BOSTON (MNI) – The following are the remarks of Boston Federal
Reserve Bank Pres. Eric Rosengren prepared for the South Shore Chamber
of Commerce Thursday:
Good morning and thank you for the opportunity to be with you at
the South Shore Chamber of Commerce.
As always, I would like to note that the views I express today are
my own, not necessarily those of my colleagues on the Federal Reserve’s
Board of Governors or the Federal Open Market Committee (the FOMC).
I know it’s still early morning, but allow me to start with an
observation about economists, historians, and the word “Great.”
Historians tend to use “Great” to reflect success, particularly military
success that results in territorial expansion — think Alexander the
Great or Peter the Great. In economics, “Great” is used quite
differently.
It’s usually applied to difficult episodes with serious economic
consequences — think of the Great Depression or the so-called Great
Recession. Often such an episode involves economic policymaking –
fiscal, monetary, or otherwise — that contributes to the situation or
fails to alleviate it.
I have titled this talk “Acting to Avoid a Great Stagnation” and
let me be clear, I do believe the Federal Reserve is taking appropriate
and forceful action to help the U.S. avoid a prolonged economic
stagnation.
Let me explain the terms. In my view a Great Stagnation — in
current times or any other — would be a long episode that generally
includes a willingness among policymakers to accept as inevitable, and
decline to resist, far-less-than-optimal outcomes. Such outcomes could
include higher unemployment, with the potential result that high
unemployment could become entrenched as a more permanent feature of the
economic landscape.1
What I am highlighting is the importance and appropriateness of
taking the policy actions that are necessary to improve economic
conditions much more quickly — so the period of very slow recovery that
we have been experiencing of late does not persist and become a Great
Stagnation or in fact a “Great” anything.
Unfortunately, the global economy is experiencing a slowdown, and
that slowdown is one of the significant impediments to faster growth in
the domestic economy. Failure to react to this slowdown would risk a
situation where difficult conditions prevail for long enough to become
“Great” in the economist’s sense. This could occur if policymakers of
all sorts — monetary, fiscal, economic, and financial — were to adopt
a stance of only reacting to large negative shocks, while accepting (and
declining to act against) a status quo of substantial underutilization
of resources, for an extended period of time.
This sort of scenario would be particularly tragic in the job
market, and I would note that over the course of this year there has
been no meaningful improvement in the unacceptably high level of the
U.S. unemployment rate. Fed Chairman Ben Bernanke has called this a
“grave concern” and I fully agree with him. Last week the group charged
with monetary policymaking in the U.S., the FOMC, took additional
monetary policy actions to promote faster economic growth. I fully
support the policy actions. Let me say a bit about them. First, the FOMC
noted that it anticipates that low short-term rates are likely to be
warranted at least through mid- 2015. This guidance makes clear that
monetary policy will remain accommodative for a considerable time,
likely even after labor markets improve from their current subdued
state, in order to promote a robust and sustainable recovery.
Second, given the desire to increase policy accommodation even
while the traditional policy instrument (the federal funds rate) is at
the zero lower bound, the FOMC announced plans to buy $40 billion worth
of mortgage-backed securities a month — until such time as there is
substantial ongoing improvement in labor markets. The more open-ended
nature of the action — intending to continue such purchases until labor
markets have improved — is an important change. Of course, the Fed will
do so in the context of price stability (which is the other half of the
Fed’s “dual mandate,” along with maximum sustainable employment) — and
hand in hand with a careful ongoing assessment of the program’s costs
and efficacy.
Of course policy actions such as these are unconventional, and do
entail risks. However, in my view the risks involved in pursuing these
policies are considerably smaller and more manageable than the risk of
allowing the economy to stagnate for another year or more.
The U.S. has seen a series of “false starts” during this recovery.
After earlier periods of policy accommodation the economy has improved,
but that improvement has not been sustained. These false starts have
been interrupted by both natural and manmade disasters, here and abroad.
As a consequence of these interruptions, the recovery has been painfully
slow by historical standards — resulting in our current highly-elevated
unemployment rate and an inflation rate below our objective.
Absent further policy action, most economists expect several more
years of weak labor markets and low inflation. As a consequence, it was
time for the Fed to announce stimulus that will continue until the U.S.
achieves both faster economic growth and lower unemployment, no matter
the unanticipated interruptions.
