by Calculated Risk on 4/11/2012 07:15:00 PM

Fed Vice Chair Janet Yellen argues that the Fed is falling "far short" of the "maximum employment objective", and that inflation will be "at or below the FOMC's longer-run goal of 2 percent". She discusses reasons for considering keeping the Fed funds rate close to zero "until late 2015" as opposed to the current 2014.

On QE3, she discussed additional stimulus "if the recovery faltered or inflation drifted down", but then added "doing so involves costs and risks."

From Fed Vice Chair Janet Yellen: The Economic Outlook and Monetary Policy. Excerpt:

I see no good reason to doubt that our nation's high unemployment rate indicates a substantial degree of slack in the labor market. Moreover, while I recognize the significant uncertainty surrounding such forecasts, I anticipate that growth in real gross domestic product (GDP) will be sufficient to lower unemployment only gradually from this point forward, in part because substantial headwinds continue to restrain the recovery.

One headwind comes from the housing sector, which has typically been a driver of business cycle recoveries. We have seen some improvement recently, but demand for housing is likely to pick up only gradually given still-elevated unemployment, uncertainties over the direction of house prices, and mortgage credit availability that seems likely to remain very restricted for all but the most creditworthy buyers. When housing demand does pick up more noticeably, the huge overhang of both unoccupied dwellings and homes in the foreclosure pipeline will likely allow demand to be met for a time without a sizable expansion in homebuilding.

A second headwind comes from fiscal policy. State and local governments continue to face extremely tight budget situations in light of the weak economy, depressed home prices, and the phasing out of federal stimulus grants, though overall tax revenues have been improving and that should continue as the economy expands further. At the federal level, stimulus-related policies are scheduled to wind down, while both real defense and nondefense purchases are expected to decline over the next several years under the spending caps put in place last year.

A third factor weighing on the outlook is the sluggish pace of economic growth abroad. Strains in global financial markets have eased somewhat since late last year, an improvement that reflects in part policy actions taken by European authorities. Nonetheless, risk premiums on sovereign debt and other securities are still elevated in many European countries, while European banks continue to face pressure to shrink their balance sheets, and concerns about the outlook for the region remain. A further slowdown in economic activity in Europe and in other foreign economies would inhibit U.S. export growth.

For these reasons, I anticipate that the U.S. economy will continue to recover only gradually and that labor market slack will remain substantial for a number of years to come.

And on inflation:

Let me now turn to inflation. Overall consumer price inflation has fluctuated quite a bit in recent years, largely reflecting movements in prices for oil and other commodities. ...

In my view, the subdued inflation environment largely reflects two factors. First, the substantial slack in the labor market has restrained inflation by holding down labor costs. Second, and of critical importance, longer-term inflation expectations have been remarkably stable.

Conclusion:

In summary, I expect the economic recovery to continue--indeed, to strengthen somewhat over time. Even so, over the next several years, I anticipate that we will fall far short in achieving our maximum employment objective, and I expect inflation to remain at or below the FOMC's longer-run goal of 2 percent.