Ben S Bernanke: The US economic outlook
Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the Federal Reserve
System, at the International Monetary Conference, Atlanta, Georgia, 7 June 2011.
* * *
I would like to thank the organizers for inviting me to participate once again in the
International Monetary Conference. I will begin with a brief update on the outlook for the U.S.
economy, then discuss recent developments in global commodity markets that are
significantly affecting both the U.S. and world economies, and conclude with some thoughts
on the prospects for monetary policy.
The outlook for growth
U.S. economic growth so far this year looks to have been somewhat slower than expected.
Aggregate output increased at only 1.8 percent at an annual rate in the first quarter, and
supply chain disruptions associated with the earthquake and tsunami in Japan are
hampering economic activity this quarter. A number of indicators also suggest some loss of
momentum in the labor market in recent weeks. We are, of course, monitoring these
developments. That said, with the effects of the Japanese disaster on manufacturing output
likely to dissipate in coming months, and with some moderation in gasoline prices in
prospect, growth seems likely to pick up somewhat in the second half of the year. Overall,
the economic recovery appears to be continuing at a moderate pace, albeit at a rate that is
both uneven across sectors and frustratingly slow from the perspective of millions of
unemployed and underemployed workers.
As is often the case, the ability and willingness of households to spend will be an important
determinant of the pace at which the economy expands in coming quarters. A range of
positive and negative forces is currently influencing both household finances and attitudes.
On the positive side, household incomes have been boosted by the net improvement in job
market conditions since earlier this year as well as from the reduction in payroll taxes that the
Congress passed in December. Increases in household wealth - largely reflecting gains in
equity values - and lower debt burdens have also increased consumers' willingness to
spend. On the negative side, households are facing some significant headwinds, including
increases in food and energy prices, declining home values, continued tightness in some
credit markets, and still-high unemployment, all of which have taken a toll on consumer
confidence.
Developments in the labor market will be of particular importance in setting the course for
household spending. As you know, the jobs situation remains far from normal. For example,
aggregate hours of production workers - a comprehensive measure of labor input that
reflects the extent of part-time employment and opportunities for overtime as well as the
number of people employed - fell, remarkably, by nearly 10 percent from the beginning of
the recent recession through October 2009. Although hours of work have increased during
the expansion, this measure still remains about 6-1/2 percent below its pre-recession level.
For comparison, the maximum decline in aggregate hours worked in the deep 1981-82
recession was less than 6 percent. Other indicators, such as total payroll employment, the
ratio of employment to population, and the unemployment rate, paint a similar picture.
Particularly concerning is the very high level of long-term unemployment - nearly half of the
unemployed have been jobless for more than six months. People without work for long
periods can find it increasingly difficult to obtain a job comparable to their previous one, as
their skills tend to deteriorate over time and as employers are often reluctant to hire the
longterm unemployed.
Although the jobs market remains quite weak and progress has been uneven, overall we
have seen signs of gradual improvement. For example, private-sector payrolls increased at
an average rate of about 180,000 per month over the first five months of this year, compared
with less than 140,000 during the last four months of 2010 and less than 80,000 per month in
the four months prior to that. As I noted, however, recent indicators suggest some loss of
momentum, with last Friday's jobs market report showing an increase in private payrolls of
just 83,000 in May. I expect hiring to pick up from last month's pace as growth strengthens in
the second half of the year, but, again, the recent data highlight the need to continue
monitoring the jobs situation carefully.
The business sector generally presents a more upbeat picture. Capital spending on
equipment and software has continued to expand, reflecting an improving sales outlook and
the need to replace aging capital. Many U.S. firms, notably in manufacturing but also in
services, have benefited from the strong growth of demand in foreign markets. Going
forward, investment and hiring in the private sector should be facilitated by the ongoing
improvement in credit conditions. Larger businesses remain able to finance themselves at
historically low interest rates, and corporate balance sheets are strong. Smaller businesses
still face difficulties in obtaining credit, but surveys of both banks and borrowers indicate that
conditions are slowly improving for those firms as well.
