William C Dudley: The road to recovery - Puerto Rico and the mainland
Remarks by Mr William C Dudley, President and Chief Executive Officer of the Federal
Reserve Bank of New York, at the E-3 Summit of the Americas: Export Trade Basics
Forum 101, San Juan, Puerto Rico, 1 April 2011.
* * *
Good morning. I am pleased to be back in Puerto Rico to speak to you and meet with various
communities in the Commonwealth. Each visit gives me a chance to deepen the Bank's
relationship with the island. Last year I visited La Cantera and met with community leaders,
business people, academics, bankers and government officials. This year I visited Goya
Foods - the oldest Hispanic-owned plant in our country with subsidiary facilities in my home
state, New Jersey, and upstate New York. I will also meet with a similar wide range of people
to talk about what we do and to hear first-hand the economic and financial issues important
to Puerto Ricans so that I can best represent all my constituents in my work at the Fed. Your
beautiful island is unique within the Second Federal Reserve District. For me, personally,
being here also recalls special memories of my childhood visit with my parents.
I thank the organizers for inviting me to speak at the Export Trade Basics Forum, to help kick
off the week-long summit on Education, Exports and Entrepreneurship that begins next
week. This morning I will talk about economic conditions in the mainland and in Puerto Rico,
paying particular attention to the developments since my visit last year and to the role of
exports. As always, what I have to say reflects my own views and not necessarily those of
the Federal Open Market Committee (FOMC) or the Federal Reserve System.
Introduction to the New York Fed
By way of introduction, let me start with a synopsis of what the New York Fed is, what we do,
and what makes my job so interesting.
The New York Fed is part of the Federal Reserve System, America's central bank, which
was created by Congress in 1913. With this act, Congress delegated to the Fed System its
constitutional authority to manage the supply of money in the nation's economy. Congress
designed the central bank to be decentralized, representative of all regions of the country
- including Puerto Rico and the Virgin Islands - and independent of the political process.
The Fed System is comprised of the Board of Governors in Washington, D.C. - a federal
agency currently led by Chairman Ben Bernanke - plus 12 regional Reserve Banks that span
the country. For example, the district overseen by the New York Fed includes all of New
York, the 12 northern counties of New Jersey; Fairfield County, Connecticut; Puerto Rico and
the U.S. Virgin Islands.
Each Reserve Bank is distinct, with its own charter and a board of directors drawn from its
district, but overseen by the Board of Governors. The law that created the Federal Reserve
made the central bank independent so that policymakers could make decisions about
monetary policy - such as whether to adjust interest rates - in the national interest,
somewhat insulated from political pressure. However, the Fed is accountable to Congress.
Congress has set an explicit objective for monetary policy: To pursue the highest level of
employment consistent with price stability. This objective is often referred to as our "dual
mandate," because it combines two goals: high employment, and low and stable inflation. In
order to promote these objectives, we also pay close attention to financial stability, because
without financial stability, it is very hard to achieve our goals for jobs and inflation.
The FOMC consists of the Board of Governors plus the presidents of each of the 12 district
Banks. It meets in Washington, D.C., eight times per year to deliberate and vote on monetary
policy. As the current New York Fed president, I am vice chairman at these meetings. At
these meetings, each committee member presents his or her current outlook for the
economy. For these assessments, we augment input from our research departments with
critical information about local economic conditions supplied by our boards of directors,
regional advisory councils and conversations with local stakeholders. My visit to Puerto Rico
today is a part of these regional activities, in which I learn first-hand about the economic and
financial conditions important to Puerto Ricans.
One thing that makes my job even more interesting is that New York has some roles unique
within the Fed. For example, the New York Fed is the Reserve Bank charged with
implementing monetary policy. This means that at the direction of the FOMC, we buy and sell
Treasury securities. We are also the eyes and ears of the Fed on Wall Street, and we
supervise many of the largest financial institutions in the country. We operate Fedwire® - the
conduit for large money transfers between banks. And, we provide banking services to the
U.S. Treasury, and central banks and governments from around the world.
