Charles I Plosser: The outlook and the hazards of accelerationist policy
Speech by Mr Charles I Plosser, President and Chief Executive Officer of the Federal
Reserve Bank of Philadelphia, at the Economic Forecast, The University of Delaware Center
for Economic Education and Entrepreneurship, Newark, Delaware, 14 February 2012.
* * *
Introduction
Thank you for inviting me back again to the University of Delaware. It has been three years
since I last spoke at this event and a lot has happened. Yet, as I will explain, we have come
a long way on the road to recovery from the Great Recession. So, this morning I will share
with you my take on the economic outlook. Then I want to discuss the hazards of trying to
apply ever more monetary accommodation to speed up the recovery process.1
Economic outlook
We are now in the third year of a moderate economic recovery that has had more than a few
bumps along the way. We finished 2011 with real GDP at 1.6 percent, compared to
3.1 percent in the prior year. Some of this weakness is perfectly understandable, given the
unexpected shocks we experienced during the year. Yet, the economy persevered. Indeed,
growth accelerated across each of the four quarters, from less than half of a percent in the
first quarter to around 2-3/4 percent in the fourth quarter. I anticipate that we will continue to
see moderate growth of around 3 percent in 2012 and 2013, which is slightly above trend.
Business spending, especially investment in equipment and software, was relatively healthy
last year, buoyed by solid growth in corporate earnings. In January, the Philadelphia Fed's
Business Outlook Survey showed that regional manufacturing activity continued to expand at
a moderate pace, the fourth consecutive monthly increase since a late summer lull. The
survey's measures of future activity also indicated that our respondents expect activity to
continue to pick up over the next six months. I take this as a sign that business sentiment is
also improving.
On the housing front, I expect to see stabilization but not much improvement in 2012. We
entered the Great Recession over-invested in residential real estate, and we are not likely to
see a housing recovery until the surplus inventory of foreclosed and distressed properties
declines.
Even as the economy rebalances, we should not seek, nor should we expect, housing and
related sectors to return to those pre-recession highs. Those highs were unsustainable, and
the housing crash that ensued destroyed a great deal of wealth for consumers and the
economy as a whole. The losses are real and the consequences severe for many individuals
and many businesses. Moreover, monetary policy cannot paper over these losses, nor
should it try to do so. Households and businesses, nevertheless, continue to make progress
on restoring the health of their balance sheets by paying down debt and increasing savings.
Most economists, including me, believe that this process will continue into 2012.
The labor market has grown stronger in recent months. Although there are still too many
people unemployed in our region and the nation, I am encouraged by the most recent
employment reports. The January employment report showed a net gain of 243,000 jobs,
and revisions to November and December added another 60,000 jobs to the recovery. Some
have downplayed the report, suggesting that one good data point does not make a trend,
and I wholeheartedly agree. But what we have seen is more than one data point. Net
employment gains were 103,000 in October, 157,000 in November, 203,000 in December,
and 243,000 in January - a clear positive trend.
The household survey also reported a significant decline in the unemployment rate. Here,
too, the trend is encouraging - 8.9 percent in October, 8.7 in November, 8.5 in December,
and 8.3 in January. That is the lowest level in nearly three years. As growth continues and
strengthens, I expect further gradual declines in the unemployment rate, with the rate falling
to 8 percent or less, by the end of 2012.
In our District, all three states ended 2011 with lower unemployment rates. New Jersey's
rate, at about 9 percent, is still higher than the national average, but Delaware's and
Pennsylvania's were below the national average, with rates of 7.4 and 7.6 percent,
respectively.
As we continue down the road to recovery, I expect we will face further hiccups along the
way. One significant risk is the potential effects of the continuing sovereign debt crisis in
Europe. The economic slowdown in the euro zone will likely restrain U.S. exports. And while
strains in financial markets have been limited to European institutions so far, we must
continue to monitor events to ensure that there are no adverse spillovers to U.S. financial
institutions. Of course, regardless of how the European situation plays out, it has already
imposed considerable uncertainty on growth prospects for the global economy. Moreover,
our own nation's inability to establish a clear plan to put our fiscal house in order contributes
additional uncertainty to the economic landscape.
Until the economic environment becomes clearer, firms and consumers are likely to
postpone significant spending and hiring decisions - imposing a drag on the recovery, even
though economic developments in the U.S. continue to improve.
Inflation risks in the near term remain modest. However, I remain concerned that monetary
policy has exposed us to substantial inflation risk over the medium to longer term. Total
inflation in 2011, as measured by the consumer price index on a year-over-year basis, was
3 percent, reflecting strong increases in energy and food prices, particularly in the early part
of the year. The personal consumption expenditures price index rose 2.4 percent. While
these inflation rates exceed our target, I anticipate that with many commodity prices now
leveling off or falling, and inflation expectations relatively stable, inflation will remain
moderate in the near term. My forecast is that inflation will settle around 2 percent in 2012.
Yet, inflation often develops gradually, and if monetary policy waits too long to respond, it
can be very costly to correct. Measures of slack such as the unemployment rate are often
thought to prevent inflation from rising. But that did not turn out to be true in the 1970s. Thus,
we need to proceed with caution and be circumspect as to the degree of monetary
accommodation we supply to the economy. So let me review some of the policy actions the
Fed has taken.
