An overview at Yellen's way to look at the US economy

1. What we are looking at
Capital Markets - Structuring
Desk Rates Inflation
Cristiana Corno +39 02 72612754
Introducing Yellen Published and data as of: 3 November, 2013
Given Yellen mandate, we thought it could be interesting to summarize her views on the state of the economy and monetary policy
rules and possible market implications.
Economy
In different occasions, she has stressed the importance of addressing the labour market slack in the present moderate recovery, in
the commitment to the Fed dual mandate.
The central point is that, when the unemployment rate is so far from its natural level, «it has to take centre stage in the
conduct of monetary policy», in order not to become structural.
When acknowledging the improvement of the labour market via a reduction in the unemployment rate, (7.2% from the 2009 peak
at 10% ), she has stressed the limitations of the unemployment rate, itself, as a measure of labour market strength.
Specifically, she has pointed out the amount of reduction in the labour force due to discouraged and part-time working
people, thereby referring to a broader measure of unemployment (U6, USUDMAER index on bbg).
In chart1, below, historical behaviour of Us Unrate versus U6.
In the aftermath of the 2009 crisis, the spread between the two unemployment indicators has increased and it seems to have
stabilized at high levels (chart2).
Chart1. Historical UNRATE versus broader U6.
Chart2. Spread between the two unemployment measure.
Increasing divergence
between two
unemployment
measures due to part-time
for economic
reasons and exit from
labour force.
Spread has not come
back to pre-crisis levels,
some of it due to aging
population.
THIS DOCUMENT IS A MARKETING COMMUNICATION: It has not been prepared in accordance with legal requirements
designed to promote the independence of investment research and is also not subject to any prohibition on dealing ahead of the
dissemination of investment research. All data used are derived from Bloomberg database and elaborated by Banca IMI.

2. What we are looking at
Capital Markets - Structuring
Desk Rates Inflation
Cristiana Corno +39 02 72612754
Introducing Yellen Published and data as of: 3 November, 2013
Yellen stresses the importance of addressing a high prolonged unemployment, which eroding skill (unemployed less
employable) rises the natural rate of unemployment, with the final result of shifting the unemployment from cyclical to
structural.
In the debate over the nature of present high unemployment (cyclical rather than structural), she concludes that the most of it is
cyclical and, therefore, can be addressed by stimulating aggregate demand without stoking inflation.
When speaking about employment, she gives a broad perspective and stresses the importance to consider a range of labour market
indicators in order to judge the strength of the market.
We summarize, below, the main indicators she has pointed out in different conferences:
1. U6 unemployment rate for a more complete picture (USUDNMAER index in Bloomberg): to take in account phenomena like
part time for economic reasons and labour force exit (chart1 and 2 previous page).
2. Actual unemployment rate less CBO estimate of NAIRU, we have re-built and plotted it in chart3 below.
3. Consumer confidence ration between people who find hard/easy to find job (Concjobh Index less Concjobp Index in
Bloomberg, chart3 below)
4. Firms ability to fill jobs from NFIB survey: to identify lack of skill in the market.
5. Quit rate (Joljquit Index): to appreciate strength in labour demand (chart4).
6. Pace of employment growth.
5.00
4.00
3.00
2.00
1.00
0.00
‐1.00
‐2.00
50.00
40.00
30.00
20.00
10.00
0.00
‐10.00
‐20.00
‐30.00
‐40.00
‐50.00
hard versus easy to find
gap unrate‐nairu
01/03/1990
01/10/1990
01/05/1991
01/12/1991
01/07/1992
01/02/1993
01/09/1993
01/04/1994
01/11/1994
01/06/1995
01/01/1996
01/08/1996
01/03/1997
01/10/1997
01/05/1998
01/12/1998
01/07/1999
01/02/2000
01/09/2000
01/04/2001
01/11/2001
01/06/2002
01/01/2003
01/08/2003
01/03/2004
01/10/2004
01/05/2005
01/12/2005
01/07/2006
01/02/2007
01/09/2007
01/04/2008
01/11/2008
01/06/2009
01/01/2010
01/08/2010
01/03/2011
01/10/2011
01/05/2012
01/12/2012
Chart3. Unemployment gap and labour confidence (jobs hard to find – plenty of jobs)
5.00
4.00
3.00
2.00
1.00
0.00
‐1.00
‐2.00
gap unrate‐nairu
quit rate
01/12/2000
01/04/2001
01/08/2001
01/12/2001
01/04/2002
01/08/2002
01/12/2002
01/04/2003
01/08/2003
01/12/2003
01/04/2004
01/08/2004
01/12/2004
01/04/2005
01/08/2005
01/12/2005
01/04/2006
01/08/2006
01/12/2006
01/04/2007
01/08/2007
01/12/2007
01/04/2008
01/08/2008
01/12/2008
01/04/2009
01/08/2009
01/12/2009
01/04/2010
01/08/2010
01/12/2010
01/04/2011
01/08/2011
01/12/2011
01/04/2012
01/08/2012
01/12/2012
01/04/2013
Chart4. Unemployment gap and quit rate
Indicators point in same
direction: job market
has improved and
seems to have
stabilized.
3.00
2.50
2.00
1.50
1.00
0.50
0.00
THIS DOCUMENT IS A MARKETING COMMUNICATION: It has not been prepared in accordance with legal requirements
designed to promote the independence of investment research and is also not subject to any prohibition on dealing ahead of the
dissemination of investment research. All data used are derived from Bloomberg database and elaborated by Banca IMI.

