The dynamics of the financial markets as well as the global nature of the current downturn both have similarities to the depression of the 1930s, Janet Yellen, president of the San Francisco Federal Reserve Bank, told reporters after a speech to the 128th Assembly for Bank Directors meeting on the Kohala Coast of Hawaii.
"The economy is in the midst of a downward spiral, and that calls for strong policy responses," Yellen said. "Government policies to restore confidence, create jobs by boosting the demand for goods and services, and improve the functioning of our financial system represent our main hope of avoiding a very severe economic contraction."
Yellen is a voting member of the policy-setting Federal Open Market Committee in 2009.
Yellen, speaking on the same day the government announced the biggest job losses in 34 years, said now is not the time to dither or debate endlessly on the shape of fiscal stimulus.
"It is critical that decisions on these matters be made on a timely basis," she said.
The U.S. jobless rate hit 7.6 percent in January, the Labor Department said on Friday. Yellen said most economists see the rate peaking in the 8 percent or 9 percent range, still short of the peak of the 1981-82 recession and far below the 20 percent plus rate of the Great Depression.
The U.S. Senate on Friday evening reached a deal on a $780 million stimulus package to stem the recession. The Senate is expected to vote on the measure soon, and if it passes then lawmakers would have to resolve differences between the Senate bill and an $819 billion version passed by the House of Representatives last week.
'No end in sight'Yellen said consumer spending had been stopped in its tracks as American households have hunkered down and acted to boost their savings in response to spiraling unemployment and a "staggering" $10 trillion loss of household wealth.
Yellen said that "unfortunately, there is no end in sight" to the housing woes that triggered the current recession, with inventories of unsold homes remaining high and private mortgage credit still scarce.
Meanwhile, a yawning output gap in the U.S. economy suggests "inflation will remain, for some time, below levels that are consistent with price stability."
Still, Yellen said outright deflation, while possible, was less of a worry to her than rising "real" interest rates now that nominal rates are already as low as they can go, inflation is falling, and the economy is still contracting.
The U.S. inflation rate, both headline and the core rate excluding volatile food and energy costs, is likely to fall below 1 percent in 2009, she said.
"The committee does not regard it as desirable to allow inflation to fall to very low levels," she said, referring to the policy-setting FOMC.
Yellen said the FOMC's recent comments that it intends to keep short-term interest rates low for a considerable period are one way it can bolster the economy now that it has reached the "zero bound" on the fed funds rate.
Banks have to unclog their balance sheetsYellen said past banking crises have shown the importance of removing bad assets from banks' balance sheets, and looked for a proposal on that score from the Obama administration soon, as a prerequisite to restoring stability to the financial system and, ultimately, the economy.
Treasury Secretary Timothy Geithner is due on Monday to outline a "comprehensive plan" to stabilize the financial system in a speech set for noon Eastern time.
"As long as hard-to-value, troubled assets clog their balance sheets, banks find it difficult to attract private capital and to focus on new lending," Yellen said.
She urged bank directors to act in ways that would help restore economic growth.
"My hope is that, while avoiding imprudent practices that would put your institution at risk, you will also resist extreme risk averse, since it would undermine efforts to get the economy going," she said.
As the Fed continues to cross "traditional boundaries" in providing liquidity to various corners of the credit markets, Yellen said she was "absolutely open" to the idea of the central bank buying long-term Treasuries if it would help the overall functioning of the credit market.
Meanwhile, Yellen told reporters the Fed needed to fight back against the notion that its liquidity efforts would inevitably lead to higher inflation and higher interest rates, terming the notion "ludicrous."
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