In contrast, virtually all segments of the construction industry remain troubled. In the
residential sector, low home prices and mortgage rates imply that housing is quite affordable
by historical standards; yet, with underwriting standards for home mortgages having
tightened considerably, many potential homebuyers are unable to qualify for loans.
Uncertainties about job prospects and the future course of house prices have also deterred
potential buyers. Given these constraints on the demand for housing, and with a large
inventory of vacant and foreclosed properties overhanging the market, construction of new
single-family homes has remained at very low levels, and house prices have continued to
fall. The housing sector typically plays an important role in economic recoveries; the
depressed state of housing in the United States is a big reason that the current recovery is
less vigorous than we would like.
Developments in the public sector also help determine the pace of recovery. Here, too, the
picture is one of relative weakness. Fiscally constrained state and local governments
continue to cut spending and employment. Moreover, the impetus provided to the growth of
final demand by federal fiscal policies continues to wane.
The prospect of increasing fiscal drag on the recovery highlights one of the many difficult
tradeoffs faced by fiscal policymakers: If the nation is to have a healthy economic future,
policymakers urgently need to put the federal government's finances on a sustainable
trajectory. But, on the other hand, a sharp fiscal consolidation focused on the very near term
could be self-defeating if it were to undercut the still-fragile recovery. The solution to this
dilemma, I believe, lies in recognizing that our nation's fiscal problems are inherently
longterm in nature. Consequently, the appropriate response is to move quickly to enact a
credible, long-term plan for fiscal consolidation. By taking decisions today that lead to fiscal
consolidation over a longer horizon, policymakers can avoid a sudden fiscal contraction that
could put the recovery at risk. At the same time, establishing a credible plan for reducing
future deficits now would not only enhance economic performance in the long run, but could
also yield near-term benefits by leading to lower long-term interest rates and increased
consumer and business confidence.
The outlook for inflation
Let me turn to the outlook for inflation. As you all know, over the past year, prices for many
commodities have risen sharply, resulting in significantly higher consumer prices for gasoline
and other energy products and, to a somewhat lesser extent, for food. Overall inflation
measures reflect these price increases: For example, over the six months through April, the
price index for personal consumption expenditures has risen at an annual rate of about
3-1/2 percent, compared with an average of less than 1 percent over the preceding two
years.
Although the recent increase in inflation is a concern, the appropriate diagnosis and policy
response depend on whether the rise in inflation is likely to persist. So far at least, there is
not much evidence that inflation is becoming broad-based or ingrained in our economy;
indeed, increases in the price of a single product - gasoline - account for the bulk of the
recent increase in consumer price inflation.1 Of course, gasoline prices are exceptionally
important for both family finances and the broader economy; but the fact that gasoline price
increases alone account for so much of the overall increase in inflation suggests that
developments in the global market for crude oil and related products, as well as in other
commodities markets, are the principal factors behind the recent movements in inflation,
rather than factors specific to the U.S. economy. An important implication is that if the prices
of energy and other commodities stabilize in ranges near current levels, as futures markets
and many forecasters predict, the upward impetus to overall price inflation will wane and the
recent increase in inflation will prove transitory. Indeed, the declines in many commodity
prices seen over the past few weeks may be an indication that such moderation is occurring.
I will discuss commodity prices further momentarily.
Besides the prospect of more-stable commodity prices, two other factors suggest that
inflation is likely to return to more subdued levels in the medium term. First, the
stillsubstantial slack in U.S. labor and product markets should continue to have a moderating
effect on inflationary pressures. Notably, because of the weak demand for labor, wage
increases have not kept pace with productivity gains. Thus the level of unit labor costs in the
business sector is lower than it was before the recession. Given the large share of labor
costs in the production costs of most firms (typically, a share far larger than that of raw
materials costs), subdued unit labor costs should remain a restraining influence on inflation.
To be clear, I am not arguing that healthy increases in real wages are inconsistent with low
inflation; the two are perfectly consistent so long as productivity growth is reasonably strong.
