Given the sharp drop in output during the recession and lackluster early recovery, GDP is currently below its potential by nearly 7 percent, or $ trillion dollars.1 Just prior to the recession, the unemployment rate averaged between 4-1/2 and 5 percent. It peaked at 10.1 percent during the recession and, as I just noted, is still 9.1 percent today. In terms of jobs, payroll employment is about 6-1/2 million below its pre-recession level. These are massive shortfalls in output and employment. It does not appear as if these gaps are going to be reduced significantly any time soon. Real GDP growth has been anemic so far this year. Gains in employment have slowed markedly. Even though credit conditions overall have been improving, many households and small businesses still seem to be having trouble getting credit. In addition, the repair process in residential real estate markets is painstakingly slow, and households are still in the process of paring debt and adapting to the huge losses in real estate and financial wealth that they experienced during the recession. I largely agree with economists such as Paul Krugman, Mike Woodford and others who see the economy as being in a liquidity trap: Short-term nominal interest rates are stuck near zero, even while desired saving still exceeds desired investment. This situation is the natural result of the abundance of caution exercised by many households and businesses that still worry that they have inadequate buffers of assets to cushion against unexpected shocks.
As in the 1930s, today’s low Treasury interest rates in good part reflect elevated demand for low-risk assets – we see investors run to U.S. Treasury markets every time they hear any bad economic news from anywhere in the world. Consider another metric for interest rates, the well-known Taylor  4  BIS central bankers’ speeches  Rule, which captures how monetary policy typically adjusts to output gaps and deviations in inflation from target. Its prescriptions would call for the federal funds rates to be something like –3.6 percent now, well below the zero lower bound the funds rate is currently stuck at. Our large-scale asset purchases have provided additional stimulus, but by most estimates not enough to bring us down to the Taylor Rule prescriptions. Also, I should note that in 1998, Friedman gave a similar recommendation to the Japanese, advocating that the Bank of Japan undertake more accommodation by buying government bonds on the open market. Other critics raise the specter of 1970s-like structural changes in the economy. Such changes, they argue, have reduced our productive potential, in particular the mechanisms by which resources – most notably labor – move from declining to expanding sectors of the economy.3 I am acutely aware of the costs of making such an error. No central banker wants to repeat the painful experiences of the 1979–83 period.