Ben S Bernanke: The US economic outlook
Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal
Reserve System, at the Economic Club of Minnesota Luncheon, Minneapolis, Minnesota,
8 September 2011.
* * *
Good afternoon. I am delighted to be in the Twin Cities and would like to thank the Economic
Club of Minnesota for inviting me to kick off its 2011-2012 speaker series. Today I will
provide a brief overview of the U.S. economic outlook and conclude with a few thoughts on
monetary policy and on the longer-term prospects for our economy.
The outlook for US economic growth
In discussing the prospects for the economy and for policy in the near term, it bears recalling
briefly how we got here. The financial crisis that gripped global markets in 2008 and 2009
was more severe than any since the Great Depression. Economic policymakers around the
world saw the mounting risks of a global financial meltdown in the fall of 2008 and
understood the extraordinarily dire economic consequences that such an event could have.
Governments and central banks consequently worked forcefully and in close coordination to
avert the looming collapse. The actions to stabilize the financial system were accompanied,
both in the United States and abroad, by substantial monetary and fiscal stimulus. Despite
these strong and concerted efforts, severe damage to the global economy could not be
avoided. The freezing of credit, the sharp drops in asset prices, dysfunction in financial
markets, and the resulting blows to confidence sent global production and trade into free fall
in late 2008 and early 2009.
It has been almost exactly three years since the beginning of the most intense phase of the
financial crisis, in the late summer and fall of 2008, and a bit more than two years since the
official beginning of the economic recovery, in June 2009, as determined by the National
Bureau of Economic Research's Business Cycle Dating Committee. Where do we stand?
There have been some positive developments over the past few years. In the financial
sphere, our banking system and financial markets are significantly stronger and more stable.
Credit availability has improved for many borrowers, though it remains tight in categories
- such as small business lending - in which the balance sheets and income prospects of
potential borrowers remain impaired. Importantly, given the sources of the crisis, structural
reform is moving forward in the financial sector, with ambitious domestic and international
efforts under way to enhance financial regulation and supervision, especially for the largest
and systemically most important financial institutions.
Nevertheless, it is clear that the recovery from the crisis has been much less robust than we
had hoped. From recent comprehensive revisions of government economic data, we have
learned that the recession was even deeper and the recovery weaker than we had previously
thought; indeed, aggregate output in the United States still has not returned to the level that it
had attained before the crisis. Importantly, economic growth over the past two years has, for
the most part, been at rates insufficient to achieve sustained reductions in the unemployment
rate, which has recently been fluctuating a bit above 9 percent.
The pattern of sluggish economic growth was particularly evident in the first half of this year,
with real gross domestic product (GDP) estimated to have increased at an annual rate of less
than 1 percent, on average, in the first and second quarters. Some of this weakness can be
attributed to temporary factors, including the strains put on consumer and business budgets
by the run-ups earlier this year in the prices of oil and other commodities and the effects of
the disaster in Japan on global supply chains and production. Accordingly, with commodity
prices coming off their highs and manufacturers' problems with supply chains well along
toward resolution, growth in the second half looks likely to pick up. However, the incoming
data suggest that other, more persistent factors also have been holding back the recovery.
Consequently, as noted in its statement following the August meeting, the Federal Open
Market Committee (FOMC) now expects a somewhat slower pace of recovery over coming
quarters than it did at the time of the June meeting, with greater downside risks to the
economic outlook.
One striking aspect of the recovery is the unusual weakness in household spending. After
contracting very sharply during the recession, consumer spending expanded moderately
through 2010, only to decelerate in the first half of 2011. The temporary factors I mentioned
earlier - the rise in commodity prices, which has hurt households' purchasing power, and the
disruption in manufacturing following the Japanese disaster, which reduced auto availability
and hence sales - are partial explanations for this deceleration. But households are
struggling with other important headwinds as well, including the persistently high level of
unemployment, slow gains in wages for those who remain employed, falling house prices,
and debt burdens that remain high for many, notwithstanding that households, in the
aggregate, have been saving more and borrowing less. Even taking into account the many
financial pressures they face, households seem exceptionally cautious. Indeed, readings on
consumer confidence have fallen substantially in recent months as people have become
more pessimistic about both economic conditions and their own financial prospects.
