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The Current State of the Economy
and a Look to the Future
(With Reference to William ‘Sidestroke’ Miles, W. Somerset
Maugham, Don Ameche and Kenneth Arrow)
Remarks before the Austin Headliners Club

Richard W. Fisher
President and CEO
Federal Reserve Bank of Dallas

Austin, Texas
November 10, 2009

The views expressed are my own and do not necessarily reflect official positions of the Federal Reserve System.

The Current State of the Economy and a Look to the Future
(With Reference to William ‘Sidestroke’ Miles, W. Somerset Maugham,
Don Ameche and Kenneth Arrow)

Richard W. Fisher
Thank you, Tom [Granger], for that kind introduction.
Coming in from the airport, I again saw that fabled bumper sticker calling on local voters to
“Keep Austin Weird.” It reminded me of the old saw that Washington is 10 square miles
surrounded by reality.
Austin might be justly proud to consider itself 272 square miles surrounded by normality. But I
know better. When I made my hapless run for the U.S. Senate in 1994, I managed to visit every
nook and cranny of this state. I know from personal experience that, thankfully, there is nothing
normal about Texas.
Take my wife’s family, for example. Her great-great grandfather was William Miles. He hailed
from Nip ’n Tuck, a little town near what is now Longview in East Texas. He served gallantly in
the Mexican Wars and then, after a substantial interlude, joined the 14th Regiment of the Texas
Unmounted Cavalry—they had no horses but they were proud Texans and called themselves
“cavalry” nonetheless—and went off to fight for the Confederacy. He had his arm shot off in
battle, was discharged and sent home. To get back, he swam across the Mississippi—no small
feat for a one-armed man. He is memorialized by the nickname “Sidestroke” in the family
annals. Old “Sidestroke” then walked back to Nip ’n Tuck to become a dirt farmer.
He arrived home broke; he could not immediately afford a mule, so until he could, he hitched a
plow to his six daughters—there was a seventh but she got smart, married a Yankee and was
promptly disowned. William Miles never spent a dime; he saved every penny he earned and
prospered handsomely. He died in 1910. His will instructed his executor to auction off all he had
accumulated—his house, his equipment, the works—so his net worth could be calculated in hard
currency.
All this is captured on his tombstone in the Gum Springs graveyard near Longview. His stone
records the dates of his and his wife Nancy’s births and deaths, and the dates of his service in
both the Army of the U.S.A. and the Army of Jefferson Davis. On the back of the stone, for all
the world to see, are carved the words “Value of my estate $44,378.34.” That’s nearly $1 million
in today’s dollars. That’s the good news. He died a rich man. The bad news is that his will
required his daughters to buy everything back that was sold in his estate sale.
You cannot tell me that Austin has a corner on the market for being “weird.”
Interesting as all of that is, I know you didn’t ask me to return tonight to regale you with the
legends and lore of my wife’s family. You asked me here to provide insight into something even
more resilient and more “weird” than William “Sidestroke” Miles—our economy. So let’s get
down to business.