The second additional factor restraining inflation is the stability of longer-term inflation
expectations. Despite the recent pickup in overall inflation, measures of households'
longerterm inflation expectations from the Michigan survey, the 10-year inflation projections of
professional economists, the 5-year-forward measure of inflation compensation derived from
yields on inflation-protected securities, and other measures of longer-term inflation
expectations have all remained reasonably stable.2 As long as longer-term inflation
expectations are stable, increases in global commodity prices are unlikely to be built into
domestic wage- and price-setting processes, and they should therefore have only transitory
effects on the rate of inflation. That said, the stability of inflation expectations is ensured only
as long as the commitment of the central bank to low and stable inflation remains credible.
Thus, the Federal Reserve will continue to closely monitor the evolution of inflation and
inflation expectations and will take whatever actions are necessary to keep inflation well
controlled.
Commodity prices
As I noted earlier, the rise in commodity prices has directly increased the rate of inflation
while also adversely affecting consumer confidence and consumer spending. Let's look at
these price increases in closer detail.
The basic facts are familiar. Oil prices have risen significantly, with the spot price of West
Texas Intermediate crude oil near $100 per barrel as of the end of last week, up nearly
40 percent from a year ago. Proportionally, prices of corn and wheat have risen even more,
roughly doubling over the past year. And prices of industrial metals have increased notably
as well, with aluminum and copper prices up about one-third over the past 12 months. When
the price of any product moves sharply, the economist's first instinct is to look for changes in
the supply of or demand for that product. And indeed, the recent increase in commodity
prices appears largely to be the result of the same factors that drove commodity prices
higher throughout much of the past decade: strong gains in global demand that have not
been met with commensurate increases in supply.
From 2002 to 2008, a period of sustained increases in commodity prices, world economic
activity registered its fastest pace of expansion in decades, rising at an average rate of about
4-1/2 percent per year. This impressive performance was led by the emerging and
developing economies, where real activity expanded at a remarkable 7 percent per annum.
The emerging market economies have likewise led the way in the recovery from the global
financial crisis: From 2008 to 2010, real gross domestic product (GDP) rose cumulatively by
about 10 percent in the emerging market economies even as GDP was essentially
unchanged, on net, in the advanced economies.3
Naturally, increased economic activity in emerging market economies has increased global
demand for raw materials. Moreover, the heavy emphasis on industrial development in many
emerging market economies has led their growth to be particularly intensive in the use of
commodities, even as the consumption of commodities in advanced economies has
stabilized or declined. For example, world oil consumption rose by 14 percent from 2000 to
2010; underlying this overall trend, however, was a 40 percent increase in oil use in
emerging market economies and an outright decline of 4-1/2 percent in the advanced
economies. In particular, U.S. oil consumption was about 2-1/2 percent lower in 2010 than in
2000, with net imports of oil down nearly 10 percent, even though U.S. real GDP rose by
nearly 20 percent over that period.
This dramatic shift in the sources of demand for commodities is not unique to oil. If anything,
the pattern is even more striking for industrial metals, where double-digit percentage rates of
decline in consumption by the advanced economies over the past decade have been
overwhelmed by triple-digit percentage increases in consumption by the emerging market
economies.4 Likewise, improving diets in the emerging market economies have significantly
increased their demand for agricultural commodities. Importantly, in noting these facts, I
intend no criticism of emerging markets; growth in those economies has conferred
substantial economic benefits both within those countries and globally, and in any case, the
consumption of raw materials relative to population in emerging-market countries remains
substantially lower than in the United States and other advanced economies. Nevertheless, it
is undeniable that the tremendous growth in emerging market economies has considerably
increased global demand for commodities in recent years.
Against this backdrop of extremely robust growth in demand, the supply of many
commodities has lagged behind. For example, world oil production has increased less than
1 percent per year since 2004, compared with nearly 2 percent per year in the prior decade.
In part, the slower increase in the supply of oil reflected disappointing rates of production in
countries that are not part of the Organization of the Petroleum Exporting Countries (OPEC).
