Ben S Bernanke: The economic recovery and economic policy
Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the Federal Reserve
System, at the New York Economic Club, New York, New York, 20 November 2012.
* * *
Good afternoon. I am pleased to join the New York Economic Club for lunch today. I know
that many of you and your friends and neighbors are still recovering from the effects of
Hurricane Sandy, and I want to let you know that our thoughts are with everyone who has
suffered during the storm and its aftermath.
My remarks today will focus on the reasons for the disappointingly slow pace of economic
recovery in the United States and the policy actions that have been taken by the Federal
Open Market Committee (FOMC) to support the economy. In addition, I will discuss some
important economic challenges our country faces as we close out 2012 and move into 2013
- in particular, the challenge of putting federal government finances on a sustainable path in
the longer run while avoiding actions that would endanger the economic recovery in the near
term.
The recovery from the financial crisis and recession
The economy has continued to recover from the financial crisis and recession, but the pace
of recovery has been slower than FOMC participants and many others had hoped or
anticipated when I spoke here about three years ago. Indeed, since the recession trough in
mid-2009, growth in real gross domestic product (GDP) has averaged only a little more than
2 percent per year.
Similarly, the job market has improved over the past three years, but at a slow pace. The
unemployment rate, which peaked at 10 percent in the fall of 2009, has since come down
2 percentage points to just below 8 percent. This decline is obviously welcome, but it has
taken a long time to achieve that progress, and the unemployment rate is still well above
both its level prior to the onset of the recession and the level that my colleagues and I think
can be sustained once a full recovery has been achieved. Moreover, many other features of
the jobs market, including the historically high level of long-term unemployment, the large
number of people working part time because they have not been able to find full-time jobs,
and the decline in labor force participation, reinforce the conclusion that we have some way
to go before the labor market can be deemed healthy again.
Meanwhile, inflation has generally remained subdued. As is often the case, inflation has
been pushed up and down in recent years by fluctuations in the price of crude oil and other
globally traded commodities, including the increase in farm prices brought on by this
summer's drought. But with longer-term inflation expectations remaining stable, the ebbs and
flows in commodity prices have had only transitory effects on inflation. Indeed, since the
recovery began about three years ago, consumer price inflation, as measured by the
personal consumption expenditures (PCE) price index, has averaged almost exactly
2 percent, which is the FOMC's longer-run objective for inflation.1 Because ongoing slack in
labor and product markets should continue to restrain wage and price increases, and with the
public's inflation expectations continuing to be well anchored, inflation over the next few
years is likely to remain close to or a little below the Committee's objective.
As background for our monetary policy decisionmaking, we at the Federal Reserve have
spent a good deal of effort attempting to understand the reasons why the economic recovery
has not been stronger. Studies of previous financial crises provide one helpful place to start.2
This literature has found that severe financial crises - particularly those associated with
housing booms and busts - have often been associated with many years of subsequent
weak performance. While this result allows for many interpretations, one possibility is that
financial crises, or the deep recessions that typically accompany them, may reduce an
economy's potential growth rate, at least for a time.
The accumulating evidence does appear consistent with the financial crisis and the
associated recession having reduced the potential growth rate of our economy somewhat
during the past few years. In particular, slower growth of potential output would help explain
why the unemployment rate has declined in the face of the relatively modest output gains we
have seen during the recovery. Output normally has to increase at about its longer-term
trend just to create enough jobs to absorb new entrants to the labor market, and
faster-thantrend growth is usually needed to reduce unemployment. So the fact that unemployment has
declined in recent years despite economic growth at about 2 percent suggests that the
growth rate of potential output must have recently been lower than the roughly 2-1/2 percent
rate that appeared to be in place before the crisis.3
There are a number of ways in which the financial crisis could have slowed the rate of growth
of the economy's potential. For example, the extraordinarily severe job losses that followed
the crisis, especially in housing-related industries, may have exacerbated for a time the
extent of mismatch between the jobs available and the skills and locations of the
unemployed. Meanwhile, the very high level of long-term unemployment has probably led to
some loss of skills and labor force attachment among those workers. These factors may
have pushed up to some degree the so-called natural rate of unemployment - the rate of
unemployment that can be sustained under normal conditions - and reduced labor force
participation as well. The pace of productivity gains - another key determinant of growth in
potential output - may also have been restrained by the crisis, as business investment
declined sharply during the recession; and increases in risk aversion and uncertainty,
together with tight credit conditions, may have impeded the commercial application of new
technologies and slowed the pace of business formation.
