by Calculated Risk on 1/04/2009 02:09:00 PM

From San Francisco Fed President Janet Yellen: Comments on "The Revival of Fiscal Policy"

I agree with [Martin Feldstein] that the current downturn is likely to be far longer and deeper than the "garden-variety" recession in which GDP bounces back quickly. As Marty points out, a defining characteristic of this downturn is its cause. Typically, recessions occur when monetary policy is tightened to subdue the inflationary pressures that emerge during a boom. This time, the cause was the eruption of a severe financial crisis. Cross-country evidence suggests that, following such an event, GDP remains subdued for an extended period.2 And consistent with this evidence, many forecasters expect this to be one of the longest and deepest recessions since the Great Depression. Indeed, the crisis is ongoing. Risk-aversion in financial markets remains exceptionally high; deleveraging is widespread; the markets for most private asset-backed securities are dysfunctional; financial institutions, both large and small, have failed; and the economic downturn is causing delinquencies to rise, threatening further financial distress; households and businesses face an ongoing credit crunch; and housing and financial wealth has plunged. Marty points out, and I agree, that the likely impact on consumer spending of the decline in wealth thus far—one of a number of factors weighing on this sector—is, on its own, quite substantial. And house prices are continuing to slide.

And Dr. Yellen argues a fiscal stimulus package is needed:

If ever, in my professional career, there was a time for active, discretionary fiscal stimulus, it is now. Although our economy is resilient and has bounced back quickly from downturns in the past, the financial and economic firestorm we face today poses a serious risk of an extended period of stagnation—a very grim outcome. Such stagnation would intensify financial market strains, exacerbating the problems that triggered the downturn. It's worth pulling out all the stops to ensure those outcomes don't occur.