Finally, I must mention that the New York Fed's district could be the most diverse in the
System: ranging from the urban density of New York City to the forested sparseness of the
northern Adirondacks, to here in the Caribbean island of Puerto Rico. All in all, there is a lot
to keep my colleagues and me quite busy - even in normal times.
U.S. economic outlook
Now, what is the outlook for economic activity, employment and inflation on the mainland? In
particular, what are the areas of vulnerability that we should be most concerned about?
I am pleased to say that the economic outlook for the mainland has improved in the past six
months. Despite this, we are still very far away from achieving our dual mandate of maximum
sustainable employment and price stability. Faster progress toward these objectives would
be very welcome.
On the activity side, a wide range of indicators show a broadening and strengthening of
demand by households and production by firms. For example, on the demand side, after an
unusually deep retrenchment during the recession, consumer spending has begun to
recover, and that recovery strengthened considerably in the final months of 2010. Not
surprisingly, businesses' orders and production are following suit.
These factors led to a 3.1 percent growth rate in our most comprehensive measure of
national output (real, or inflation-adjusted, gross domestic product or GDP) in the fourth
quarter of 2010. Growth for the first quarter looks likely to be similar, near 3 percent. In my
view, the revival in demand and production - while not as strong as desired - suggests that
we may be much closer to establishing a virtuous circle that will support stronger growth.
What I have in mind is a cycle in which rising household and business demand generate
more rapid income and employment growth, which in turn bolsters confidence and leads to
further increases in spending. This is why we upgraded our assessment of the economy at
last month's FOMC meeting, noting the economy is now on a "firmer footing". The major
missing piece of the puzzle has been the absence of strong payroll job growth. We will need
to see sustained strong employment growth in order to be certain that this virtuous circle has
become firmly established.
With respect to the labor market, we have seen some conflicting signals. On one hand, the
unemployment rate has fallen sharply over the past four months, dropping to 8.8 percent
from 9.8 percent in November. On the other hand, payroll employment gains have been
relatively modest.
The good news is that the data on payroll employment for the past two months was better
than for the prior months. The economy added a notable 216,000 jobs in March. Particularly
encouraging is the growth of manufacturing jobs. Over the past year we have added factory
jobs at the fastest pace since the 1990s. Other labor market indicators, such as initial claims
for unemployment insurance benefits and the employment components of both
manufacturing and nonmanufacturing business surveys have also shown improvement
recently.
Although there is still uncertainty over the timing and speed of the labor market recovery, I
am hopeful that job growth will increase more rapidly in the coming months. We would
welcome this. A substantial pickup is sorely needed. Even if we were to generate growth of
300,000 jobs per month, we would still likely have considerable slack in the labor market at
the end of 2012.
So, why is the economy finally showing more signs of life? In my view, the improvement
reflects three developments.
First, household and financial institution balance sheets continue to improve. On the
household side, the 2008-09 rise in the saving rate appears to have stabilized in the
5 percent to 6 percent range. Meanwhile, the amount of money that households need to
service their debt (for mortgages, cars, credit cards) has fallen sharply to levels that prevailed
during the mid-1990s. Debt service has been pushed lower by a combination of debt
repayment, refinancing at lower interest rates and debt write-offs. Financial institutions have
strengthened their balance sheets by retaining earnings and by issuing equity. Bank lending
standards, while still tight, have begun to ease somewhat. As a result, some measures of
bank credit are beginning to expand again.
Second, monetary policy and fiscal policy have provided support to the recovery. On the
monetary policy side, we at the Fed have maintained unusually low levels of short-term
interest rates and engaged in large-scale asset purchases. These measures have fostered a
sharp improvement in financial market conditions. On the fiscal side (that is, government
spending and taxation), the economy has been supported by the shift in policy to help
support growth. In particular, the temporary reduction in payroll taxes could have a strong
impact on growth during the first part of this year.
