William C Dudley: The national and regional economy
Remarks by Mr William C Dudley, President and Chief Executive Officer of the Federal
Reserve Bank of New York, at the New Jersey Performing Arts Center, Newark, New Jersey,
6 April 2015.
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Jason Bram, Chelsea Cruz, Tony Davis, Jonathan McCarthy, James Orr, Richard Peach, Paolo Pesenti and
Joseph Tracy assisted in preparing these remarks.
I am very pleased to be here at the New Jersey Performing Arts Center (NJPAC) and to have
this opportunity to speak with the members of the Business Partners Roundtable. In my
remarks, I will provide an update to my national outlook for 2015, as well as discuss
economic developments in New Jersey. I will also briefly touch on how monetary policy might
evolve should my economic outlook be largely realized over the next year.
My meeting with you today is part of our continuing efforts to understand what is going on at
the grassroots level of our economy. We plan these trips so I can meet with a diverse array
of stakeholders in the region. This allows me to get a comprehensive picture of economic
conditions in the region and a fuller understanding of the major issues and concerns. This is
our first regional trip for 2015 and the third time we have visited northern New Jersey in the
past four years.
I begin my day here at NJPAC and following this visit, I will take a tour of the Teachers
Village, which is a new mixed-use community here in downtown Newark, attend a roundtable
lunch meeting with members of the Statewide Hispanic Chamber of Commerce of New
Jersey in Union City, and hear about the economic and community development activity in
Jersey City from Mayor Steven Fulop. I will then meet with nonprofit small business lenders
to hear about lending conditions, and I'll end the day at Stevens Institute of Technology
where I will learn how they have partnered with NBC Universal to create a new minor in
media engineering to address a skills gap issue in the region.
These trips are one of the many ways in which we engage with people and businesses in our
region. We track the health of household balance sheets at the state and local level using
data from the New York Fed's Consumer Credit Panel. These data show debt balances and
delinquency trends across all forms of consumer debt, including mortgages, student loans,
auto loans and credit cards. Later this month we will release a Regional Household Debt and
Credit Snapshot that will provide an overview of the household debt trends in metropolitan
areas within New Jersey. We also conduct a biannual poll of small businesses to understand
their credit needs and availability. Based on the poll results, we have developed an ongoing
series of clinics for small businesses to help them take the next step to access capital and
identify new sources of funding. We also get important input from our Small Business and
Agricultural Advisory Council, whose members help us understand key economic and
financial issues affecting regional businesses and communities. This year we tapped two
New Jersey business leaders to join the Advisory Council: Adenah Bayoh, co-founder of
Kapwood, LLC, and Ranjini Poddar, founder of Artech Information Systems, LLC.
Let me now review recent developments in the national and regional economy, and at the
end of my talk, I will be happy to answer questions you may have about the economic
outlook. As always, what I have to say reflects my own views and not necessarily those of
the Federal Reserve System or the Federal Open Market Committee (FOMC).1
National economic conditions
After growing at just a 2 percent annual rate from 2010 through 2012, real GDP expanded
more quickly in 2013 and 2014, rising at a 2.7 percent annual rate. This was sufficient to
push the unemployment rate down by more than two percentage points over this period. This
firming in growth reflected several important developments that, in my view, are likely to
continue through 2015. The data we follow suggest that the household deleveraging process
has largely run its course and the imbalances in the housing market have been mostly
worked off. Federal fiscal consolidation appears to be over for now, and employment and
spending are increasing at the state and local government level.
That said, economic performance in this cycle has been disappointing compared to historical
patterns. Even though household wealth relative to disposable income is nearly at its
prefinancial crisis level and conditions in labor markets are substantially improved, consumer
spending growth has been slower and the personal saving rate higher than what we would
have expected based on past historical relationships. Similarly, even with low mortgage
rates, single-family housing construction has been surprisingly sluggish. And, despite very
accommodative financial conditions and record corporate profits, growth of business fixed
investment has been tepid.