Importantly, however, although the nation's potential output may have grown more slowly
than expected in recent years, this slowing seems at best a partial explanation of the
disappointing pace of the economic recovery. In particular, even though the natural rate of
unemployment may have increased somewhat, a variety of evidence suggests that any such
increase has been modest, and that substantial slack remains in the labor market. For
example, the slow pace of employment growth has been widespread across industries and
2
See Carmen M. Reinhart and Kenneth S. Rogoff (2009), This Time Is Different: Eight Centuries of Financial
Folly (Princeton: Princeton University Press); Moritz Schularick and Alan M. Taylor (2012), "Credit Booms
Gone Bust: Monetary Policy, Leverage Cycles, and Financial Crises, 1870-2008," American Economic
Review, vol. 102 (April), pp. 1029-61; Valerie Cerra and Sweta Chaman Saxena (2008), "Growth Dynamics:
The Myth of Economic Recovery," American Economic Review, vol. 98 (March), pp. 439-57; Greg Howard,
Robert Martin, and Beth Anne Wilson (2011), "Are Recoveries from Banking and Financial Crises Really So
Different?" International Finance Discussion Papers 1037 (Washington: Board of Governors of the Federal
Reserve System, November); and Michael D. Bordo and Joseph G. Haubrich (2012), "Deep Recessions, Fast
Recoveries, and Financial Crises: Evidence from the American Record," Working Paper 12-14 (Cleveland:
Federal Reserve Bank of Cleveland, June).
3
That said, GDP growth in excess of potential is probably not the whole explanation for the decline in
unemployment. Some of the decline in unemployment during the recovery could also reflect a reversal of the
especially large increases that occurred during the deepest part of the recession, when firms appeared to cut
their workforces by greater numbers than would normally be associated with the decline in GDP. (For a
discussion, see Ben S. Bernanke (2012), "Recent Developments in the Labor Market," speech delivered at the
National Association for Business Economics 28th Annual Economic Policy Conference, Arlington, Va.,
March 26.) A reduction in the number of people receiving extended or emergency unemployment insurance
benefits may have contributed to the decline in unemployment as well.
regions of the country. That pattern suggests a broad-based shortfall in demand rather than
a substantial increase in mismatch between available jobs and workers, because greater
mismatch would imply that the demand for workers would be strong in some regions and
industries, not weak almost across the board. Likewise, if a mismatch of jobs and workers is
the predominant problem, we would expect to see wage pressures developing in those
regions and industries where labor demand is strong; in fact, wage gains have been quite
subdued in most industries and parts of the country.4 Indeed, as I indicated earlier, the
consensus among my colleagues on the FOMC is that the unemployment rate is still well
above its longer-run sustainable level, perhaps by 2 to 2-1/2 percentage points or so.5
A critical question, then, is why significant slack in the job market remains three years after
the recovery began. A likely explanation, which I will discuss further, is that the economy has
been faced with a variety of headwinds that have hindered what otherwise might have been
a stronger cyclical rebound. If so, we may take some encouragement from the likelihood that
there are potentially two sources of faster GDP growth in the future. First, the effects of the
crisis on potential output should fade as the economy continues to heal.6 And second, if the
headwinds begin to dissipate, as I expect, growth should pick up further as many who are
currently unemployed or out of the labor force find work.
Headwinds affecting the recovery
What are the headwinds that have slowed the return of our economy to full employment?