Today I would like to walk through my analysis of the economic
situation in more detail. In doing so I hope it will become clear why I
have strongly supported the kind of forceful action that the FOMC took
last week. In my view, these policies are essential to achieving a
strong sustainable recovery that is resilient, despite the inevitable
disruptions. Let me add that I am only discussing monetary policy, not
fiscal policy, since fiscal policy, though powerful, is not in the Fed’s
jurisdiction.
Avoiding a Stagnation
Figure 1 provides a powerful real-world example of the potential
for a Great Stagnation — the experience of Japan after their financial
crisis, which began in 1990. While this period is sometimes called the
“Lost Decade,” that is actually a misnomer — since the period of
stagnant growth has lasted over two decades.
There are many factors contributing to a Great Stagnation in Japan,
including a very slow realization of the need to recapitalize banks, and
a population whose average age is rapidly rising (which changes the
composition of economic activity in a country), and a substantial
slowdown in population growth. Still, it is striking that there was a
dramatic change in the growth of real GDP in Japan coinciding with the
start of their financial crisis.2 The muted policy response to the
slower growth that began during the financial crisis is partly
responsible for the fact that Japanese growth never returned to its
pre-crisis rate, or to where output would have been had the crisis not
occurred (the path illustrated by the trend line, based on growth over
the 1980-1990 period).
Figure 2 shows the level of U.S. GDP since 1980. Note that we too
have a noticeable break in the growth rate of GDP at the advent of the
recent financial crisis. However, unlike the Japanese, it appears that
we have resumed the pre-crisis growth rate. But we have not returned the
economy back to its original growth path, the only time we have failed
to do so in all ten of our other post-war recessions – including the
severe recession in 1982.
Failing to return quickly to the original trend line is much more
serious than a graph can convey. It implies a significant cumulative
loss in goods and services that should have been produced (measured as
the sum of the difference between those two lines), which in turn
implies a significant shortfall in employment relative to full
employment.
As a result, the goal of monetary and fiscal policy should be to
return the economy back to the original trend line. This means getting
faster than normal growth until resources are once again fully utilized.
A risk in not doing so is that we permanently reduce our trend growth
rate, which is what appears to have happened in Japan.
Causes of Slow Growth in the United States
Exploring in detail the many possible causes of slow growth in the
current economy is beyond the scope of this talk. But let me just
highlight some important factors. Figure 3 shows, and compares, the
growth rates of real GDP and real GDP excluding residential investment
(housing) and government spending. As the chart shows, there is a
notable difference in the growth rates. While real GDP has grown only by
2.21 percent, real GDP excluding housing and government spending grew by
2.45 percent. Had the economy not had the headwinds from government and
housing dragging growth lower — had it grown just by that higher rate
of 2.45 percent over the three years of the recovery — outcomes would
be somewhat better. However, normally a sector like housing would be
expected to grow much more quickly than other sectors of the economy in
the early stages of a recovery — given housing’s interest-rate
sensitivity — and thus we would expect it to provide more impetus to
overall economic growth. To consider the role of housing a bit more,
Figure 4 shows housing starts from 2000 onward. The decline in housing
starts is striking, and unlike in most other recoveries the housing
sector did not participate in the initial stages of the current recovery
– although there has been some improvement recently.
However, I think there are some reasons to believe the recent
nascent signs of a housing recovery might be durable. Since the onset of
the housing bust the population has grown and per capita income has
grown, while interest rates are very low and prices are more affordable.
These are all positives when it comes to having potential buyers ready
to purchase homes.
These circumstances make it an important time for policymakers to
consider additional stimulus to the housing market to finally induce
progress. Consider the market psychology: if home buyers feel that house
prices are on the rise (as many indicators suggest), and that mortgage
rates will only remain this low temporarily, we could see new home
buyers come off the sidelines and commit to purchase new homes before
rates rise and before house prices rise further than they have.
Also, Figure 5 shows growth in state and local government spending
since 2000 and highlights that it has been unusually weak in this
recovery. This is, in large part, a result of state and local
governments pulling back in response to greatly diminished revenues – a
direct consequence of the depth of the recession and the weakness of the
recovery. Many states were prepared for a revenue shortfall, having
accumulated “rainy day” funds, but the long downturn sapped those funds.
Since nationally, the sum of state and local government spending is
larger than federal spending3, the net impact has been that
government-sector spending has been a significant drag on growth during
the recovery.
Figure 6 highlights another force dragging on the U.S. recovery,
the global economic slowdown. Many advanced economies experienced a
deeper recession (as measured by output) than did the United States, and
countries such as the U.K., France, and Japan have real GDP levels
indexed below where they were at the end of 2007, an even weaker rebound
than in the United States. Furthermore, in the last several quarters
several of the advanced economies in Europe have actually been in
decline as they have slashed their government spending.