Looking forward, my outlook for 2015 is that economic growth will be close to the pace of the
past two years, supported by continued solid fundamentals and accommodative financial
conditions. If I am correct, then this would lead to a further reduction of labor market slack,
with the unemployment rate approaching 5 percent by the second half of the year.
An important element of this forecast is continued strength in household spending. This
strength is supported by the restored health of household balance sheets, improved
household income prospects and the benefit of significantly lower energy prices. The data for
the second half of 2014 reflect these positive forces: real personal consumption expenditures
grew at a 3.2 annualized rate in the third quarter and a 4.4 percent rate in the fourth quarter.
This strength in consumption was accompanied by solid income growth, as real disposable
income increased at a 3.6 percent annual rate in the fourth quarter, reflecting the stronger
labor market.
The pace of improvement in the labor market has slowed in recent months from the strong
pace at the end of last year. Nonfarm payroll employment increased in the first quarter by
about 200,000 per month, well below the pace of the fourth quarter. This slowdown was
broad-based, with job growth slowing in both the goods-producing and the service-providing
sectors.
The unemployment rate was 5.5 percent in March: analysis by my staff suggests that the
unemployment rate is nearing the point where we may begin to see a pickup in the pace of
real wage gains. If this proves correct and unemployment continues to decline as I expect,
then these stronger wage gains could help support solid income growth even if the pace of
employment growth slows. However, it will be important to monitor developments to
determine whether the softness in the March labor market report evident on Friday
foreshadows a more substantial slowing in the labor market than I currently anticipate.
The March labor market report is another indicator that the first quarter is likely to be quite
weak. Our current projection is that the economy will grow at about a 1 percent annual rate in
the first quarter of 2015. This softer performance is suggested by a wide range of recent
indicators that have surprised to the downside over the past couple of months. Examples of
such indicators include retail sales, the ISM manufacturing index, manufacturing production
and orders, and single-family housing starts.
Overall, I view these downside surprises as reflecting temporary factors to a significant
degree. For example, some of the recent softness is likely due to yet another harsh winter in
the Northeast and the Midwest. My staff's analysis of a measure of both the amount of snow
and the population affected indicates that January and February weather was 20 to
25 percent more severe than the five-year average. Such large deviations appear to have
meaningful negative impacts on a number of economic indicators.
Even so, there are some downside risks to the growth outlook. In particular, the steep decline
in crude oil prices is likely to lead to a further sharp drop in U.S. oil and gas investment.
Additionally, the significant rise in the value of the dollar is likely to lead to weaker U.S. trade
performance.
Let me discuss each of these in more detail. Energy prices have declined sharply since
mid2014. In recent weeks, the benchmark West Texas Intermediate (WTI) oil price has been
hovering in a range of $45 to $50 per barrel, less than half the price in June of last year. This
creates both positives and negatives for the U.S. economy. Starting with the positives, since
the U.S. is still a net importer of petroleum, this development has provided substantial
benefits, with our oil import bill down by about a 1⁄2 percentage point of GDP. As I indicated
earlier, that represents a significant boost to real disposable income for households. How
much this energy windfall boosts consumption will depend, though, on how much is spent
versus saved.
Turning to the negatives, the support to growth from rapidly rising U.S. oil production almost
certainly will fade away. U.S. oil production has been rising rapidly for several years, due
largely to new technology that has expanded the amount of oil that can be recovered from
existing wells and that has facilitated shale oil production by fracking. Now, with prices
dramatically lower, U.S. oil exploration and drilling activity is falling off very sharply. This will
exert a meaningful drag on economic activity.
Another significant shock is the nearly 15 percent appreciation of the exchange value of the
dollar since mid-2014. Such an appreciation makes U.S. exports more expensive and
imports more competitive. My staff's analysis concludes that an appreciation of this
magnitude would, all else equal, reduce real GDP growth by about 0.6 percentage point over
this year.