Third - and very much linked to the topic of this meeting - is growth abroad. Much of the rest
of the world - especially the emerging market economies - have been growing strongly. This
growth has led to an increase in the demand for U.S.-made goods and services. Over the
four quarters of 2010, real, or inflation-adjusted, exports rose 9.2 percent. All told, real
exports accounted for about 40 percent real GDP growth in 2010. In a few moments, I will
talk about how this growth abroad also presents an opportunity for Puerto Rico.
The firming in economic activity, in short, is due both to natural healing and past and present
policy support.
In this regard, it is important to emphasize that we at the Federal Reserve have been
expecting the economy to strengthen. We provided additional monetary policy stimulus via
the asset purchase program to help ensure that the recovery regained momentum. A
stronger recovery with more rapid progress toward our dual mandate objectives is what we
have been seeking. This is welcome and not a reason to reverse course.
Yet, we must not be overly optimistic about the growth outlook. The coast is not completely
clear - the healing process in the aftermath of the crisis takes time and there are still several
areas of vulnerability and weakness. In particular, housing activity remains unusually weak
and home prices have begun to soften again in many parts of the country. State and local
government finances remain under stress, and this is likely to lead to further spending cuts,
tax increases, or job losses in this sector that will offset at least a part of the federal fiscal
stimulus.
Moreover, in recent weeks we have experienced several shocks from abroad that could have
some impact on the economy's forward momentum, at least in the short term. For example,
higher oil prices cut into household purchasing power, and the tragedy in Japan is leading to
supply disruptions that may dampen growth somewhat in the near-term. Also, conditions in
Japan, the Middle East and North Africa remain uncertain and could worsen, with negative
implications for global economic growth. Furthermore, we cannot ignore the risks stemming
from the longer-term fiscal challenges that we face in the United States.
But in the near-term, the most immediate domestic problems may recede rather than
become more prevalent. On the housing side, stronger job growth should lead to more
household formation. For example, more young people will be able to move out of their
parents' homes when they get jobs. This trend should provide more support to housing
demand. On the state and local side, a rising economy would boost sales and income tax
revenue, and help narrow near-term fiscal shortfalls.
We also need to remain watchful to ensure that low interest rates do not foster a buildup of
financial excesses or bubbles that might pose a medium-term risk to both full employment
and price stability. In this regard we monitor interest rates on risky and safer assets. An
unusual narrowing of these differences could signal that risk is not being appropriately
assessed. These differentials for risk on U.S. assets in general do not seem obviously
compressed today.
On the inflation side of the ledger, the risk of deflation is greatly diminished. At the moment,
both total, or headline, inflation and core inflation, which excludes the volatile food and
energy prices, have increased but remain below levels consistent with our dual mandate
objectives - which most members of the FOMC consider to be 2 percent or a bit less on the
personal consumption expenditures measure. Moreover, the rise in commodity prices is likely
to put further upward pressure on headline inflation in the coming months. Provided
commodity prices level off around current levels, the effect on inflation should be transitory.
But we will need to ensure that commodity price pressures do not cause inflation
expectations to become unmoored. If that were to occur, it would be more difficult to keep
inflation in check.
To sum up, economic conditions have improved in the past year. Yet, the recovery is still
tenuous. And, we are still far from the mark with regard to the Fed's dual mandate. In
particular, the unemployment rate is much too high.
Economic conditions in Puerto Rico
Now let me turn to economic conditions in Puerto Rico. In contrast to the situation during my
last visit, I am pleased to see signs that the Commonwealth may finally be emerging from
this painful recession. Nevertheless, conditions remain difficult for many families.
The recession here has been deeper than the downturn on the mainland. By mid-2010, total
employment in Puerto Rico had fallen by 13 percent or 138,000 jobs from its peak in 2005.
