The Blog

Did Janet Yellen Predict the Recession?

No, no, and no.

12:31 PM, Jul 31, 2013 • By ETHAN EPSTEIN
Widget tooltip
Single Page Print Larger Text Smaller Text Alerts

Have you heard the news? Janet Yellen is positively clairvoyant!

Janet Yellen

Yellen, vice chairman of the Federal Reserve and, evidently, a front-runner to replace Ben Bernanke as chairman in several months, “was one of the first members of the Federal Open Market Committee . . . to realize that the [housing market’s troubles] could cause a major recession.” (Alan Blinder, Wall Street Journal, July 29.) She “was one of the only top Fed policy makers who warned about the housing bubble before the crisis.” (Edward Harrison, New York Times, July 29.) Yellen “raised concerns about the housing bubble in the mid-2000s, and highlighted the danger of a credit crunch in 2007.” (Matthew O’Brien, The Atlantic, July 30.) She displayed “prescience” and “identified the impending threats that both the housing bubble and the shadow banking sector posed to our entire economy.” (Roughly a third of Senate Democrats, in a letter to President Obama, July 26.) She “warned early and often, starting at least in 2005, about the problems in housing and the looming economic catastrophe.” (Mark Gungloff, Huffington Post, July 29.) 

A bona fide economic Nostradamus, it would seem. But a perusal of her past reveals that Yellen’s soothsaying record is decidedly more muddled. 

Here is Yellen in a speech in October 2005, when she was chairman of the San Francisco Fed. Remember, this was, according to Matthew O’Brien, back when she was “raising concerns about the housing bubble.”  

In my view, it makes sense to organize one’s thinking around three consecutive questions—three hurdles to jump before pulling the monetary policy trigger. First, if the bubble were to deflate on its own, would the effect on the economy be exceedingly large? Second, is it unlikely that the Fed could mitigate the consequences? Third, is monetary policy the best tool to use to deflate a house-price bubble?

My answers to these questions in the shortest possible form are, “no,” “no,” and “no.”

She went on to say that, even in the event of a housing downturn, “it could be large enough to feel like a good-sized bump in the road, but the economy would likely to be able to absorb the shock.”

A few months later, in a speech in April 2006, Yellen noted the remarkable uptick in housing prices (i.e. the catastrophic housing bubble) in the San Francisco Bay Area. Yet she all but shrugged the high prices off. “There are well-known and unique features of this area that lend some justification to its high housing values,” she said, “First, there is not much land available for new home building, so the supply of new homes is fairly limited. In addition, this area enjoys very favorable lifestyle amenities and it has a job base that attracts high-income residents.” (San Francisco housing prices would end up falling by more than 50 percent from their 2006 peak, one of the worst performances in the country.)

At a Fed meeting in September 2006, Yellen was similarly sanguine, despite by-then falling home prices: “The speed of the falloff in housing activity and the deceleration in house prices continue to surprise us,” she allowed. But not to worry! “Of course, housing is a relatively small sector of the economy, and its decline should be self-correcting,” she cooed.

Recent Blog Posts