Costs of a Slow Recovery
A slow recovery can have significant costs. Allow me to show you
some charts that are compelling — acknowledging, of course, that charts
cannot convey the human toll of the situation they depict.
Figure 7 shows the ratio of employment to population, which has
remained very flat during the recovery. This is consistent with the
growth in GDP being only about 2 percent — which is enough to keep up
with the growth in productivity and the labor force but not leading to
the employment of a larger percent of the population. By the way, while
there have been some demographic shifts within the workforce that might
explain some decline in the employment-to-population ratio, they do not
explain the trend in Figure 7; indeed, a very similar pattern emerges
when looking at the employment-topopulation ratio for particular age
groups.
Figure 8 shows one of the painful and unusual features of this
recession and recovery, the very elevated percentage of the unemployed
who have been out of work for more than six months. Unlike the deep
recession in 1982, in which there was a quick recovery and as a result a
relatively small and short-lived increase in long-duration unemployment,
the last recession and long, weak recovery have resulted in
substantially more people suffering long spells of unemployment. Long
periods of unemployment frequently deplete the savings of the
unemployed, make re-employment harder (as employers may be tentative
about hiring those who have been unemployed for long periods of time),
and may lead to skills becoming less than current. These problems
highlight why it is important to generate faster growth to avoid what
some call labor market “scarring” – where long-duration unemployment
becomes ingrained into our labor market.
What Should Monetary Policymakers Do?
The Great Stagnation in Japan did lead to a monetary policy
response from the Japanese central bank. The Bank of Japan eased rates
until they hit the zero lower bound, and then as Figure 9 shows, began
to gradually expand the assets of the central bank. However, there were
key differences from the policy actions we have taken at the Federal
Reserve. The Bank of Japan only gradually expanded the assets on its
balance sheet, and only after a delay of a number of years. Many of its
purchases were of shortterm securities, which had little impact on
already-low short-term rates. This is in contrast to the impact that the
U.S. Federal Reserve’s purchases of longer-duration assets have had on
longer-term rates, which remain well above zero and thus have room to
decline.
Finally, the Japanese central bank may in my view have prematurely
stopped the growth in their balance sheet, considering the weakness in
the Japanese economy at the time. As a result, the Japanese economy has
remained stagnant and despite having an expanded balance sheet for an
extended period, the Japanese continue to struggle with a deflation
problem rather than an inflation problem, as the bottom chart on Figure
9 shows.
Turning to the U.S., the differences in policy are quite striking.
There was a rapid expansion of the Fed’s balance sheet (see Figure 10),
as well as a fiscal stimulus. This may be why we have not experienced a
significant decline in the trend growth rate in the economy, seen in an
earlier chart. There has also been a focus on bringing long-term
interest rates down, and more recently on utilizing monetary policy
communication strategies to convey that rates will likely remain low
until the recovery and labor markets show a more sustained improvement.
To reiterate, a key difference is that we didn’t hesitate (by
years) to take significant actions in the U.S. And when we took actions,
they were forceful. And going forward, we also don’t want to make the
mistake of retreating at the first, early signs of improvement. Japan’s
experience suggests one must continue until improvement is sustainable
and will persist.
However, despite these differences there is an important similarity
between our situation and Japan’s, as well. Just as Japan has not
experienced inflation despite a rapid expansion of their balance sheet,
our measure of inflation (the personal consumption expenditure deflator)
is currently only 1.3 percent through July despite our balance sheet
expanding significantly four years ago (see the bottom chart on Figure
10).
Recent Actions
Last Thursday the FOMC announced several new policies, summarized
in the next two slides. The Fed announced a number of important policy
changes. First, in addition to exchanging (as previously announced) $45
billion of short-term Treasury securities for an equal amount of
long-term Treasury bonds through the maturity extension program running
through December, the Fed will purchase $40 billion a month in agency
mortgage backed securities (MBS). These purchases of MBS should place
downward pressure on U.S. mortgage rates, which should support the
housing market by lowering borrowing costs and providing additional
support for house-prices to appreciate from depressed levels. The
housing market should be stronger than if these actions were not taken.
