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The First Phase of the U.S. Recovery James Bullard President and CEO Federal Reserve Bank of St. Louis Commerce Bank Economic Breakfast 18 November 2009 Any opinions expressed here are mine and do not necessarily reflect those of other Federal Open Market Committee members. Plan For This Talk The nascent recovery How to think about current monetary policy The regulatory reform debate The Nascent Recovery Forecasters See Growth Ahead Real Gross Domestic Product. Actual and forecasted, percent change from previous quarter at annual rate. Percent 10 8 6 4 2 0 -2 Real GDP Growth Nov-2009 BC Forecast Nov-2009 MA Forecast -4 -6 -8 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: Bureau of Economic Analysis, Blue Chip Consensus, Macroeconomic Advisers. Forces Driving the Recovery Stronger-than-expected global growth, especially in Asia. Recovering consumption expenditure in the U.S. Less stress in financial markets. A stabilizing housing sector. Global Growth is Improving Canada -3.4, 0.0, 5.0 U.S. -0.7, 3.5, 4.0 Latin America 1.7, 4.5, 5.2 U.K. -2.3, -1.0, 1.7 EU -0.7, 1.8, 2.0 Russia -2.2, 17.0, 13.7 China 16.4, 12.0, 9.6 India 8.0, 9.5, 9.0 South Africa -3.0, 0.0, 2.2 Japan 2.3, 1.9, 2.4 Australia 2.5, 2.0, 1.9 Growth Rate in Real GDP, SAAR, Percent 2009:Q2, 2009:Q3,2009:Q4 Source: Barclays Capital Global Economic Weekly. Manufacturing Around The Globe Is Improving Source: Financial Times and Thomson Reuters Datastream. U.S. Consumption Is Stabilizing Real Personal Consumption Expenditures (Monthly Data. Last observation: Sept. 2009) Billions of Chained 2005 Dollars 9400 9350 9300 9250 WTI crude oil price tops $100/barrel 9200 9150 9100 Lehman Brothers' collapse 9050 9000 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Source: Bureau of Economic Analysis. House Prices Are Stabilizing Three-month percent change, annual rates (Monthly Data. Last observation: Aug. 2009) Percent 25 Case-Shiller Composite 20 20 15 10 5 LP-HPI FHFA: PO 0 -5 -10 -15 -20 -25 -30 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: Loan Performance/FHFA/S&P. Housing Market Begins Recovery? SAAR, Thousands of Units 4-quarter percent change 2400 2200 Private Housing Starts (Left Axis) 2000 1800 1600 1400 1200 1000 800 Residential Investment (Right Axis) 600 400 200 0 1987 1988 1990 1991 1993 1994 1996 1997 1999 2000 2002 2003 2005 2006 2008 2009 60 50 40 30 20 10 0 -10 -20 -30 -40 Source: U.S. Bureau of the Census, U.S. Department of Commerce, and Macroeconomic Advisors. Civilian Unemployment Remains High… Percent Thousands 700 11 650 10 600 9 550 Unemployment Rate 500 450 400 350 8 Initial Claims for Unemployment Insurance (4-week Moving Average) 7 6 300 5 250 200 2007 4 2008 2009 Source: Bureau of Labor Statistics/Department of Labor. …But the Pace of Job Losses Has Slowed Nonfarm Payroll Employment Growth Change from previous month (Monthly Data. Last observation: Oct. 2009). Thousands 400 7.3 Million Jobs have been lost since December 2007 200 0 -200 -400 -600 -800 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Source: Bureau of Labor Statistics. Financial Markets and Inflation Credit Spreads Have Narrowed Bond Spreads to 10-Yr Treasury (Monthly data. Last Observation: Oct. 2009) Basis Points 800 700 BBB 600 500 400 AA 300 200 AAA 100 0 Jan-2007 Jul-2007 Jan-2008 Jul-2008 Jan-2009 Jul-2009 Source: Federal Reserve. Credit Default Swap Prices Are Improving Basis Points 1000 900 800 700 600 500 400 300 JPMorgan Chase Goldman Sachs Morgan Stanley Citi Bank of America Wells Fargo 200 100 0 2007 2008 2009 Source: Bloomberg. Equity Markets Are Improving Index Jan. 2007=100 120 Dow Jones U.S. Total Stock Market Index 100 80 60 S&P Financial Stock Market Index 40 20 0 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Source: Standard and Poor’s and Wall Street Journal. Inflation Remains Low… PCE Inflation 3-month percentage change 0.8 0.6 Headline PCE 0.4 Core PCE 0.2 0 -0.22000 2001 2002 2003 