Ben S Bernanke: Economic outlook and policy
Testimony by Mr Ben S Bernanke, Chairman of the Board of Governors of the Federal
Reserve System, before the Joint Economic Committee, US Congress, Washington DC,
7 June 2012.
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Chairman Casey, Vice Chairman Brady, and other members of the Committee, I appreciate
this opportunity to discuss the economic outlook and economic policy.
Economic growth has continued at a moderate rate so far this year. Real gross domestic
product (GDP) rose at an annual rate of about 2 percent in the first quarter after increasing at
a 3 percent pace in the fourth quarter of 2011. Growth last quarter was supported by further
gains in private domestic demand, which more than offset a drag from a decline in
government spending.
Labor market conditions improved in the latter part of 2011 and earlier this year. The
unemployment rate has fallen about 1 percentage point since last August; and payroll
employment increased 225,000 per month, on average, during the first three months of this
year, up from about 150,000 jobs added per month in 2011. In April and May, however, the
reported pace of job gains slowed to an average of 75,000 per month, and the
unemployment rate ticked up to 8.2 percent. This apparent slowing in the labor market may
have been exaggerated by issues related to seasonal adjustment and the unusually warm
weather this past winter.1 But it may also be the case that the larger gains seen late last year
and early this year were associated with some catch-up in hiring on the part of employers
who had pared their workforces aggressively during and just after the recession.2 If so, the
deceleration in employment in recent months may indicate that this catch-up has largely
been completed, and, consequently, that more-rapid gains in economic activity will be
required to achieve significant further improvement in labor market conditions.
Economic growth appears poised to continue at a moderate pace over coming quarters,
supported in part by accommodative monetary policy. In particular, increases in household
spending have been relatively well sustained. Income growth has remained quite modest, but
the recent declines in energy prices should provide some offsetting lift to real purchasing
power. While the most recent readings have been mixed, consumer sentiment is nonetheless
up noticeably from its levels late last year. And, despite economic difficulties in Europe, the
demand for U.S. exports has held up well. The U.S. business sector is profitable and has
become more competitive in international markets.
However, some of the factors that have restrained the recovery persist. Notably, households
and businesses still appear quite cautious about the economy. For example, according to
surveys, households continue to rate their income prospects as relatively poor and do not
expect economic conditions to improve significantly. Similarly, concerns about developments
in Europe, U.S. fiscal policy, and the strength and sustainability of the recovery have left
some firms hesitant to expand capacity.
The depressed housing market has also been an important drag on the recovery. Despite
historically low mortgage rates and high levels of affordability, many prospective homebuyers
cannot obtain mortgages, as lending standards have tightened and the creditworthiness of
many potential borrowers has been impaired. At the same time, a large stock of vacant
houses continues to limit incentives for the construction of new homes, and a substantial
backlog of foreclosures will likely add further to the supply of vacant homes. However, a few
encouraging signs in housing have appeared recently, including some pickup in sales and
construction, improvements in homebuilder sentiment, and the apparent stabilization of home
prices in some areas.
Banking and financial conditions in the United States have improved significantly since the
depths of the crisis. Notably, recent stress tests conducted by the Federal Reserve of the
balance sheets of the 19 largest U.S. bank holding companies showed that those firms have
added about $300 billion to their capital since 2009; the tests also showed that, even in an
extremely adverse hypothetical economic scenario, most of those firms would remain able to
provide credit to U.S. households and businesses. Lending terms and standards have
generally become less restrictive in recent quarters, although some borrowers, such as small
businesses and (as already noted) potential homebuyers with less-than-perfect credit, still
report difficulties in obtaining loans.
Concerns about sovereign debt and the health of banks in a number of euro-area countries
continue to create strains in global financial markets. The crisis in Europe has affected the
U.S. economy by acting as a drag on our exports, weighing on business and consumer
confidence, and pressuring U.S. financial markets and institutions. European policymakers
have taken a number of actions to address the crisis, but more will likely be needed to
stabilize euro-area banks, calm market fears about sovereign finances, achieve a workable
fiscal framework for the euro area, and lay the foundations for long-term economic growth.
U.S. banks have greatly improved their financial strength in recent years, as I noted earlier.
Nevertheless, the situation in Europe poses significant risks to the U.S. financial system and
economy and must be monitored closely. As always, the Federal Reserve remains prepared
to take action as needed to protect the U.S. financial system and economy in the event that
financial stresses escalate.
Another factor likely to weigh on the U.S. recovery is the drag being exerted by fiscal policy.
Reflecting ongoing budgetary pressures, real spending by state and local governments has
continued to decline. Real federal government spending has also declined, on net, since the
third quarter of last year, and the future course of federal fiscal policies remains quite
uncertain, as I will discuss shortly.