Compared with the household sector, the business sector generally presents a more upbeat
picture. Manufacturing production has risen nearly 15 percent since its trough, driven
importantly by growth in exports. Indeed, the U.S. trade deficit has narrowed substantially
relative to where it was before the crisis, reflecting in part the improved competitiveness of
U.S. goods and services. Business investment in equipment and software has also continued
to expand. Corporate balance sheets are healthy, and although corporate bond markets
have tightened somewhat of late, companies with access to the bond markets have generally
had little difficulty obtaining credit on favorable terms. But problems are evident in the
business sector as well: Business investment in nonresidential structures, such as office
buildings, factories, and shopping malls, has remained at a low level, held back by elevated
vacancy rates at existing properties and difficulties, in some cases, in obtaining construction
loans. Also, some business surveys, including those conducted by the Federal Reserve
System, point to weaker conditions recently, with businesses reporting slower growth in
production, new orders, and employment.
Why has this recovery been so slow and erratic? Historically, recessions have tended to sow
the seeds of their own recoveries as reduced spending on investment, housing, and
consumer durables generates pent-up demand. As the business cycle bottoms out and
confidence returns, this pent-up demand, often augmented by the effects of stimulative
monetary and fiscal policies, is met through increased production and hiring. Increased
production in turn boosts business revenues and increased hiring raises household incomes -
providing further impetus to business and household spending. Improving income prospects
and balance sheets also make households and businesses more creditworthy, and financial
institutions become more willing to lend. Normally, these developments create a virtuous
circle of rising incomes and profits, more-supportive financial and credit conditions, and lower
uncertainty, allowing the process of recovery to develop momentum.
These restorative forces are at work today, and they will continue to promote recovery over
time. Unfortunately, the recession, besides being extraordinarily severe as well as global in
scope, was also unusual in being associated with both a very deep slump in the housing
market and a historic financial crisis. These two features of the downturn, individually and in
combination, have acted to slow the natural recovery process.
Notably, the housing sector has been a significant driver of recovery from most recessions in
the United States since World War II, but this time - with an overhang of distressed and
foreclosed properties, tight credit conditions for builders and potential homebuyers, and
ongoing concerns by both potential borrowers and lenders about continued house price
declines - the rate of new home construction has remained at less than one-third of its
precrisis peak. Depressed construction also has hurt providers of a wide range of goods and
services related to housing and homebuilding, such as the household appliance and home
furnishing industries. Moreover, even as tight credit for builders and potential homebuyers
has been one of the factors restraining the housing recovery, the weak housing market has
in turn adversely affected financial markets and the flow of credit. For example, the sharp
declines in house prices in some areas have left many homeowners "underwater" on their
mortgages, creating financial hardship for households and, through their effects on rates of
mortgage delinquency and default, stress for financial institutions as well.
As I noted, the financial crisis of 2008 and 2009 played a central role in sparking the global
recession. A great deal has been and continues to be done to address the causes and
effects of the crisis, including extensive financial reforms. However, although banking and
financial conditions in the United States have improved significantly since the depths of the
crisis, financial stress continues to be a significant drag on the recovery, both here and
abroad. This drag has become particularly evident in recent months, as bouts of sharp
volatility and risk aversion in markets have reemerged in reaction to concerns about
European sovereign debts and related strains as well as developments associated with the
U.S. fiscal situation, including last month's downgrade of the U.S. long-term credit rating by
one of the major ratings agencies and the recent controversy surrounding the raising of the
U.S. federal debt ceiling. It is difficult to judge how much these events and the associated
financial volatility have affected 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.
While the weakness of the housing sector and continued financial volatility are two key
reasons for the frustratingly slow pace of the recovery, other factors also may restrain growth
in coming quarters. For example, state and local governments continue to tighten their belts
by cutting spending and reducing payrolls in the face of ongoing budgetary pressures, and
federal fiscal stimulus is being withdrawn. There is ample room for debate about the
appropriate size and role for the government in the longer term, but - in the absence of
adequate demand from the private sector - a substantial fiscal consolidation in the shorter
term could add to the headwinds facing economic growth and hiring.
The prospect of an increasing fiscal drag on the economy in the face of an already sluggish
recovery highlights one of the many difficult tradeoffs currently faced by fiscal policymakers.