Second, the purchases of agency MBS will likely affect the yields
on other, similar long-term assets, such as Treasury bonds and corporate
bonds. Bonds of similar maturity, duration and risk characteristics are
viewed as substitutes for MBS by many investors. Removing some of the
MBS from private circulation will create a scarcity of long-maturity,
lower-risk securities. This shortage will lower both MBS and other
longterm interest rates in the marketplace, with effects that are
qualitatively similar to the effects we have when we lower the federal
funds rate (something we cannot do now, as it is at the zero lower
bound). As a consequence, our policy will have effects on a broad array
of economic activity beyond the direct effects on residential
investment. Third, I would note that the plan to purchase MBS securities
is open-ended. As the FOMC indicated in its statement last week, the MBS
purchases and potentially the use of other tools will continue until
there has been improvement in labor markets. This means the policy
actions are being conditioned on an economic outcome rather than a set
timeframe. This should provide market participants confidence that the
Federal Reserve will do what it takes to improve economic outcomes.
Fourth, highly accommodative policy will continue for a
considerable time after the economic recovery strengthens. This means
that we will ensure the economy is truly strengthening before raising
interest rates. Highly accommodative policy is currently likely to be
warranted at least through mid-2015.
The Initial Impact of Policy Actions
The table shown in Figure 11 provides some estimates of the
financial impacts of the Fed’s recent policy announcement. Such impacts
are difficult to measure with any precision, given anticipation about
our possible actions built into markets, and the reality that other
events can occur coincident with the action. Still, for reference the
first column provides the financial market response when the FOMC
announcement was made. The second column extends the period to Thursday
and Friday as financial market participants had more time to analyze the
policy change and Chairman Bernanke’s press conference explaining the
announcement. The third column begins the financial response at the
Chairman’s August speech at the Jackson Hole conference, which was
widely viewed as increasing the likelihood of a more forceful easing,
though the specifics were not known. The final column dates the event
from the prior FOMC meeting, when most observers interpreted the
statement as making further forceful action more likely.
While this table shows a range of impacts, I would say in sum that
regardless of the event window chosen, stock prices are up
substantially, mortgage rates are lower, and exchange rates are lower.
On the latter I would point out that our efforts to lower long rates are
focused on stimulating domestic demand, but at the same time lower
long-term rates affect demand for U.S. assets, resulting in a modest
change in the exchange rate — and this is likely to provide some
support for export-oriented industries. All of these impacts are very
consistent with what we would expect of the monetary transmission
“channels” of purchasing mortgage backed securities and providing
additional forward guidance on policy. In fact, they are also quite
consistent with the transmission channel that we expect when conducting
“normal” — i.e. federal funds rate — monetary policy when we are not
constrained by the zero lower bound.
Concluding Observations
In sum, the actions taken by the Federal Reserve last week provide
significant additional support to the economic recovery. They should
result in stronger economic growth, and return us to full employment
more quickly than would be the case absent the policies.
However, monetary policy is not a panacea. Appropriate fiscal
policies domestically, and improvement in the global economy could both
provide significant positive effects, and shorten the time needed for
unconventional monetary policy actions like those we have announced. In
addition, it is important to note that significant fiscal policy
mistakes, such as an unlikely failure to address the looming “fiscal
cliff” in the U.S., would have effects on economic growth that would be
difficult to fully offset with monetary policy.
It is my firm belief that the monetary policy actions taken last
week should contribute to a faster economic recovery and a more rapid
improvement in labor markets than we would have seen in their absence.
However, I want to be careful not to appear to promise too much, as
there are limits to the effects of monetary policy. Even with these
actions, and assuming no additional negative shocks domestically or
internationally, it will still be several years before we are likely to
return to full employment. While that is not an especially upbeat
sentiment on which to end my remarks, I think it underlines the
importance of our taking action. A very challenging economic climate
confronts us all, but I am very pleased that monetary policymakers in
the U.S. are proving willing to take difficult actions like these rather
than accept the possibility of a long, slow recovery turning into a
stagnation that someday earns the dubious title of “Great.” Japan’s
experience is a sobering real-world reminder of why forceful and timely
action is appropriate.
Thank you.
1 Recent examples of a Great Stagnation include Japan, as I will
discuss in this talk, and the dynamic in some European countries that
experience high rates of unemployment and lagging job creation even
during periods of growth — a dynamic that some associate with
unaffordable social benefit policies and that in some corners is given
the moniker “Eurosclerosis.”
2 I would note that demographic changes occurring in Japan include
a gradually shrinking domestic workforce. But I see this as a gradual
change that would not explain the abrupt change in the growth-path line
shown in the chart around the time of Japan’s financial crisis.
3 State and local government accounted for 63 percent of government
spending on average over the period 2000-2011.
Pelias' views 