Turning to inflation, the data continue to come in below the FOMC's objective of a 2 percent
annualized rate for the personal consumption expenditures (PCE) deflator. The twelve-month
change of the total PCE deflator was 0.3 percent in February, with the core PCE deflator at
1.4 percent. Despite this, my expectation is that inflation will begin to firm later this year. In
particular, most of the impact from the decline in energy prices that has weighed down
overall inflation is likely over. Although the appreciation of the dollar is likely to cause some
further softness in import prices, the continued decline in resource slack as the economy
expands should push in the opposite direction. In addition, longer-term household inflation
expectations have been well maintained through this period of very low inflation, as indicated
by our Survey of Consumer Expectations. The combination of stable expectations and
declining slack should push inflation slowly back towards the FOMC's objective.
Monetary policy
As the FOMC has consistently communicated, the timing of lift-off will depend on how the
economic outlook evolves. As I have discussed, the labor market has improved substantially
and I expect to see inflation begin to firm later this year. If this labor market improvement
continues and the FOMC is reasonably confident that inflation will move back to our
2 percent objective over the medium-term, then it would be appropriate to begin to normalize
interest rates. At the March meeting, the FOMC removed language from the statement that
indicated that we would be patient in beginning the process of normalizing monetary policy.
But, as Chair Yellen remarked in her most recent press conference, removal of "patient" from
the statement does not indicate that we will be "impatient" to begin to normalize monetary
policy. Rather, the timing of normalization will be data dependent and remains uncertain
because the future evolution of the economy cannot be fully anticipated.
Whenever the data support a decision to lift off, I think it is important to recognize what this
would signify. It does not mean that monetary policy will be tight. We will simply be moving
from an extremely accommodative monetary policy to one that is slightly less so. It also will
be a positive signal about the progress we have made in restoring the economy to health. In
my view, it would be a cause for celebration, because it would signal that the FOMC believes
that slightly higher short-term interest rates are consistent with its objectives of maximum
employment and price stability. Near-zero short-term interest rates and a larger Federal
Reserve balance sheet were designed to be a temporary extraordinary treatment to help the
economy regain its vitality, and not a permanent palliative.
I remain confident that when the FOMC does decide to begin to remove policy
accommodation that we have the requisite tools to effectively support this decision. We have
tested numerous tools including overnight reverse repurchase operations, term reverse
repurchase operations, and term deposit facilities to ensure that, when the time comes, lift-off
can be managed smoothly. The primary tool will be interest on excess reserves (IOER), with
overnight reverse repurchases as a supplemental tool to be used as needed to ensure a firm
floor under short-term interest rates.
For financial markets, the likely path of short-term rates after lift-off is just as important as the
timing of lift-off. Here, I anticipate that the path will be relatively shallow. Headwinds in the
aftermath of the financial crisis are still in evidence, particularly the diminished availability
and tougher terms for residential mortgage credit.
How fast the normalization process will proceed depends mainly on two factors: how the
economy evolves and how financial market conditions respond to movements in the federal
funds rate. If financial market conditions do not tighten much in response to higher short-term
interest rates, we might have to move more quickly. After all, the point of raising short-term
interest rates is to exert some restraint on financial market conditions. In contrast, if financial
conditions tighten unduly, then this will likely cause us to go much more slowly or even to
pause for a while. At the end of the day, we will move short-term interest rates to generate
the set of financial market conditions that we deem is most consistent with our employment
and inflation objectives.
How high will short-term rates ultimately need to go? I think this issue is very difficult to judge
for a number of reasons. First, it depends on how financial market conditions evolve in
response to our monetary policy adjustments. Second, it depends on other factors, such as
real potential GDP growth, which, in turn, depends on the growth rates of the labor force and
of productivity. My current thinking is that the long-run nominal federal funds rate consistent
with 2 percent inflation is somewhat lower than in the past. My point estimate is 31⁄2 percent,
but I wouldn't bet the farm on this. I have considerable uncertainty about this estimate.