Some have come from the housing sector. Previous recoveries have often been associated
with a vigorous rebound in housing, as rising incomes and confidence and, often, a decline in
mortgage interest rates led to sharp increases in the demand for homes.7 But the housing
bubble and its aftermath have made this episode quite different. In the first half of the past
decade, both housing prices and construction rose to what proved to be unsustainable
levels, leading to a subsequent collapse: House prices declined almost one-third nationally
from 2006 until early this year, construction of single-family homes fell two-thirds, and the
number of construction jobs decreased by nearly one-third. And, of course, the associated
surge in delinquencies on mortgages helped trigger the broader financial crisis.
Recently, the housing market has shown some clear signs of improvement, as home sales,
prices, and construction have all moved up since early this year. These developments are
encouraging, and it seems likely that, on net, residential investment will be a source of
economic growth and new jobs over the next couple of years. However, while historically low
4
In addition, while the changing relationship between job vacancies and unemployment - the shift in the
Beveridge curve - probably does point to some greater difficulty matching jobs with workers, factors other
than mismatch likely explain some of that shift. For example, evidence suggests that firms tend to become
more selective in hiring when their hiring needs are not urgent. For further discussion of these labor market
issues, see Bernanke, "Recent Developments," in note 3 and the references cited therein. See also Edward
P. Lazear and James R. Spletzer (2012), "The United States Labor Market: Status Quo or a New Normal?
(PDF)" paper delivered at "The Changing Policy Landscape," a symposium sponsored by the Federal Reserve
Bank of Kansas City, held in Jackson Hole, Wyo., August 30-September 1.
5
In the September 2012 Summary of Economic Projections (SEP), the central tendency of FOMC participants'
estimates of the long-run normal rate of unemployment ranged from 5.2 to 6 percent. The SEP is an
addendum to the FOMC minutes and is available at Board of Governors of the Federal Reserve System
(2012), "Minutes of the Federal Open Market Committee, September 12-13, 2012," press release, October 4.
6
For example, mismatch problems in the labor market should fade as the economy strengthens, a further rise
in business investment would contribute to faster growth in the capital stock, and an improving economy
should cause investors to become less risk averse.
7
In the recoveries following the 1975 and 1982 recessions, for example, residential construction directly
contributed about 1 percentage point to GDP growth during the two years following the recession trough;
indirect effects - through the effect of home prices on consumer spending or through multiplier effects - no
doubt added to the contribution.
mortgage interest rates and the drop in home prices have made housing exceptionally
affordable, a number of factors continue to prevent the sort of powerful housing recovery that
has typically occurred in the past. Notably, lenders have maintained tight terms and
conditions on mortgage loans, even for potential borrowers with relatively good credit.8
Lenders cite a number of factors affecting their decisions to extend credit, including ongoing
uncertainties about the course of the economy, the housing market, and the regulatory
environment. Unfortunately, while some tightening of the terms of mortgage credit was
certainly an appropriate response to the earlier excesses, the pendulum appears to have
swung too far, restraining the pace of recovery in the housing sector.
Other factors slowing the recovery in housing include the fact that many people remain
unable to buy homes despite low mortgage rates; for example, about 20 percent of existing
mortgage borrowers owe more on their mortgages than their houses are worth, making it
more difficult for them to refinance or sell their homes. Also, a substantial overhang of vacant
homes, either for sale or in the foreclosure pipeline, continues to hold down house prices and
reduce the need for new construction. While these headwinds on both the supply and
demand sides of the housing market have clearly started to abate, the recovery in the
housing sector is likely to remain moderate by historical standards.
A second set of headwinds stems from the financial conditions facing potential borrowers in
credit and capital markets. After the financial system seized up in late 2008 and early 2009,
global economic activity contracted sharply, and credit and capital markets suffered
significant damage. Although dramatic actions by governments and central banks around the
world helped these markets to stabilize and begin recovering, tight credit and a high degree
of risk aversion have restrained economic growth in the United States and in other countries
as well.
Measures of the condition of U.S. financial markets and institutions suggest gradual but
significant progress has been achieved since the crisis. For example, credit spreads on
corporate bonds and syndicated loans have narrowed considerably, and equity prices have
recovered most of their losses. In addition, indicators of market stress and illiquidity - such
as spreads in short-term funding markets - have generally returned to levels near those seen
before the crisis. One gauge of the overall improvement in financial markets is the National
Financial Conditions Index maintained by the Federal Reserve Bank of Chicago. The index
shows that financial conditions, viewed as a whole, are now about as accommodative as
they were in the spring of 2007.