2004 2005 2006 2007 2008 2009 -0.4 -0.6 -0.8 Source: Bureau of Economic Analysis/Macroeconomic Advisers. … But Inflation Uncertainty is Elevated Percent, Constant Maturity 4 5 Year Forward 3 2 1 10 Year 0 -1 -2 -3 Jan-07 5 Year Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Source: Federal Reserve. Monetary Policy Three Parts to Current Monetary Policy Liquidity programs: lending on collateral to mitigate the panic. A near-zero interest rate policy. An asset purchase program, “quantitative easing.” Liquidity Programs Liquidity programs: lending on collateral to mitigate the panic. Standard central bank response to a financial crisis ... ... this time on a grand scale. The liquidity programs naturally taper off as the crisis recedes. Not an inflationary concern. Liquidity Programs Naturally Tapering Off Short-Term Lending to Financial Firms and Markets Billions $ 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 01/07 07/07 01/08 07/08 01/09 07/09 Near-Zero Policy Rates in the G-7 Rate (%) 6 U.K. 5 4 Canada 3 Euro Area 2 U.S. 1 0 Jan-07 Japan Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 A Near-Zero Policy Rate A near-zero interest rate policy Past two recessions: 2.5 - 3.0 years after the recession end before policy rate increases began. The “too low for too long” argument may weigh heavily on the FOMC this time. The market focus on interest rates is disappointing given quantitative easing. Composition of Federal Reserve Assets (Weekly Data. Last Observation: Nov. 11, 2009) Billions $ 3,000 2,500 2,000 1,500 Short-Term Lending to Financial Firms and Markets Rescue Operations Operations Focused on Longer-Term Credit Conditions Traditional Portfolio Traditional Portfolio and Long-Term Assets 1,000 500 0 01/07 07/07 01/08 07/08 01/09 07/09 01/10 The Asset Purchase Program The Committee announced an intention to buy up to $1.725 trillion in assets by 2010 Q1. Considered successful as quantitative easing. Causing a large and persistent increase in the monetary base ... ... and a medium-term inflation risk. The FOMC asset purchase program does not have a statecontingent character. Main issue: How to adjust the asset purchase program going forward and not generate inflation? Regulatory Reform Key Problem: Too Big To Fail “Too Big to Fail” is an intolerable situation which must be addressed. Large, complex, global institutions, many of which are not banks. One important idea: A resolution regime for large financial firms. Large S&P 500 Financial Firms (As of 2007:Q4) Firm Total Assets, Bill. (2007:Q4 ) Pct. of Tot. Assets in S&P 500 Fin. Cum. Percent Citigroup Inc. $2,187 10.9% 10.9% BHC Bank of America Corp. 1,715 8.5 19.5 BHC JPM Chase & Co. 1,562 7.8 27.3 BHC Goldman Sachs Grp. 1,119 5.5 32.9 BHC AIG 1,060 5.3 38.2 Insurance Morgan Stanley 1,045 5.2 43.4 BHC Merrill Lynch 1,020 5.1 48.5 Inv. Bank Fannie Mae 882 4.4 53.9 GSE FHL Mortg. 794 3.9 56.9 GSE Wachovia Corp. 782 3.9 60.8 BHC Type of Firm (2007: Q4) Large S&P500 Financial Firms (As of 2007:Q4) Firm Total Assets, Bill. (2007:Q4) Pct. of Tot. Assets in S&P 500 Fin. Cum. Percent Type of Firm (2007:Q4) Lehman Bros. 691 3.4 64.2 Inv. Bank Wells Fargo 575 2.8 67.1 Thrift MetLife Inc. 558 2.7 69.9 Insurance Prudential Financial 485 2.4 72.3 Fin. Adv./Ins. Hartford Financial Svcs. 360 1.8 74.1 Insurance Washington Mutual 327 1.6 75.7 Thrift U.S. Bancorp 237 1.1 76.9 BHC Countrywide Financial Corp. 211 1.0 78.0 Thrift Bank of NY Mellon Corp. 197 0.9 79.0 BHC Lincoln National 191 0.9 79.9 Insurance The Role of the Fed Discount window: The Fed needs to have a role in regulating institutions to which it may lend. Monetary policy: To be effective, the Fed needs to know the condition of the financial system through hands on regulatory involvement. Fed independence is vital in maintaining credible monetary policy. Federal Reserve Bank of St. Louis stlouisfed.org Federal Reserve Economic Data (FRED) research.stlouisfed.org/fred2/ James Bullard research.stlouisfed.org/econ/bullard/