With regard to inflation, large increases in energy prices earlier this year caused the price
index for personal consumption expenditures to rise at an annual rate of about 3 percent
over the first three months of this year. However, oil prices and retail gasoline prices have
since retraced those earlier increases. In any case, increases in the prices of oil or other
commodities are unlikely to result in persistent increases in overall inflation so long as
household and business expectations of future price changes remain stable. Longer-term
inflation expectations have, indeed, been quite well anchored, according to surveys of
households and economic forecasters and as derived from financial market information. For
example, the five-year-forward measure of inflation compensation derived from yields on
nominal and inflation-protected Treasury securities suggests that inflation expectations
among investors have changed little, on net, since last fall and are lower than a year ago.
Meanwhile, the substantial resource slack in U.S. labor and product markets should continue
to restrain inflationary pressures. Given these conditions, inflation is expected to remain at or
slightly below the 2 percent rate that the Federal Open Market Committee (FOMC) judges
consistent with our statutory mandate to foster maximum employment and stable prices.
With unemployment still quite high and the outlook for inflation subdued, and in the presence
of significant downside risks to the outlook posed by strains in global financial markets, the
FOMC has continued to maintain a highly accommodative stance of monetary policy. The
target range for the federal funds rate remains at 0 to 1/4 percent, and the Committee has
indicated in its recent statements that it anticipates that economic conditions are likely to
warrant exceptionally low levels of the federal funds rate at least through late 2014. In
addition, the Federal Reserve has been conducting a program, announced last September,
to lengthen the average maturity of its securities holdings by purchasing $400 billion of
longer-term Treasury securities and selling an equal amount of shorter-term Treasury
securities. The Committee also continues to reinvest principal received from its holdings of
agency debt and agency mortgage-backed securities (MBS) in agency MBS and to roll over
its maturing Treasury holdings at auction. These policies have supported the economic
recovery by putting downward pressure on longer-term interest rates, including mortgage
rates, and by making broader financial conditions more accommodative. The Committee
reviews the size and composition of its securities holdings regularly and is prepared to adjust
those holdings as appropriate to promote a stronger economic recovery in a context of price
stability.
The economy's performance over the medium and longer term also will depend importantly
on the course of fiscal policy. Fiscal policymakers confront daunting challenges. As they do
so, they should keep three objectives in mind. First, to promote economic growth and
stability, the federal budget must be put on a sustainable long-run path. The federal budget
deficit, which averaged about 9 percent of GDP during the past three fiscal years, is likely to
narrow in coming years as the economic recovery leads to higher tax revenues and lower
income support payments. Nevertheless, the Congressional Budget Office (CBO) projects
that, if current policies continue, the budget deficit would be close to 5 percent of GDP in
2017 when the economy is expected to be near full employment.3 Moreover, under current
policies and reasonable economic assumptions, the CBO projects that the structural budget
gap and the ratio of federal debt to GDP will trend upward thereafter, in large part reflecting
rapidly escalating health expenditures and the aging of the population. This dynamic is
clearly unsustainable. At best, rapidly rising levels of debt will lead to reduced rates of capital
formation, slower economic growth, and increased foreign indebtedness. At worst, they will
provoke a fiscal crisis that could have severe consequences for the economy. To avoid such
outcomes, fiscal policy must be placed on a sustainable path that eventually results in a
stable or declining ratio of federal debt to GDP.
Even as fiscal policymakers address the urgent issue of fiscal sustainability, a second
objective should be to avoid unnecessarily impeding the current economic recovery. Indeed,
a severe tightening of fiscal policy at the beginning of next year that is built into current law
- the so-called fiscal cliff - would, if allowed to occur, pose a significant threat to the
recovery. Moreover, uncertainty about the resolution of these fiscal issues could itself
undermine business and household confidence. Fortunately, avoiding the fiscal cliff and
achieving long-term fiscal sustainability are fully compatible and mutually reinforcing
objectives. Preventing a sudden and severe contraction in fiscal policy will support the
transition back to full employment, which should aid long-term fiscal sustainability. At the
same time, a credible fiscal plan to put the federal budget on a longer-run sustainable path
could help keep longer-term interest rates low and improve household and business
confidence, thereby supporting improved economic performance today.
A third objective for fiscal policy is to promote a stronger economy in the medium and long
term through the careful design of tax policies and spending programs. To the fullest extent
possible, federal tax and spending policies should increase incentives to work and save,
encourage investments in workforce skills, stimulate private capital formation, promote
research and development, and provide necessary public infrastructure. Although we cannot
expect our economy to grow its way out of federal budget imbalances without significant
adjustment in fiscal policies, a more productive economy will ease the tradeoffs faced by
fiscal policymakers.
Thank you. I would be glad to take your questions.