In spite of this broad improvement, the harm inflicted by the financial crisis has yet to be fully
repaired in important segments of the financial sector. One example is the continued
weakness in some categories of bank lending. Banks' capital positions and overall asset
quality have improved substantially over the past several years, and, over time, these
balance sheet improvements will position banks to extend considerably more credit to
bankdependent borrowers. Indeed, some types of bank credit, such as commercial and industrial
loans, have expanded notably in recent quarters. Nonetheless, banks have been
conservative in extending loans to many consumers and some businesses, likely even
beyond the restrictions on the supply of mortgage lending that I noted earlier. This caution in
lending by banks reflects, among other factors, their continued desire to guard against the
risks of further economic weakness.
A prominent risk at present - and a major source of financial headwinds over the past couple
of years - is the fiscal and financial situation in Europe. This situation, of course, was not
anticipated when the U.S. recovery began in 2009. The elevated levels of stress in European
economies and uncertainty about how the problems there will be resolved are adding to the
risks that U.S. financial institutions, businesses, and households must consider when making
lending and investment decisions. Negative sentiment regarding Europe appears to have
weighed on U.S. equity prices and prevented U.S. credit spreads from narrowing even
further. Weaker economic conditions in Europe and other parts of the world have also
weighed on U.S. exports and corporate earnings.
Policymakers in Europe have taken some important steps recently, and in doing so have
contributed to some welcome easing of financial conditions. In particular, the European
Central Bank's new Outright Monetary Transactions program, under which it could purchase
the sovereign debt of vulnerable euro-area countries who agree to meet prescribed
conditions, has helped ease market concerns about those countries. European governments
have also taken steps to strengthen their financial firewalls and to move toward greater fiscal
and banking union. Further improvement in global financial conditions will depend in part on
the extent to which European policymakers follow through on these initiatives.
A third headwind to the recovery - and one that may intensify in force in coming quarters - is
U.S. fiscal policy. Although fiscal policy at the federal level was quite expansionary during the
recession and early in the recovery, as the recovery proceeded, the support provided for the
economy by federal fiscal actions was increasingly offset by the adverse effects of tight
budget conditions for state and local governments. In response to a large and sustained
decline in their tax revenues, state and local governments have cut about 600,000 jobs on
net since the third quarter of 2008 while reducing real expenditures for infrastructure projects
by 20 percent.
More recently, the situation has to some extent reversed: The drag on economic growth from
state and local fiscal policy has diminished as revenues have improved, easing the pressures
for further spending cuts or tax increases. In contrast, the phasing-out of earlier stimulus
programs and policy actions to reduce the federal budget deficit have led federal fiscal policy
to begin restraining GDP growth. Indeed, under almost any plausible scenario, next year the
drag from federal fiscal policy on GDP growth will outweigh the positive effects on growth
from fiscal expansion at the state and local level. However, the overall effect of federal fiscal
policy on the economy, both in the near term and in the longer run, remains quite uncertain
and depends on how policymakers meet two daunting fiscal challenges - one by the start of
the new year and the other no later than the spring.
Upcoming fiscal challenges
What are these looming challenges? First, the Congress and the Administration will need to
protect the economy from the full brunt of the severe fiscal tightening at the beginning of next
year that is built into current law - the so-called fiscal cliff. The realization of all of the
automatic tax increases and spending cuts that make up the fiscal cliff, absent offsetting
changes, would pose a substantial threat to the recovery - indeed, by the reckoning of the
Congressional Budget Office (CBO) and that of many outside observers, a fiscal shock of
that size would send the economy toppling back into recession. Second, early in the new
year it will be necessary to approve an increase in the federal debt limit to avoid any
possibility of a catastrophic default on the nation's Treasury securities and other obligations.
As you will recall, the threat of default in the summer of 2011 fueled economic uncertainty
and badly damaged confidence, even though an agreement ultimately was reached. A failure
to reach a timely agreement this time around could impose even heavier economic and
financial costs.
