Economists
have noted that areas of the country that saw a larger boom and bust in housing have
subsequently fared worse economically than other areas of the country.3 Rhode Island is
one such place. While the housing bust was not as large here as in Florida, Nevada, and
parts of California, it was larger than average, and the largest in New England. This
factor likely has contributed to the fact that the overall recovery here in Rhode Island has
lagged.4
In some respects, this headwind has diminished. Home prices have moved up
appreciably in many areas of the country, alleviating the burden for many homeowners,
though the improvement in some areas, including Rhode Island, has lagged. Nationally,
the share of mortgages that are underwater fell by about one-half between 2011 and
2014.5 And credit availability for mortgages has improved as well, although mortgages
are still very hard to obtain for would-be homeowners without pristine credit records. So
I would score this headwind as still a concern, but one that is likely to continue to fade.
A second headwind, also quite important here in Rhode Island, has come from
changes in fiscal policy to reduce budget deficits. At the federal level, the fiscal stimulus

3

See Atif Mian and Amir Sufi (2014), House of Debt: How They (and You) Caused the Great Recession,
and How We Can Prevent It from Happening Again (Chicago: University of Chicago Press).
4
See Burke, “Rhode Island in the Great Recession,” in note 1.
5
The share varies by source of data. According to Zillow’s October 2014 Real Estate Market Overview,
the share of mortgages in negative equity positions declined from about 30 percent in 2011 to 17 percent in
2014. According to CoreLogic’s 4th quarter 2014 Equity Report, the share declined from about 25 percent
to 11 percent over that period.

-6of 2008 and 2009 supported economic output, but the effects of that stimulus faded; by
2011, federal fiscal policy actions became a drag on output growth when the recovery
was still weak. Meanwhile, states and municipalities, faced with serious budget problems
due to the recession and required by law to balance their budgets, were forced to cut
spending and raise taxes. The recovery has by now boosted tax revenue in most states,
though Rhode Island, I know, is among those areas still facing considerable budget strain.
Overall, fiscal policy actions at both the federal and the state and local levels look like
they are no longer a significant drag on economic growth. So this headwind, I hope, is
mostly behind us.
A third headwind has been the restraining influences on the United States from
the global economy. I won’t say as much about this factor today, but I will make just a
few observations. Initially the euro-area crisis was the biggest headwind coming from
the rest of the world. Supported by monetary stimulus, reduced fiscal drag, and
significant institutional reforms, the recovery in the euro area now appears to be on a
firmer footing. However, growth in many other parts of the global economy, including
China and some other emerging market economies, has slowed. Weak growth abroad,
together with its accompanying implications for exchange rates, has dented U.S. exports
and weighed on our economy. This headwind too should abate as growth in the global
economy firms, supported by monetary policies that generally remain highly
accommodative.
Factors Affecting the Outlook
With the waning of the headwinds that I have discussed, the U.S. economy seems
well positioned for continued growth. Households are seeing the benefits of the

-7improving jobs situation, and consumer confidence has been solid. In addition, the drop
in oil prices amounts to a sizable boost in household purchasing power. The annual
savings in gasoline costs has been estimated at about $700 per household, on average,
and savings on heating costs--especially here in the Northeast, where it was so cold this
winter--are also large.6 Given these energy savings on top of the job gains, real
disposable income has risen almost 4 percent nationally over the past four quarters.
Households and businesses also are benefiting from favorable financial conditions.
Borrowing costs are low, supported by the Fed’s accommodative monetary policies. And
credit availability to both households and small businesses has improved.
In recent months, as I noted earlier, there has been some softness in the economic
data. Recent indicators of both household spending and business investment have
slowed, and industrial output has declined. The Commerce Department’s initial estimate
was that real gross domestic product was nearly flat in the first quarter of 2015. If
confirmed by further estimates, my guess is that this apparent slowdown was largely the
result of a variety of transitory factors that occurred at the same time, including the
unusually cold and snowy winter and the labor disputes at ports on the West Coast, both
of which likely disrupted some economic activity. And some of this apparent weakness
may just be statistical noise. I therefore expect the economic data to strengthen.
All of that said, the headwinds facing our economy have not fully abated, and, as
such, I expect that continued growth in employment and output will be moderate over the
remainder of the year and beyond.