This is almost double the 7 percent job loss on the mainland from the employment peak to its
trough. Furthermore, the recession in Puerto Rico has lasted about five years - three times
as long as the mainland downturn. The recovery has also lagged that of the mainland. While
the mainland's economy began to recover in mid-2009, Puerto Rico's economy continued to
decline for another year.
But, since mid-2010 there have been promising signs: Recently released revisions suggest
that job growth on the island, while still very weak, improved modestly since last summer.
And most of the weakness since then has not been broad-based, but instead concentrated in
construction and manufacturing. The unemployment rate has come down by a full
percentage point since its peak. However, at just over 16 percent, it remains unacceptably
high.
Inflation generally remains subdued on the Commonwealth - although there has been some
recent volatility. After a period of falling prices in 2009, inflation picked up in December 2009
with annualized rates of around 4 percent for a few months - with medical care a key driver
for these increases. Since June 2010, reported inflation rates have reverted to a range
between 1 percent and 2 percent. However, the rise in food and energy prices is likely to
push inflation somewhat higher over the next few months.
To help keep track of conditions in Puerto Rico, we can now look at the Institute of Statistics'
new Manufacturing Purchasing Managers Index (PR-PMI), which is conducted in conjunction
with the Puerto Rico Manufacturers Association and Scotiabank. The survey shows that
business conditions on the island were steady in January, following improvement at the end
of 2010. The PR-PMI has signaled growth for seven of the past nine months. It will take
some time before this new index has a clear track record, but we welcome this source of
timely information on economic activity in Puerto Rico.
Now, what about credit conditions in Puerto Rico: how much debt do families have and how
have they been doing in terms of meeting their obligations? I needn't tell you how important it
has been to monitor these trends over the course of the Great Recession. Using a new
source of information - the New York Fed's Consumer Credit Panel - we can now track how
families in the mainland and Puerto Rico have managed their credit in recent years.
Overall, compared with the mainland, Puerto Ricans avoided much of the recent boom and
bust in the use of household credit. Yet, signs of distress are readily apparent, owing to the
long and deep recession here. Unlike the mainland, households on the island did not raise
their borrowing much in the run-up to the recession. Thus, it is not surprising that Puerto Rico
did not see the sharp spike in loan delinquencies that many areas saw from late 2007 to
early 2009. Instead, Puerto Rico's delinquencies on household debt - that is, the proportion
of debt where payments are 90 or more days late - have risen gradually as the recession
has persisted. In 2005, households were behind on about 5 percent of the total debt. As of
2010, they were delinquent on about 9 percent of the debt, about the same as the national
average - reflecting the stress imposed on many families by the deep and long recession.
The outlook and exports
Looking ahead to the rest of 2011, I see grounds for cautious optimism. In particular, exports,
which have been so important to the economic recovery on the mainland, have the potential
to contribute to growth here in Puerto Rico as well.
Currently, Puerto Rico runs a sizeable trade surplus, selling more products to the world than
it buys. In 2009, the latest year for which full-year data are reported, the value of exports was
roughly $60 billion compared with roughly $40 billion of imports. Based on data through
November, exports grew briskly, by about 10 percent, in 2010.
What does Puerto Rico export? Pharmaceuticals are by far the island's largest export. In
addition, Puerto Rico is a successful exporter of medical equipment, computer and electronic
products, and electrical equipment.
The mainland is Puerto Rico's primary trading partner, accounting for half of the island's
imports and three-quarters of its exports. There are many reasons for this. While Puerto Rico
interacts with many other economies, for generations the mainland United States and Puerto
Rico have had a special multifaceted economic relationship. One of the most obvious of
these ties is the free flow of goods between the mainland and the island. Another link is our
common use of the dollar. This means that tourists from the mainland can visit without
worrying about changing currencies. In addition, businesses can make long-term
investments in Puerto Rico without worrying that currency fluctuations against the dollar will
undermine their competitiveness.
The island runs a surplus with the mainland that accounts for much of the island's overall
surplus. So the signs of a further pickup in economic growth on the mainland bode well for
the island.