As fiscal policymakers face these critical decisions, they should keep two objectives in mind.
First, as I think is widely appreciated by now, the federal budget is on an unsustainable path.
The budget deficit, which peaked at about 10 percent of GDP in 2009 and now stands at
about 7 percent of GDP, is expected to narrow further in the coming years as the economy
continues to recover. However, the CBO projects that, under a plausible set of policy
assumptions, the budget deficit would still be greater than 4 percent of GDP in 2018,
assuming the economy has returned to its potential by then. Moreover, under the CBO
projection, the deficit and the ratio of federal debt to GDP would subsequently return to an
upward trend.9 Of course, we should all understand that long-term projections of
everincreasing deficits will never actually come to pass, because the willingness of lenders to
continue to fund the government can only be sustained by responsible fiscal plans and
actions. A credible framework to set federal fiscal policy on a stable path - for example, one
on which the ratio of federal debt to GDP eventually stabilizes or declines - is thus urgently
needed to ensure longer-term economic growth and stability.
Even as fiscal policymakers address the urgent issue of longer-run fiscal sustainability, they
should not ignore a second key objective: to avoid unnecessarily adding to the headwinds
that are already holding back the economic recovery. Fortunately, the two objectives are fully
compatible and mutually reinforcing. Preventing a sudden and severe contraction in fiscal
policy early next year will support the transition of the economy back to full employment; a
stronger economy will in turn reduce the deficit and contribute to achieving long-term fiscal
sustainability. At the same time, a credible plan to put the federal budget on a path that will
be sustainable in the long run could help keep longer-term interest rates low and boost
household and business confidence, thereby supporting economic growth today.
Coming together to find fiscal solutions will not be easy, but the stakes are high. Uncertainty
about how the fiscal cliff, the raising of the debt limit, and the longer-term budget situation will
be addressed appears already to be affecting private spending and investment decisions and
may be contributing to an increased sense of caution in financial markets, with adverse
effects on the economy. Continuing to push off difficult policy choices will only prolong and
intensify these uncertainties. Moreover, while the details of whatever agreement is reached
to resolve the fiscal cliff are important, the economic confidence of both market participants
and the general public likely will also be influenced by the extent to which our political system
proves able to deliver a reasonable solution with a minimum of uncertainty and delay.
Finding long-term solutions that can win sufficient political support to be enacted may take
some time, but meaningful progress toward this end can be achieved now if policymakers
are willing to think creatively and work together constructively.
Monetary policy
Let me now turn briefly to monetary policy.
Monetary policy can do little to reverse the effects that the financial crisis may have had on
the economy's productive potential. However, it has been able to provide an important offset
to the headwinds that have slowed the cyclical recovery. As you know, the Federal Reserve
took strong easing measures during the financial crisis and recession, cutting its target for
the federal funds rate - the traditional tool of monetary policy - to nearly zero by the end of
2008. Since that time, we have provided additional accommodation through two
nontraditional policy tools aimed at putting downward pressure on longer-term interest rates:
asset purchases that reduce the supply of longer-term securities outstanding in the market,
and communication about the future path of monetary policy.
Most recently, after the September FOMC meeting, we announced that the Federal Reserve
would purchase additional agency mortgage-backed securities (MBS) and continue with the
program to extend the maturity of our Treasury holdings.10 These additional asset purchases
should put downward pressure on longer-term interest rates and make broader financial
conditions more accommodative.11 Moreover, our purchases of MBS, by bringing down
mortgage rates, provide support directly to housing and thereby help mitigate some of the
headwinds facing that sector. In announcing this decision, we also indicated that we would
continue purchasing MBS, undertake additional purchases of longer-term securities, and
employ our other policy tools until we judge that the outlook for the labor market has
improved substantially in a context of price stability.