As I have emphasized on previous occasions, without significant policy changes to address
the increasing fiscal burdens that will be associated with the aging of the population and the
ongoing rise in health-care costs, the finances of the federal government will spiral out of
control in coming decades, risking severe economic and financial damage. But, while prompt
and decisive action to put the federal government's finances on a sustainable trajectory is
urgently needed, fiscal policymakers should not, as a consequence, disregard the fragility of
the economic recovery. Fortunately, the two goals - achieving fiscal sustainability, which is
the result of responsible policies set in place for the longer term, and avoiding creation of
fiscal headwinds for the recovery - are not incompatible. Acting now to put in place a
credible plan for reducing future deficits over the long term, while being attentive to the
implications of fiscal choices for the recovery in the near term, can help serve both
objectives.
The outlook for inflation
Let me turn now from the outlook for growth to the outlook for inflation. Prices of many
commodities, notably oil, increased sharply earlier this year. Higher gasoline and food prices
translated directly into increased inflation for consumers, and in some cases producers of
other goods and services were able to pass through their higher costs to their customers as
well. In addition, the global supply disruptions associated with the disaster in Japan put
upward pressure on motor vehicle prices. As a result of these influences, inflation picked up
significantly; over the first half of this year, 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.
However, inflation is expected to moderate in the coming quarters 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. Meanwhile, the step-up in automobile
production should reduce pressure on car prices. Importantly, we see little indication that the
higher rate of inflation experienced so far this year has become ingrained in the economy.
Longer-term inflation expectations have remained stable according to the indicators we
monitor, such as the measure of households' longer-term expectations from the Thompson
Reuters/University of Michigan survey, the 10-year inflation projections of professional
forecasters, and the five-year-forward measure of inflation compensation derived from yields
of inflation-protected Treasury securities. In addition to the stability of longer-term inflation
expectations, the substantial amount of resource slack that exists in U.S. labor and product
markets should continue to have a moderating influence on inflationary pressures. Notably,
because of ongoing weakness in labor demand over the course of the recovery, nominal
wage increases have been roughly offset by productivity gains, leaving the level of unit labor
costs close to where it had stood at the onset of the recession. Given the large share of labor
costs in the production costs of most firms, subdued unit labor costs should be an important
restraining influence on inflation.
Monetary policy
Although the FOMC expects a moderate recovery to continue and indeed to strengthen over
time, the Committee has responded to recent developments - as I have already noted - by
marking down its outlook for economic growth over coming quarters. The Committee also
continues to anticipate that inflation will moderate over time, to a rate at or below the
2 percent or a bit less that most FOMC participants consider to be consistent with the
Committee's dual mandate to promote maximum employment and price stability.
Given this outlook, the Committee decided at its August meeting to provide more specific
forward guidance about its expectations for the future path of the federal funds rate. In
particular, the statement following the meeting indicated that economic conditions - including
low rates of resource utilization and a subdued outlook for inflation over the medium run -
are likely to warrant exceptionally low levels for the federal funds rate at least through
mid-2013. That is, in what the Committee judges to be the most likely scenarios for resource
utilization and inflation in the medium term, the target for the federal funds rate would be held
at its current low level for at least two more years.
In addition to refining our forward guidance, the Federal Reserve has a range of tools that
could be used to provide additional monetary stimulus. We discussed the relative merits and
costs of such tools at our August meeting. My FOMC colleagues and I will continue to
consider those and other pertinent issues, including, of course, economic and financial
developments, at our meeting in September and are prepared to employ these tools as
appropriate to promote a stronger economic recovery in a context of price stability.
Conclusion
Let me conclude with just a few words on the longer-term prospects for our economy. As
monetary and fiscal policymakers consider the appropriate policies to address the economy's
current weaknesses, it is important to acknowledge its enduring strengths. Notwithstanding
the trauma of the crisis and the recession, the U.S. economy remains the largest in the
world, with a highly diverse mix of industries and a degree of international competitiveness
that, if anything, has improved in recent years. Our economy retains its traditional
advantages of a strong market orientation, a robust entrepreneurial culture, and flexible
capital and labor markets. And our country remains a technological leader, with many of the
world's leading research universities and the highest spending on research and development
of any nation. Thus I do not expect the long-run growth potential of the U.S. economy to be
if
materially affected by the financial crisis and the recession if - and I stress - our country
takes the necessary steps to secure that outcome. Economic policymakers face a range of
difficult decisions, and every household and business must cope with the stresses and
uncertainties that our current situation presents. These are not easy tasks. I have no doubt,
however, that those challenges can be met, and that the fundamental strengths of our
economy will ultimately reassert themselves. The Federal Reserve will certainly do all that it
can to help restore high rates of growth and employment in a context of price stability.