Monetary policy
As you know, the Fed has kept the federal funds rate near zero for more than three years to
support the recovery. We have also conducted two rounds of asset purchases that have
more than tripled the size of the balance sheet and changed its composition from short-term
Treasuries to longer-term Treasuries and housing-related securities, mostly
mortgagebacked securities. Today, we are in a modest recovery from a deep recession and financial
crisis. The financial crisis has passed, however, and monetary policy should not continue to
act as if the crisis was still with us.
In January, the Federal Open Market Committee announced that economic conditions were
"likely to warrant exceptionally low levels for the federal funds rate at least through late 2014"
- that's almost three years from now. And that is 18 months longer than the mid-2013
calendar date first signaled last August. In addition, the Committee announced that the Fed
intends to continue the maturity extension program, or "operation twist", first launched last
September. In this program, the Fed is buying $400 billion of longer-term Treasuries and
selling an equal amount of shorter-term Treasuries, in an effort to reduce yields from already
historically low levels. The FOMC is also continuing to reinvest principal payments from its
holdings of agency debt and MBS into MBS in an effort to help mortgage markets.
You may know that I dissented from the FOMC decisions in August and September because
it was not clear to me that further monetary policy accommodation was appropriate. After all,
inflation was higher and unemployment was lower relative to the previous year.
In addition, I do not support the practice of offering forward policy guidance by saying
economic conditions are likely to lead to low rates through some calendar date. Such
statements are, in my mind, particularly problematic from a communications perspective.
Monetary policy should be contingent on the economic environment and not on the calendar.
Thus, I was not supportive of the Committee's actions in January. I think that economic
conditions, as they have evolved since late last year, do not call for further accommodation.
In fact, the economy has actually improved. Moreover, I continue to oppose using calendar
dates to communicate forward guidance.
Yet, despite the extraordinary steps taken to support the economy, many argue that
monetary policy should do more. The argument is that while inflation may be close to our
target, unemployment remains elevated, and thus, monetary policy must act more
aggressively if it is to meet its mandated employment objective.
I disagree and believe that doing so would lead us down a very treacherous path - one that
would be ever more difficult to navigate and one that would increase the already substantial
risk of higher inflation. But the problem is not just inflation risk down the road. Prolonged
efforts to hold interest rates near zero can lead to financial market distortions and the
misallocation of resources.
Let me offer an analogy that might help you visualize the risks.
Imagine you're driving a car down the Delaware Turnpike on a rainy and foggy day on the
way to a birthday party for your mother. Unfortunately, you can't see very far ahead because
of the weather, and you don't know exactly how far you are from the exit. You are anxious
because you don't want to miss the party. Your children are in the back seat, giddy with
excitement about seeing their grandmother. So you decide to go a little faster. You
accelerate.
After some time passes, you still think you are some distance from your exit. The children are
now fidgeting in the back seat, and you don't want to be late, so you decide to step on the
gas a little more. Now, you are speeding, hoping to get to your destination sooner.
Eventually, though, as you are flying down the highway, you finally catch a glimpse of the exit
through the fog and rain, only now you are going too fast to safely navigate the off ramp. You
are faced with two very unattractive options.
One option is to slam on the brakes to make the exit. This strategy risks causing a multicar
accident, as your abrupt efforts to slow down surprises drivers behind you who had expected
you to continue at high speed. The result is an accident, perhaps injuries to innocent people,
and maybe a severe traffic jam, diverting or delaying many others. The second option is to
continue down the road to the next exit, turn around, and then backtrack to the right exit. This
strategy means that you are late, you miss the party, you disappoint everyone, you pay extra
for tolls and gas, and you incur numerous other costs in the process.
Monetary policy is sometimes criticized for such "go-stop" policies. Policymakers step on the
accelerator aggressively, only to slam on the brakes in order to change course. Such an
approach to policy can be highly destabilizing, creating added volatility for financial markets
and the economy.
I would add that constant acceleration only makes these risks even more hazardous.
Slamming on the brakes or abruptly changing course could disrupt the economy. Failing to
slow down and exit at the right time risks excessive inflation, which then has to be controlled.
It also risks the misallocation of resources and capital, and perhaps even credit bubbles or
other distortions that could pose problems for the economy.
Thus, in my mind, such an accelerationist approach to monetary policy is risky and the
potential costs may be quite high. It is an approach most often driven by an excessive focus
on the short run and perhaps some hubris that we will be able to successfully avert the risks
such a strategy poses for the economy over the longer run.
Conclusion
In summary, the U.S. economy is continuing to grow at a moderate pace. I expect annual
growth of around 3 percent in 2012 and 2013.
Prospects for labor markets will continue to improve, with job growth strengthening and the
unemployment rate falling gradually over time. I believe inflation expectations will be
relatively stable and inflation will moderate in the near term. However, with the very
accommodative stance of monetary policy, we must guard against the medium- and
longerterm risks of inflation and the potential for distortions such accommodation can create.
Finally, I believe we must also guard against an accelerationist approach to policy - one that
calls for monetary policy to do more and more in an attempt to get to our objectives that
much faster. The risks to economic stability of such an approach over the medium term could
be quite high and could jeopardize our ability to achieve our longer-terms goals.