NEW YORK (MNI) – The following is the text of Federal Reserve Vice
Chairman Janet Yellen’s prepared remarks Wednesday to the Committee for
Economic Development 2010 International Counterparts Conference:

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 years.

For 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.

A 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
question 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 Federal 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.

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