William C Dudley: Panel remarks at Bank Indonesia-Federal Reserve
Bank of New York Joint International Seminar
Remarks by Mr William C Dudley, President and Chief Executive Officer of the Federal
Reserve Bank of New York, at the Bank Indonesia-Federal Reserve Bank of New York Joint
International Seminar, Bali, 31 July 2016.
* * *
Linda Goldberg, Jonathan McCarthy and Joseph Tracy assisted in preparing these remarks.
In my remarks today, I will focus on why global growth has been so anemic following the
financial crisis and what we can do about it.
I think it is fair to say that the global recovery following the financial crisis has been
disappointing. Growth is below pre-crisis levels for the United States, Europe, Japan and
China. For example, in the U.S., real GDP growth has averaged only about 2.2 percent per
year over the period from 2010 to 2015, below the pre-crisis average of 2.4 percent from
2003 to 2008. This slower growth performance has been accompanied by relatively low
inflation rates - persistently below the objectives of the monetary policy authorities in the
United States, Europe and Japan.
As I see it, there are many causes for these persistent shortfalls in growth, and they vary
across regions and countries. Let me focus on the reasons for the United States in the post
crisis period.
Growth has been weaker than expected for many reasons. The financial crisis was a searing
experience that damaged household and business confidence in a profound way - with a
more lasting effect than the typical economic downturn. The housing bust created both a
large housing supply overhang and a large number of households that were underwater on
their mortgages. Households needed to repair their balance sheets and bring down their debt
service burdens to more manageable levels. Higher levels of unemployment further
depressed demand.
Credit availability contracted. The tightening of credit standards occurred quite broadly - in
housing credit, consumer credit cards and business lending. Some of the credit supply
restrictions were imposed by banks that needed to repair their balance sheets, deleveraging
by building up capital and working down their bad assets.
Fiscal outlays were not high enough to compensate for the contractionary impulse from these
first three sources. The crisis led to a significant deterioration in the U.S. federal budget
deficit and put pressure on state and local budgets. After the federal budget deficit reached
around 10 percent of GDP at the peak, fiscal consolidation occurred at the federal level, as
well as at state and local levels, restraining economic activity instead of supporting growth.
Productivity growth has also been quite low. In the period before the crisis (2003 to 2008),
U.S. nonfarm productivity growth averaged 2 percent per year. Since 2010, productivity has
been closer to 1 percent. While some of this decline can be explained by lower capital
spending, the decline is difficult to fully explain.
Another explanation some have offered is that there is a measurement problem - we are
understating output growth and overstating price inflation. This type of issue, long flagged as
a hedonic adjustment, seems most credible in particular market segments, such as in
healthcare. Alan Blinder has posed this question: Would you rather have 1970 healthcare at
1970 prices or 2016 healthcare at 2016 prices? Based on the measurement of prices, 1970
healthcare is a much better deal. Yet, when offered this choice, almost all choose 2016
healthcare. Why? The reason is that people highly value the advances in healthcare
technology, such as in cardiac care, or in the procedures that are practical today, such as hip
and knee replacement, that simply weren't available 50 years ago.
U.S. economic performance has also been held back by developments in the rest of the
world. Growth outside of the United States has slowed. In the euro area, comparing the
period from 2003 to 2008 to the period from 2010 to 2015, annual real GDP growth slowed
from 1.9 percent to 0.8 percent. Japanese growth has remained muted over these periods at
0.1 percent and 1.0 percent respectively. In China, reported growth rates over these two
periods slowed from 11.3 percent to 8.3 percent. These developments, along with policy and
risk events that have increased demand for U.S. assets, have contributed to significant U.S.
dollar appreciation over the last two years. This dollar strength has created competitive
challenges for U.S. exporters, especially in manufacturing, and has caused the trade sector
to be a drag on U.S. economic activity.
Looking forward, despite the fact that U.S. economic growth has been disappointing, we
have actually made considerable progress toward our monetary policy objectives. The United
States is quite close to its employment and inflation objectives. On employment, there still
seems to be a bit of slack in the U.S. labor market. But, that margin has shrunk greatly over
the past few years. Payroll gains have been at least as robust as anticipated.
On inflation, we are still somewhat below our 2 percent objective. But, even here, I think
there has been progress. Despite the strengthening of the dollar and the decline in energy
prices, core PCE inflation has been quite stable over the past year - currently running at
around 1.6 percent. That is not a tremendous difference from our 2 percent objective.
So why has the United States done a bit better compared to Europe and Japan in terms of
achieving our monetary policy objectives. I think there are a number of contributing factors.
First, U.S. household balance sheet repair occurred relatively quickly. This is in part because
the housing foreclosure process wiped out many mortgage debts. Part was accomplished by
a long period of very slow household debt growth. And part was accomplished by the sharp
fall in interest rates that helped cut debt servicing costs.
Second, in the U.S., the banking system was recapitalized and deleveraging occurred quite
quickly following the financial crisis. Capital from the Troubled Asset Relief Program, or
TARP, was put into the large banks and soon many of them replaced this TARP capital by
raising new equity. The SCAP stress test in 2009, and the annual CCAR stress tests that
followed, worked to constrain the rate of bank capital distributions and, thereby, helped to
build up bank capital ratios. And, U.S. banks worked hard to clean up their balance sheets.
Poor assets were managed down or run off, and underwriting standards were tightened.
Third, the Federal Reserve was particularly aggressive early on in its pursuit of monetary
policy accommodation in order to keep inflation expectations well-anchored. This is a
necessary condition, in my view, to maintain the efficacy of monetary policy. If inflation
expectations were to get unmoored to the downside, then it becomes more difficult to pursue
a stimulative monetary policy.
Could things have been done differently in the U.S. in such a way that would have led to
better outcomes? Absolutely. With the benefit of hindsight, we could have and should have
been even more aggressive on the monetary policy side. While we made progress with some
of the innovations on monetary policy that we eventually introduced - such as the
openended purchase of $85 billion of Treasury and MBS securities per month - it would have
been better if we had done this sooner.
There is a lot as well that is outside the Fed's purview that could have been done to make
the U.S. economy perform better. This includes tax reform, job retraining programs and
infrastructure investment.
So, what can we do to bolster global growth in the future? The first is to undertake the
necessary structural reforms to make our economies more efficient. Productivity growth is
not preordained. The steps we take as countries to eliminate and lessen bottlenecks and
improve our human and physical capital are important. The second is to ensure that our
financial systems are well-functioning. Tremendous progress has been made globally in
implementing higher capital and liquidity standards post-crisis. But we still see some
important banking systems impaired by bad loans, low profitability and inadequate capital.
The population aging in the developed world does imply that, purely from the productive
factor side, less of the global growth contribution is likely to come from Japan, Europe and
the United States. And economies like China are likely to continue to slow as their per capita
income increases and they make the transition from investment-to consumption-led growth.
But this doesn't imply a bad outcome. There are many other countries with tremendous
potential for growth in areas such as Africa, Asia, and South America. Take, for example, the
surge in growth that we are seeing out of India.
I am an optimist. To a large degree we do control our destiny. It is up to us to seize those
opportunities.