Regional economic conditions
Now let's turn to the New Jersey economy. One feature of the state's economy is its
industrial diversity. A sizeable number of jobs in the state are in the healthcare, professional
and business services, wholesale and retail trade, and leisure and hospitality categories.
When we look at the northern part of the state, we see a greater concentration of jobs in
finance, particularly in Hudson County. Also prominent are goods distribution jobs related to
the ports, rail lines, trucking and warehousing. Other large sectors include pharmaceuticals
manufacturing and research and development, as well as private education.
Looking at recent trends in northern New Jersey, the recovery in the economy in general -
and in employment in particular - is lagging the nation and is not going as well as we would
like. The Garden State's economy lost a quarter of a million jobs during the recession, and
employment didn't begin to recover until 2011, and even then it was slow getting started.
However, the latest annual employment revisions - released just a few weeks ago - show
job gains in 2013 and 2014 were a bit stronger than previously reported. Nevertheless, four
years into the recovery, employment has recovered less than two-thirds of the job losses
from the recession. This contrasts notably with both New York State and the U.S. as a whole,
where employment has far surpassed its earlier peaks. Moreover, here in Essex County,
there has yet to be any significant upturn in jobs, although neighboring Hudson County has
seen a fairly strong rebound.
That's not to say that there aren't any strong industry sectors here in New Jersey: job growth
has been quite robust in health services, transportation and warehousing, construction and a
number of business service industries. There has also been steady job creation in retail trade
and leisure and hospitality, though these tend to be low-paying sectors. On the other hand,
employment remains depressed in other industries such as finance, publishing,
telecommunications and manufacturing.
So why is New Jersey not keeping pace with New York in terms of job growth? Well, much of
the strength in New York State has been driven by New York City; other parts of the state
have seen similar, if not weaker, job growth than New Jersey. Of course, this raises the
question: why has New York City's economy been so much stronger? In fact, there is a body
of research suggesting that the long-term drift of economic activity and jobs from cities to
suburbs has subsided, and that there is a growing trend toward re-urbanization - a
preference for both people and businesses to locate in cities, like New York.
Yet there is also a strong tendency for persistent strength in an urban hub to gradually spill
over into nearby areas. With both commercial and residential rents, not to mention sales
prices, high and rising in Manhattan, northern New Jersey has an opportunity to capitalize on
its widening cost advantage by attracting companies and residents that value an urban
location, but find New York City to be too pricey. And if preferences are indeed in the midst of
a long-term shift toward urbanization, this bodes particularly well for New Jersey's own cities.
With a major international airport and seaport, a 20-30 minute train ride from most of
Manhattan - but much cheaper rents - as well as a number of universities and a solid
infrastructure, Newark has strong potential to develop its prominence as a major local
business, economic and cultural hub.
Concluding thoughts
To conclude, I would like to say a few words concerning proposals to reform the Federal
Reserve System. First, I concur with Chair Yellen that the Federal Reserve already is very
transparent and accountable to Congress and to the public. I share her strong belief that the
independence of the central bank to make appropriate policy decisions consistent with its
legislated mandates is essential to a nation's economic well-being.
With regard to the structure of the Federal Reserve System and the role of the regional
banks, including the New York Fed, I also agree with Chair Yellen that the system is working
well, and I do not see a need for any substantive changes. I believe that the System has
been designed appropriately so that a wide range of regional views are represented. At the
same time, I believe that the Federal Reserve System's monetary policy responsibilities are
allocated appropriately by the Federal Open Market Committee, with New York playing an
important role to ensure that monetary policy is executed effectively even during periods of
duress. Of course, the Federal Reserve System and the New York Fed are not perfect
institutions. That is why we always must strive, in an open and transparent manner, to
improve what we do and how we do it, for the benefit of the American people.
Thank you for your kind attention. I would now be happy to take some questions.