6

The gasoline figure is from the U.S. Energy Information Administration (2015), Short-Term Energy
Outlook (Washington: EIA, May), available at www.eia.gov/forecasts/steo.

-8Despite the recovery I noted in home prices and a greater number of home sales,
residential construction activity remains quite low. I mentioned the ongoing issues with
mortgage credit, but more generally, many years of a weak job market and slow wage
gains seem to have induced many people to double-up on housing, and many young
adults continue to live with their parents. Population growth is creating a need for more
housing, whether to rent or to own, and I do expect that continuing job and wage gains
will encourage more people to form new households. Nevertheless, activity in the
housing sector is likely to improve only gradually.
The pace of business investment has also been only modest during this recovery,
and some of the reasons might persist a while longer. Businesses seem not to have had
sufficient confidence in the strength and durability of the recovery to undertake
substantial capital expenditures. Moreover, some analysts have suggested that
uncertainty, not only about the strength of the recovery but also about economic policy,
could be a significant factor. And the fact that many businesses seem to be holding large
amounts of cash may suggest that risk aversion is playing a role.
Weak investment in the energy sector is also likely to persist. This represents the
negative side to the fall in oil prices, one being felt by the oil-producing regions of the
country. New domestic oil drilling has plunged over the past few months, and we have
also seen a slowdown in activity in sectors that supply oil production companies,
including steel and certain types of machinery. I would add, however, that, on balance,
the plusses for energy consumers from the fall in oil prices almost surely outweigh the
minuses. Remember that we are still a net importer of oil.

-9Putting it all together, the economic projections of most members of the FOMC
call for growth in real gross domestic product of roughly 2-1/2 percent per year over the
next couple of years, a little faster than the pace of the recovery thus far, with the
unemployment rate continuing to move down to near 5 percent by the end of this year.
And for inflation, as I noted earlier, my colleagues and I expect inflation to move up
toward our objective of 2 percent as the economy strengthens further and as transitory
influences wane.
Of course, the outlook for the economy, as always, is highly uncertain. I am
describing the outlook that I see as most likely, but based on many years of making
economic projections, I can assure you that any specific projection I write down will turn
out to be wrong, perhaps markedly so. For many reasons, output and job growth over the
next few years could prove to be stronger, and inflation higher, than I expect;
correspondingly, employment could grow more slowly, and inflation could remain
undesirably low.
Implications for Monetary Policy
Given this economic outlook and the attendant uncertainty, how is monetary
policy likely to evolve over the next few years? Because of the substantial lags in the
effects of monetary policy on the economy, we must make policy in a forward-looking
manner. Delaying action to tighten monetary policy until employment and inflation are
already back to our objectives would risk overheating the economy.
For this reason, if the economy continues to improve as I expect, I think it will be
appropriate at some point this year to take the initial step to raise the federal funds rate
target and begin the process of normalizing monetary policy. To support taking this step,

- 10 however, I will need to see continued improvement in labor market conditions, and I will
need to be reasonably confident that inflation will move back to 2 percent over the
medium term.
After we begin raising the federal funds rate, I anticipate that the pace of
normalization is likely to be gradual. The various headwinds that are still restraining the
economy, as I said, will likely take some time to fully abate, and the pace of that
improvement is highly uncertain. If conditions develop as my colleagues and I expect,
then the FOMC’s objectives of maximum employment and price stability would best be
achieved by proceeding cautiously, which I expect would mean that it will be several
years before the federal funds rate would be back to its normal, longer-run level.
Having said that, I should stress that the actual course of policy will be
determined by incoming data and what that reveals about the economy. We have no
intention of embarking on a preset course of increases in the federal funds rate after the
initial increase. Rather, we will adjust monetary policy in response to developments in
economic activity and inflation as they occur. If conditions improve more rapidly than
expected, it may be appropriate to raise interest rates more quickly; conversely, the pace
of normalization may be slower if conditions turn out to be less favorable.
Longer-Run Growth
Before I conclude, let me put this discussion into a longer-term context. The
Federal Reserve’s objectives of maximum employment and price stability do not, by
themselves, ensure a strong pace of economic growth or an improvement in living
standards. The most important factor determining living standards is productivity