Although it is still too early to assess the full effects of our most recent policy actions, yields
on corporate bonds and agency MBS have fallen significantly, on balance, since the FOMC's
announcement. More generally, research suggests that our previous asset purchases have
eased overall financial conditions and provided meaningful support to the economic recovery
in recent years.12
In addition to announcing new purchases of MBS, at our September meeting we extended
our guidance for how long we expect that exceptionally low levels for the federal funds rate
will likely be warranted at least through the middle of 2015. By pushing the expected period
of low rates further into the future, we are not saying that we expect the economy to remain
weak until mid-2015; rather, we expect - as we indicated in our September statement - that
a highly accommodative stance of monetary policy will remain appropriate for a considerable
time after the economic recovery strengthens.13 In other words, we will want to be sure that
the recovery is established before we begin to normalize policy. We hope that such
assurances will reduce uncertainty and increase confidence among households and
businesses, thereby providing additional support for economic growth and job creation.
10
See Board of Governors of the Federal Reserve System (2012), "Federal Reserve Issues FOMC Statement,"
press release, September 13.
11
One way in which our asset purchases affect the economy is through the so-called portfolio balance channel.
Because different classes of financial assets are not perfect substitutes in investors' portfolios, changes in the
supplies of various assets available to private investors may affect the prices and yields of those assets. Thus,
the Federal Reserve's purchases of Treasury securities, for example, should raise the prices and lower the
yields of those securities; moreover, as investors rebalance their portfolios by replacing the Treasury
securities sold to the Federal Reserve with other assets, the prices of those other assets should rise and their
yields decline as well. An increase in our asset purchases may also act as a signal that we intend to pursue a
persistently more accommodative policy stance than previously thought, thereby lowering investors'
expectations for the future path of the federal funds rate and putting additional downward pressure on
longerterm interest rates.
12
See Ben S. Bernanke (2012), "Monetary Policy since the Onset of the Crisis," speech delivered at "The
Changing Policy Landscape," a symposium sponsored by the Federal Reserve Bank of Kansas City, held in
Jackson Hole, Wyo., August 30-September 1. For simulation results showing the effects of the FOMC's asset
purchases, see Hess Chung, Jean-Philippe Laforte, David Reifschneider, and John C. Williams (2012), "Have
Journal of Money, Credit and
We Underestimated the Likelihood and Severity of Zero Lower Bound Events?"
Banking, vol. 44 (February supplement), pp. 47-82. For a study focusing only on the second large-scale asset
purchase program that finds comparable effects, attributing to that program a bit less than a 1 percent
increase in output and 700,000 new jobs, see Jeffrey C. Fuhrer and Giovanni P. Olivei (2011), "The Estimated
Macroeconomic Effects of the Federal Reserve's Large-Scale Treasury Purchase Program," Public Policy
Briefs 11-02 (Boston: Federal Reserve Bank of Boston, April). For a study using different methodologies that
finds significantly smaller effects, see Michael T. Kiley (2012), "The Aggregate Demand Effects of Short- and
Long-Term Interest Rates," Finance and Economics Discussion Series 2012-54 (Washington: Board of
Governors of the Federal Reserve System, August); and for one that finds larger effects, see Christiane
Baumeister and Luca Benati (2010), "Unconventional Monetary Policy and the Great Recession: Estimating
the Impact of a Compression in the Yield Spread at the Zero Lower Bound, (PDF)" European Central Bank
Working Paper Series 1258 (Frankfurt: European Central Bank, October).
13
See Board of Governors, "FOMC Statement," in note 10.
Conclusion
In sum, the U.S. economy continues to be hampered by the lingering effects of the financial
crisis on its productive potential and by a number of headwinds that have hindered the
normal cyclical adjustment of the economy. The Federal Reserve is doing its part by
providing accommodative monetary policy to promote a stronger economic recovery in a
context of price stability. As I have said before, however, while monetary policy can help
support the economic recovery, it is by no means a panacea for our economic ills. Currently,
uncertainties about the situation in Europe and especially about the prospects for federal
fiscal policy seem to be weighing on the spending decisions of households and businesses
as well as on financial conditions. Such uncertainties will only be increased by discord and
delay. In contrast, cooperation and creativity to deliver fiscal clarity - in particular, a plan for
resolving the nation's longer-term budgetary issues without harming the recovery - could
help make the new year a very good one for the American economy.