However, OPEC has not shown much willingness to ramp up production, either. Most
recently, OPEC production fell 1.3 million barrels per day from January to April of this year,
reflecting the disruption to Libyan supplies and the lack of any significant offset from other
OPEC producers. Indeed, OPEC's production of oil today remains about 3 million barrels per
day below the peak level of mid-2008. With the demand for oil rising rapidly and the supply of
crude stagnant, increases in oil prices are hardly a puzzle.
Production shortfalls have plagued many other commodities as well. Agricultural output has
been hard hit by a spate of bad weather around the globe. For example, last summer's
drought in Russia severely reduced that country's wheat crop. In the United States, high
temperatures significantly impaired the U.S. corn crop last fall, and dry conditions are
currently hurting the wheat crop in Kansas. Over the past year, droughts have also afflicted
Argentina, China, and France. Fortunately, the lag between planting and harvesting for many
crops is relatively short; thus, if more-typical weather patterns resume, supplies of
agricultural commodities should rebound, thereby reducing the pressure on prices.
Not all commodity prices have increased, illustrating the point that supply and demand
conditions can vary across markets. For example, prices for both lumber and natural gas are
currently near their levels of the early 2000s. The demand for lumber has been curtailed by
weakness in the U.S. construction sector, while the supply of natural gas in the United States
has been increased by significant innovations in extraction techniques.5 Among agricultural
commodities, rice prices have remained relatively subdued, reflecting favorable growing
conditions.
In all, these cases reinforce the view that the fundamentals of global supply and demand
have been playing a central role in recent swings in commodity prices. That said, there is
usually significant uncertainty about current and prospective supply and demand.
Accordingly, commodity prices, like the prices of financial assets, can be volatile as market
participants react to incoming news. Recently, commodity prices seem to have been
particularly responsive to news bearing on the prospects for global economic growth as well
as geopolitical developments.
As the rapid growth of emerging market economies seems likely to continue, should we
therefore expect continued rapid increases in the prices of globally-traded commodities?
While it is certainly possible that we will see further increases, there are good reasons to
believe that commodity prices will not continue to rise at the rapid rates we have seen
recently. In the short run, unexpected shortfalls in the supplies of key commodities result in
sharp price increases, as usage patterns and available supplies are difficult to change
quickly. Over longer periods, however, high levels of commodity prices curtail demand as
households and firms adjust their spending and production patterns. Indeed, as I noted
earlier, we have already seen significant reductions in commodity use in the advanced
economies. Likewise, over time, high prices should elicit meaningful increases in supply,
both as temporary factors, such as adverse weather, abate and as investments in productive
capacity come to fruition. Finally, because expectations of higher prices lead financial market
participants to bid up the spot prices of commodities, predictable future developments
bearing on the demands for and supplies of commodities tend already to be reflected in
current prices. For these reasons, although unexpected developments could certainly lead to
continued volatility in global commodity prices, it is reasonable to expect the effects of
commodity prices on overall inflation to be relatively moderate in the medium term.
While supply and demand fundamentals surely account for most of the recent movements in
commodity prices, some observers have attributed a significant portion of the run-up in prices
to Federal Reserve policies, over and above the effects of those policies on U.S. economic
growth. For example, some have argued that accommodative U.S. monetary policy has
driven down the foreign exchange value of the dollar, thereby boosting the dollar price of
commodities. Indeed, since February 2009, the trade-weighted dollar has fallen by about
15 percent. However, since February 2009, oil prices have risen 160 percent and nonfuel
commodity prices are up by about 80 percent, implying that the dollar's decline can explain,
at most, only a small part of the rise in oil and other commodity prices; indeed, commodity
prices have risen dramatically when measured in terms of any of the world's major
currencies, not just the dollar. But even this calculation overstates the role of monetary
policy, as many factors other than monetary policy affect the value of the dollar. For example,
the decline in the dollar since February 2009 that I just noted followed a comparable increase
in the dollar, which largely reflected flight-to-safety flows triggered by the financial crisis in the
latter half of 2008; the dollar's decline since then in substantial part reflects the reversal of
those flows as the crisis eased. Slow growth in the United States and a persistent trade
deficit are additional, more fundamental sources of recent declines in the dollar's value; in
particular, as the United States is a major oil importer, any geopolitical or other shock that
increases the global price of oil will worsen our trade balance and economic outlook, which
tends to depress the dollar. In this case, the direction of causality runs from commodity
prices to the dollar rather than the other way around. The best way for the Federal Reserve
to support the fundamental value of the dollar in the medium term is to pursue our dual
mandate of maximum employment and price stability, and we will certainly do that.