- 11 growth, defined as increases in how much can be produced in an hour of work. Over
time, sustained increases in productivity are necessary to support rising incomes.
Here the recent data have been disappointing. The growth rate of output per hour
worked in the business sector has averaged about 1-1/4 percent per year since the
recession began in late 2007. This rate is down from gains averaging 2-3/4 percent over
the preceding decade. I have mentioned the tepid pace of wage gains in recent years, and
while I do take this as evidence of slack in the labor market, it also may be a reflection of
relatively weak productivity growth.
Productivity depends on many factors, including our workforce’s knowledge and
skills and the quantity and quality of the capital, technology, and infrastructure that they
have to work with. Economists debate how optimistic to be about our nation’s
productivity prospects. Some argue that the decade starting in the mid-1990s was
exceptional, with unusually large advances in information technologies, and that the more
recent period provides a better guide to the future. Others are more optimistic, suggesting
that recent technological innovation remains as impressive as ever, and that history shows
it may take some years to fully reap the economic benefits of such innovations.7 I do not
know who is right, but I do believe that, as a nation, we should be pursuing policies to

7

For a relatively pessimistic view of productivity growth because “the low-hanging fruit is picked,” see
Robert J. Gordon (2012), “Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six
Headwinds,” NBER Working Paper Series 18315 (Cambridge, Mass.: National Bureau of Economic
Research, August); and Tyler Cowen (2011), The Great Stagnation: How America Ate All the LowHanging Fruit of Modern History, Got Sick, and Will (Eventually) Feel Better (New York: Dutton). For a
more optimistic perspective, see Joel Mokyr (2014), “Secular Stagnation? Not in Your Life,” in Coen
Teulings and Richard Baldwin, eds., Secular Stagnation: Facts, Causes and Cures (London: CEPR
Press), pp. 83-89; and Erik Brynjolfsson and Andrew McAfee (2014), The Second Machine Age: Work,
Progress, and Prosperity in a Time of Brilliant Technologies (New York: W.W. Norton & Company). The
greatest return to adopting information technology appears five to seven years after investment, according
to Erik Brynjolfsson and Lorin M. Hitt (2003), “Computing Productivity: Firm-Level Evidence,” Review
of Economics and Statistics, vol. 85 (November), pp. 793-808.

- 12 support longer-run growth in productivity. Policies to strengthen education, to encourage
entrepreneurship and innovation, and to promote capital investment, both public and
private, can all be of great benefit.
It also is possible that a portion of the relatively weak productivity growth we
have seen recently may be the result of the recession itself.8 Firms slashed their capital
expenditures during the recession, and as I noted earlier, the increases in investment
during the recovery have been modest. In particular, investment in research and
development has been relatively weak. Moreover, a lack of financing may have impaired
the ability of people to start new businesses and implement new ideas and technologies.
As the economy strengthens further, many of these processes could work in reverse,
boosting our productivity prospects. To the extent this is so, Federal Reserve actions to
strengthen the recovery may not only help bring our economy back to its productive
potential, but it may also support the growth of productivity and living standards over the
longer run.

8

See Dave Reifschneider, William Wascher, and David Wilcox (2015), “Aggregate Supply in the United
States: Recent Developments and Implications for the Conduct of Monetary Policy,” IMF Economic
Review, advance online publication, March 17, http://dx.doi.org/10.1057/imfer.2015.1. (A previous version
of this paper is also available on the Board of Governors website at
www.federalreserve.gov/pubs/feds/2013/201377/201377abs.html.)