The Economic Outlook and the Role of Monetary Policy
William C. Dudley, President and Chief Executive Officer
Remarks at the Economic Club of New York, New York City
Conclusion
The FOMC is committed to the dual objectives of maximum sustainable employment in the context of price stability. Currently we are falling well short of our employment objective and the restrictive stance of federal fiscal policy is a factor. On inflation, we are also falling short, but by a considerably smaller margin. As a consequence, we need to keep monetary policy very accommodative.
The FOMC is committed to the dual objectives of maximum sustainable employment in the context of price stability. Currently we are falling well short of our employment objective and the restrictive stance of federal fiscal policy is a factor. On inflation, we are also falling short, but by a considerably smaller margin. As a consequence, we need to keep monetary policy very accommodative.
I do not claim that there are no costs or risks associated with our unconventional monetary policy regime. But I see greater cost and risk in moving prematurely to a policy setting that might not prove sufficiently accommodative to ensure a sustainable, strengthening recovery. I remain confident that the benefits of a stronger and earlier economic recovery will trump the costs associated with our unconventional monetary policy measures.
Excerpts: Today, I will focus on the economic outlook and the role of monetary policy. I will argue that the fundamentals underpinning the U.S. economy are improving and monetary policy is gaining additional traction. But this may not immediately lead to stronger growth because of the recent increase in fiscal restraint. As a result, I expect that labor market conditions will improve only slowly and that inflation will remain muted. Consequently, it will be appropriate for monetary policy to remain very accommodative.
Economic Outlook: Tug of War Between Improving Fundamentals and Fiscal Restraint
The U.S. economy remains on the slow growth track that has persisted since the recession ended in mid-2009. However, in the near-term, this improvement in fundamentals is being offset by increased fiscal drag.
The U.S. economy remains on the slow growth track that has persisted since the recession ended in mid-2009. However, in the near-term, this improvement in fundamentals is being offset by increased fiscal drag.
Let's first examine the fundamentals, which have improved in at least six ways.
First, household deleveraging is now well advanced.
Second, the structural adjustment in housing has largely run its course.
Third, the international economic outlook has improved somewhat.
Fourth, U.S. corporate profits relative to national income are at an all-time record and cash balances are very high.
Fifth, the U.S. is in the middle of an energy revolution marked by a steady rise in oil and natural gas production.
Sixth, financial conditions have become increasingly accommodative, as monetary easing has passed through to a broad range of financial asset prices.
So why isn't the U.S. economy growing more quickly? The fact that fiscal policy has turned significantly more restrictive is the most important reason.
In my opinion, a U.S. fiscal policy well-suited for the current set of circumstances would start with a very mild degree of restraint in the near-term that would credibly build to substantial consolidation over the next several decades.
Nevertheless, the aging of our population and simple math suggest that entitlement reform would need to be part of such a plan.
Instead, we have nearly the opposite: significant retrenchment in the near-term, but no credible action over the long-term, with partisan divisions and significant uncertainty about what will happen next. Will the sequester, for example, be sustained or not?
Economic Outlook
Looking at the outlook for 2013, I believe that growth in the first half will be sluggish as the fiscal contraction blunts the economy's forward advance. While first quarter GDP growth will likely rebound to a 2 to 3 percent annualized rate following the dip in the fourth quarter, this will be due in large part to temporary factors.
Inflation, as measured by the personal consumption expenditure deflator, is currently below the Federal Reserve's 2 percent objective. Moreover, inflation expectations remain well anchored at levels consistent with our 2 percent longer-run objective. Thus, I conclude that the risk that inflation could significantly exceed our 2 percent objective is quite low over the next few years, even if the recovery were to strengthen considerably.
The Labor Market Outlook
So how are we doing relative to our objective of a substantial improvement in the labor market outlook?
So how are we doing relative to our objective of a substantial improvement in the labor market outlook?
Since we provided additional stimulus in September there has been some improvement in labor market conditions. The unemployment rate is modestly lower and private non-farm payroll growth a bit higher than earlier in 2012, which is certainly welcome. However, other important indicators including the employment-to-population ratio and job-finding rates are essentially unchanged. This suggests that the labor market is far from healthy.
Moreover, our policy is based on the outlook for the labor market, not the level of employment or unemployment today. In this context I note that the recent improvement in payroll employment growth, which gets much of the attention, is out-sized relative to the growth rate of economic activity that supports it. We have seen this movie before. When this happened in 2011 and 2012, employment growth subsequently slowed. Because growth this year will be constrained by fiscal consolidation, there is a risk that this could happen again. As a result, it is premature to conclude that we will soon see a substantial improvement in the labor market outlook.
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