3. What we are looking at
Capital Markets - Structuring
Desk Rates Inflation
Cristiana Corno +39 02 72612754
Introducing Yellen Published and data as of: 3 November, 2013
Yellen also highlights the increase in poverty rate, young unemployment and low real wage growth (delinquency rate still high).
As further tailwinds on the economic recovery she indicates the housing sector, pointing at small residential investment
contribution to growth (housing starts has rebounded slowly due to massive inventory chart5) in recent recovery and wealth
effects.
Chart5. Housing units starts (privately owned) and inventory
Going forward the
housing sector
contribution to Us
growth could increase,
given strong depletion
of the housing
inventory.
Monetary policy rules
The Taylor rule in its classical formulation, has been systematically overruled since the early 2000s («Taylor rule and monetary
policy: a global great deviation», Bis paper). The attempts to improve the understanding of central banks reaction function have
followed 2 directions:
1. lower level of equilibrium real rates
2. larger output gap coefficients (balanced approach or aggressive Taylor rule).
The debate has become more important in recent years in order to provide a theoretical guide and justification for quantitative
easing and unconventional tools, once the zero lower bound has been reached.
In Yellen’s words («Perspectives on monetary policy» June2012, pag13) a balanced Taylor rule, defined as:
2% 0.5*( 2%) 1*( ) t t t t R       Y
where Yt is the output gap (the model is available also on BBG under Tayl, choosing as model aggressive Taylor rule) is more
consistent with Fed commitment to promote the dual mandate of maximum employment and 2% inflation target.
Yellen has gone even further showing the superiority in reaching the unemployment goal of the «optimal control policy rule»,
which minimize a quadratic loss function related to both the inflation and output gap (Woodford, chart6).
The quadratic term gives an increasing weight to the output gap when it is wide and vice versa, thereby prescribing lower rates for
longer when the output gap is wide and a quicker reaction when the output gap closes (example in chart 7, next page).
At present, Fed speeches, the use of unconventional tools like forward guidance and asset purchases seem consistent with an
optimal control policy rule regime.
In the committee words (Dec12, BoG, press release): ”When the Committee decides to begin to remove policy accommodation, it
will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 per cent”, therefore,
it seems, we will go back to a balanced Taylor rule, when unemployment rate goes towards 6.5%.
Based on Fed forecast, this will happen in 2014 or 2015 at latest.
THIS DOCUMENT IS A MARKETING COMMUNICATION: It has not been prepared in accordance with legal requirements
designed to promote the independence of investment research and is also not subject to any prohibition on dealing ahead of the
dissemination of investment research. All data used are derived from Bloomberg database and elaborated by Banca IMI.

4. What we are looking at
Capital Markets - Structuring
Desk Rates Inflation
Cristiana Corno +39 02 72612754
Introducing Yellen Published and data as of: 3 November, 2013
Different monetary
rules and they results:
optimal control seems
superior in achieving
lower and quicker
unemployment rate in a
context of stable
inflation.
Chart6. Different monetary policy rule and achievements in term of inflation and unemployment rate
Chart7. Monetary rules and rate prescriptions
Different monetary
rules and different
reaction functions:
optimal control reacts
more when the
unemployment gaps
closes.
In Dec12 statement Fed
said it will follow a
balanced approach once
the 6.5% threeshold is
achieved.
Summarizing we have a dove Yellen, well focused on unemployment situation and supporter of an “optimal control” policy
rule.
The risk, I see as we get to know our new Fed chairman (welcome!!!), is some volatility and risk premium getting priced in the
market if the economy surprises on the upside. In that case, probably, the 2015 area will suffer more.
THIS DOCUMENT IS A MARKETING COMMUNICATION: It has not been prepared in accordance with legal requirements
designed to promote the independence of investment research and is also not subject to any prohibition on dealing ahead of the
dissemination of investment research. All data used are derived from Bloomberg database and elaborated by Banca IMI.

5. What we are looking at
Capital Markets - Structuring
Desk Rates Inflation
Cristiana Corno +39 02 72612754
Introducing Yellen Published and data as of: 3 November, 2013
“Monetary policy: many targets, many instruments. Where do we stand?”, J.L.Yellen 16th April 2013
“A painfully slow recovery for America’s workers: causes, implications and the Federal reserve’s response”, J.L.Yellen 11th
February 2013
“Perspective on monetary policy”, J.L.Yellen 6th June 2012
“Taylor rule and optimal monetary policy”, M. Woodford January 2001
“Methods of policy accommodation at the interest rate lower bound”, M.Woodford 16th September 2012
THIS DOCUMENT IS A MARKETING COMMUNICATION: It has not been prepared in accordance with legal requirements
designed to promote the independence of investment research and is also not subject to any prohibition on dealing ahead of the
dissemination of investment research. All data used are derived from Bloomberg database and elaborated by Banca IMI.

6. What we are looking at
Capital Markets - Structuring
Desk Rates Inflation
Cristiana Corno +39 02 72612754
Introducing Yellen Published and data as of: 3 November, 2013
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THIS DOCUMENT IS A MARKETING COMMUNICATION: It has not been prepared in accordance with legal requirements
designed to promote the independence of investment research and is also not subject to any prohibition on dealing ahead of the
dissemination of investment research. All data used are derived from Bloomberg database and elaborated by Banca IMI.