Puerto Rico's export markets also extend overseas. Aside from the U.S. mainland, the top
export markets for the Island are Germany, Netherlands, Belgium and Spain. Exports to
these four countries combined exceeded $11 billion in 2009 and have grown by more than
30 percent since 2007.
The success that Puerto Rico has in selling its goods and services to industrialized countries
bodes well for the island's future. As more emerging economies narrow the gap between
themselves and the more developed countries, the market for Puerto Rico's goods could well
expand accordingly. Going forward, I would not be surprised to see Puerto Rico's exports
rise further as your companies take advantage of the opportunities presented by the rapidly
emerging economies.
At your upcoming forum and summit, you'll learn more about how to develop export markets
for your products. I applaud your efforts to do so, as an important component of sustaining
the vigor of the economic recovery in Puerto Rico.
The long view and the New York Fed's role
Although the signs I've mentioned suggest that the recession is over, the road to sustained
economic growth is likely to be challenging in the near term.
In its favor, Puerto Rico has some important intrinsic advantages. These include natural
beauty, a hospitable climate and unique status as a major U.S. economic and population
center in the Caribbean. Perhaps just as important, the island has a relatively well-educated
workforce. Research shows quite convincingly that abundant human capital is an important
ingredient for a thriving economy.
We at the New York Fed aim to do our part to help sustain growth in the Commonwealth. For
example, we co-sponsor a financial awareness video competition for college students here
and the Community Reinvestment Act Week activities with the Puerto Rico Bankers
Association. And, as a member of the Alliance for Economic and Financial Education we
promote economic and financial education via teacher training, a high school economic
competition, and a speaker series. The New York Fed also has several ongoing programs of
technical assistance in Puerto Rico. We partnered with other organizations throughout the
year to help provide technical training for community development professionals. We cover
the costs of two to three professors who are engaged in macroeconomic and monetary policy
research to attend our annual symposium on current economic conditions held at the New
York Fed.
We also recognize that a healthy banking system and accurate economic statistics are both
important components of a favorable business climate. To improve our understanding of the
Puerto Rican economy, the New York Fed joined a group of local businesses to sponsor and
fund a household survey, undertaken by the Center for the New Economy to benchmark
Puerto Rican consumer finances. To help businesses and government in Puerto Rico, we
have also been providing technical assistance to Puerto Rico's new Institute for Statistics in
launching the new monthly manufacturing survey I mentioned earlier. We applaud this and
other efforts to improve the measurement of economic conditions in Puerto Rico.
As a financial regulator, the New York Fed works to help the financial system run smoothly
so that it can support economic growth. We are working hard to prevent the type of financial
crisis that we recently experienced from recurring in the future, in a way that does not inhibit
businesses from growing and prospering.
We are working closely with all of the banking supervisors and other key parties to facilitate
an effective resolution to the problems facing the island's banking sector. Last year, some of
Puerto Rico's banks were consolidated and many improved their balance sheets by selling
underperforming assets. Both of these steps are likely to produce stronger, healthier
institutions more able to make the sound lending decisions that support economic growth.
All of these activities, ranging from effective monetary policy and prudent financial regulation
to fostering economic literacy and measurement, complement and reinforce each other to
help support a strong economy in Puerto Rico.
Conclusion
To sum up, the mainland economy experienced a pick-up in activity during the second half of
2010 that shows signs of continuing in 2011. The recovery in Puerto Rico has taken longer to
get off the ground, but now shows signs of firming. On the mainland and in Puerto Rico,
unemployment remains stubbornly high, but many indicators suggest that conditions are in
place for stronger employment growth in the coming months.
With government and business leaders like yourselves working together to build a better
future for Puerto Rico, I am hopeful that we will soon be able to look back at 2010 and see
not only the end of the island's long recession but also the beginning of an era of growth and
prosperity for Puerto Rico.
Thank you for your kind attention. I would be happy to take a few questions.