It has been three years since the beginning of the most intense phase
of the financial crisis in the late summer and fall of 2008, and more
than two years since the economic recovery began in June 2009. There
have been some positive developments: The functioning of financial
markets and the banking system in the United States has improved
significantly. Manufacturing production in the United States has risen
nearly 15 percent since its trough, driven substantially by growth in
exports; indeed, the U.S. trade deficit has been notably lower recently
than it was before the crisis, reflecting in part the improved
competitiveness of U.S. goods and services. Business investment in
equipment and software has continued to expand, and productivity gains
in some industries have been impressive. Nevertheless, it is clear that,
overall, the recovery from the crisis has been much less robust than we
had hoped. Recent revisions of government economic data show the
recession as having been even deeper, and the recovery weaker, than
previously estimated; indeed, by the second quarter of this year--the
latest quarter for which official estimates are available--aggregate
output in the United States still had not returned to the level that it
had attained before the crisis. Slow economic growth has in turn led to
slow rates of increase in jobs and household incomes.
The pattern of sluggish growth was particularly evident in the
first half of this year, with real gross domestic product (GDP)
estimated to have increased at an average annual rate of less than 1
percent. Some of this weakness can be attributed to temporary factors.
Notably, earlier this year, political unrest in the Middle East and
North Africa, strong growth in emerging market economies, and other
developments contributed to significant increases in the prices of oil
and other commodities, which damped consumer purchasing power and
spending; and the disaster in Japan disrupted global supply chains and
production, particularly in the automobile industry. With commodity
prices having come off their highs and manufacturers' problems with
supply chains well along toward resolution, growth in the second half of
the year seems likely to be more rapid than in the first half.
However, the incoming data suggest that other, more persistent
factors also continue to restrain the pace of recovery. Consequently,
the Federal Open Market Committee (FOMC) now expects a somewhat slower
pace of economic growth over coming quarters than it did at the time of
the June meeting, when Committee participants most recently submitted
economic forecasts.
Consumer behavior has both reflected and contributed to the slow
pace of recovery. Households have been very cautious in their spending
decisions, as declines in house prices and in the values of financial
assets have reduced household wealth, and many families continue to
struggle with high debt burdens or reduced access to credit. Probably
the most significant factor depressing consumer confidence, however, has
been the poor performance of the job market. Over the summer, private
payrolls rose by only about 100,000 jobs per month on average--half of
the rate posted earlier in the year.1 Meanwhile,
state and local governments have continued to shed jobs, as they have
been doing for more than two years. With these weak gains in employment,
the unemployment rate has held close to 9 percent since early this
year. Moreover, recent indicators, including new claims for unemployment
insurance and surveys of hiring plans, point to the likelihood of more
sluggish job growth in the period ahead.
Other sectors of the economy are also contributing to the
slower-than-expected rate of expansion. The housing sector has been a
significant driver of recovery from most recessions in the United States
since World War II. This time, however, a number of factors--including
the overhang of distressed and foreclosed properties, tight credit
conditions for builders and potential homebuyers, and the large number
of "underwater" mortgages (on which homeowners owe more than their homes
are worth)--have left the rate of new home construction at only about
one-third of its average level in recent decades.
In the financial sphere, as I noted, banking and financial
conditions in the United States have improved significantly since the
depths of the crisis. Nonetheless, financial stresses persist. Credit
remains tight for many households, small businesses, and residential and
commercial builders, in part because weaker balance sheets and income
prospects have increased the perceived credit risk of many potential
borrowers. We have also recently seen bouts of elevated volatility and
risk aversion in financial markets, partly in reaction to fiscal
concerns both here and abroad. Domestically, the controversy during the
summer regarding the raising of the federal debt ceiling and the
downgrade of the U.S. long-term credit rating by one of the major rating
agencies contributed to the financial turbulence that occurred around
that time. Outside the United States, concerns about sovereign debt in
Greece and other euro-zone countries, as well as about the sovereign
debt exposures of the European banking system, have been a significant
source of stress in global financial markets. European leaders are
strongly committed to addressing these issues, but the need to obtain
agreement among a large number of countries to put in place necessary
backstops and to address the sources of the fiscal problems has slowed
the process of finding solutions. It is difficult to judge how much
these financial strains have affected U.S. economic activity thus far,
but there seems little doubt that they have hurt household and business
confidence, and that they pose ongoing risks to growth.
Another factor likely to weigh on the U.S. recovery is the
increasing drag being exerted by the government sector. Notably, state
and local governments continue to tighten their belts by cutting
spending and employment in the face of ongoing budgetary pressures,
while the future course of federal fiscal policies remains quite
uncertain.