Another argument that has been made is that low interest rates have pushed up commodity
prices by reducing the cost of holding inventories, thus boosting commodity demand, or by
encouraging speculators to push commodity futures prices above their fundamental levels. In
either case, if such forces were driving commodity prices materially and persistently higher,
we should see corresponding increases in commodity inventories, as higher prices curtailed
consumption and boosted production relative to their fundamental levels. In fact, inventories
of most commodities have not shown sizable increases over the past year as prices rose;
indeed, increases in prices have often been associated with lower rather than higher levels of
inventories, likely reflecting strong demand or weak supply that tends to put pressure on
available stocks.
Finally, some have suggested that very low interest rates in the United States and other
advanced economies have created risks of economic overheating in emerging market
economies and have thus indirectly put upward pressures on commodity prices. In fact, most
of the recent rapid economic growth in emerging market economies appears to reflect a
bounceback from the previous recession and continuing increases in productive capacity, as
their technologies and capital stocks catch up with those in advanced economies, rather than
being primarily the result of monetary conditions in those countries. More fundamentally,
however, whatever the source of the recent growth in the emerging markets, the authorities
in those economies clearly have a range of fiscal, monetary, exchange rate, and other tools
that can be used to address any overheating that may occur. As in all countries, the primary
objective of monetary policy in the United States should be to promote economic growth and
price stability at home, which in turn supports a stable global economic and financial
environment.
Monetary policy
Let me conclude with a few words about the current stance of monetary policy. As I have
discussed today, the economic recovery in the United States appears to be proceeding at a
moderate pace and - notwithstanding unevenness in the rate of progress and some recent
signs of reduced momentum - the labor market has been gradually improving. At the same
time, the jobs situation remains far from normal, with unemployment remaining elevated.
Inflation has risen lately but should moderate, assuming that commodity prices stabilize and
that, as I expect, longer-term inflation expectations remain stable.
Against this backdrop, the Federal Open Market Committee (FOMC) has maintained a highly
accommodative monetary policy, keeping its target for the federal funds rate close to zero
and further easing monetary conditions through large-scale asset purchases. The FOMC has
indicated that it will complete its purchases of $600 billion of Treasury securities by the end
of this month while maintaining its existing policy of reinvesting principal payments from its
securities holdings. The Committee also continues to anticipate that economic conditions are
likely to warrant exceptionally low levels for the federal funds rate for an extended period.
The U.S. economy is recovering from both the worst financial crisis and the most severe
housing bust since the Great Depression, and it faces additional headwinds ranging from the
effects of the Japanese disaster to global pressures in commodity markets. In this context,
monetary policy cannot be a panacea. Still, the Federal Reserve's actions in recent years
have doubtless helped stabilize the financial system, ease credit and financial conditions,
guard against deflation, and promote economic recovery. All of this has been accomplished, I
should note, at no net cost to the federal budget or to the U.S. taxpayer.
Although it is moving in the right direction, the economy is still producing at levels well below
its potential; consequently, accommodative monetary policies are still needed. Until we see a
sustained period of stronger job creation, we cannot consider the recovery to be truly
established. At the same time, the longer-run health of the economy requires that the Federal
Reserve be vigilant in preserving its hard-won credibility for maintaining price stability. As I
have explained, most FOMC participants currently see the recent increase in inflation as
transitory and expect inflation to remain subdued in the medium term. Should that forecast
prove wrong, however, and particularly if signs were to emerge that inflation was becoming
more broadly based or that longer-term inflation expectations were becoming less well
anchored, the Committee would respond as necessary. Under all circumstances, our policy
actions will be guided by the objectives of supporting the recovery in output and employment
while helping ensure that inflation, over time, is at levels consistent with the Federal
Reserve's mandate.