To be sure, fiscal policymakers face a complex situation. I would
submit that, in setting tax and spending policies for now and the
future, policymakers should consider at least four key objectives. One
crucial objective is to achieve long-run fiscal sustainability. The
federal budget is clearly not on a sustainable path at present. The
Joint Select Committee on Deficit Reduction, formed as part of the
Budget Control Act, is charged with achieving $1.5 trillion in
additional deficit reduction over the next 10 years on top of the
spending caps enacted this summer. Accomplishing that goal would be a
substantial step; however, more will be needed to achieve fiscal
sustainability.
A second important objective is to avoid fiscal actions that
could impede the ongoing economic recovery. These first two objectives
are certainly not incompatible, as putting in place a credible plan for
reducing future deficits over the longer term does not preclude
attending to the implications of fiscal choices for the recovery in the
near term. Third, fiscal policy should aim to promote long-term growth
and economic opportunity. As a nation, we need to think carefully about
how federal spending priorities and the design of the tax code affect
the productivity and vitality of our economy in the longer term. Fourth,
there is evident need to improve the process for making long-term
budget decisions, to create greater predictability and clarity, while
avoiding disruptions to the financial markets and the economy. In sum,
the nation faces difficult and fundamental fiscal choices, which cannot
be safely or responsibly postponed.
Returning to the discussion of the economic outlook, let me turn
now to the prospects for inflation. Prices of many commodities, notably
oil, increased sharply earlier this year, as I noted, leading to higher
retail gasoline and food prices. In addition, producers of other goods
and services were able to pass through some of their higher input costs
to their customers. Separately, the global supply disruptions associated
with the disaster in Japan put upward pressure on prices of motor
vehicles. As a result of these influences, inflation picked up during
the first half of this year; over that period, the price index for
personal consumption expenditures rose at an annual rate of about 3-1/2
percent, compared with an average of less than 1-1/2 percent over the
preceding two years.
As the FOMC anticipated, however, inflation has begun to moderate
as these transitory influences wane. In particular, the prices of oil
and many other commodities have either leveled off or have come down
from their highs, and the step-up in automobile production has started
to reduce pressures on the prices of cars and light trucks. Importantly,
the higher rate of inflation experienced so far this year does not
appear to have become ingrained in the economy. Longer-term inflation
expectations have remained stable according to surveys of households and
economic forecasters, and the five-year-forward measure of inflation
compensation derived from yields on nominal and inflation-protected
Treasury securities suggests that inflation expectations among investors
may have moved lower recently. In addition to the stability of
longer-term inflation expectations, the substantial amount of resource
slack in U.S. labor and product markets should continue to restrain
inflationary pressures.
In view of the deterioration in the economic outlook over the
summer and the subdued inflation picture over the medium run, the FOMC
has taken several steps recently to provide additional policy
accommodation. At the August meeting, the Committee provided greater
clarity about its outlook for the level of short-term interest rates by
noting that economic conditions were likely to warrant exceptionally low
levels for the federal funds rate at least through mid-2013. And at our
meeting in September, the Committee announced that it intends to
increase the average maturity of the securities in the Federal Reserve's
portfolio. Specifically, it intends to purchase, by the end of June
2012, $400 billion of Treasury securities with remaining maturities of 6
years to 30 years and to sell an equal amount of Treasury securities
with remaining maturities of 3 years or less, leaving the size of our
balance sheet approximately unchanged. This maturity extension program
should put downward pressure on longer-term interest rates and help make
broader financial conditions more supportive of economic growth than
they would otherwise have been.
The Committee also announced in September that it will begin
reinvesting principal payments on its holdings of agency debt and agency
mortgage-backed securities in agency mortgage-backed securities rather
than in longer-term Treasury securities. By helping to support mortgage
markets, this action too should contribute to a stronger economic
recovery. The Committee will continue to closely monitor economic
developments and is prepared to take further action as appropriate to
promote a stronger economic recovery in a context of price stability.
Monetary policy can be a powerful tool, but it is not a panacea
for the problems currently faced by the U.S. economy. Fostering healthy
growth and job creation is a shared responsibility of all economic
policymakers, in close cooperation with the private sector. Fiscal
policy is of critical importance, as I have noted today, but a wide
range of other policies--pertaining to labor markets, housing, trade,
taxation, and regulation, for example--also have important roles to
play. For our part, we at the Federal Reserve will continue to work to
help create an environment that provides the greatest possible economic
opportunity for all Americans.