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As you all know, the Federal Reserve’s principal monetary policymaking group, the Federal
Open Market Committee (FOMC), met last Tuesday and Wednesday. Our statement—released
like clockwork at the conclusion of every FOMC meeting precisely at 1:15 p.m. Central time—
summed up our collective wisdom: With a host of caveats, we noted that activity in the
American economy has continued to pick up and appears to be on the mend. Despite this
progress, however, we remain vigilant.
Let me explain why.
Just this spring, economic conditions were drastically different than they are today. We were
engaged in battle against an attack that ravaged our economy on four fronts. First: a collapse in
home building, the worst we’d seen since the Great Depression. Second: a reversal of wealth—
the worst decline in real or nominal terms that we can find in data that begin in 1952. Third: a
financial panic, complete with extreme risk aversion and a credit contraction in securities and
direct credit markets. And last but not least: a bank credit crunch.
A severe contraction had taken root beginning in the fall of 2008, and the Federal Reserve, as the
monetary authority of the United States, was duty-bound to do everything within its power to
mitigate the damage. Our task was no less than to drag the global economy abruptly and
forcefully from the edge of the abyss.
I believe we will be judged by history as having done so. Time will tell, of course. But this much
I know: The policy actions taken by the Federal Reserve, combined with the inherent resiliency
of the American economy, have helped us reverse the onslaught on three of those four fronts.
Despite deterioration in nonresidential construction, the housing sector appears to be stabilizing.
With regard to wealth, after plunging 24 percent in inflation-adjusted terms from mid 2007
through the first quarter of this year, net worth across all American households rose slightly in
the second quarter and will likely be found to have risen in the third. And, after surging to
incredibly high levels, interest rate spreads have returned to near-normalcy in the commercial
paper and mortgage markets and are returning to Earth in the bond market.
Efforts to free up bank credit have helped slow the pace at which banks have tightened their
credit standards. The latest reports we have received from bank lending officers, released just
yesterday, confirm this. However, with the lagging effects of loan quality problems, difficulties
in the commercial real estate market and uncertainty over regulatory reform, a full resuscitation
of bank credit has yet to take place and will take considerable time.
The progress we’ve made on each of these fronts is most certainly a welcome relief, but
questions remain. Where are we headed, and when will we get there?
As we closed out the summer, I pointed out in an interview with the Dallas Morning News that
there were good reasons to expect fairly strong output growth—what an economist would call
“above trend growth”—in the second half of this year.1 The reason? I like to call it the “Johnny
Mercer effect,” after the great Hollywood lyricist of the 1940s: Growth follows almost
automatically if you “ac-cen-chu-ate the positive and e-lim-i-nate the negative.”2
1
2

“Recession Over, Dallas Fed Chief Says, But Jobs Lag,” by Brendan Case, Dallas Morning News, Aug. 26, 2009.
“Ac-Cent-Tchu-Ate the Positive,” lyrics by Johnny Mercer and music by Harold Arlen, 1944.
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That’s essentially what we saw in the third quarter. Fixed investment flattened out and ceased to
be a drag on the economy, eliminating an important negative from the GDP calculus. Consumer
spending, which was neutral in the first half, became a strong positive. And exports and
inventory investment did a 180, flipping from sources of weakness to sources of strength.3
Now, I’ve often thought that economic forecasters seem to be cursed—or maybe blessed, I
suppose, dependent upon your point-of-view—with a short-term memory: They tend to
extrapolate only the most recent trends into the future. As if goosed by the more optimistic tone
of the latest GDP release, many now believe that solid output growth will extend into the first
half of next year. The latest Blue Chip survey, for example, shows that professional forecasters
expect GDP growth averaging 2.8 percent in the first half of 2010.
I am wary of the consensus view. For a good while now, I’ve suggested that we are more likely
to see a more uneven recovery—not a “V”-shaped recovery but something more akin to a check
mark, where the elongated arm of that check mark inclines at a slope that is less than desirable
and might possibly be repressed by an occasional pause or several quarters of weak growth.
Why a check mark?
Several recent sources of strength are likely to wane as we head into next year. Cash-for-clunkers
and the first-time-homebuyer tax credit have both shifted demand forward, increasing sales today
at the expense of sales tomorrow. Neither of these programs can be repeated with any real hope
of achieving anywhere near the same effect: The more demand you steal from the future, the less
future demand there is for you to steal. The general tax cuts and government spending increases
included in this year’s fiscal stimulus package won’t have their peak impact on the level of GDP
until sometime in 2010, but their peak impact on the growth of GDP has come and gone; the
fiscal stimulus continues to drive GDP upward, compared with what it would otherwise have
been, but the increments to GDP are beginning to shrink. And, as we all know, the shot in the
arm that our economy is receiving from inventory adjustments is, while welcome, inherently
transitory.
What about growth in the longer term—the second half of 2010 and beyond? American
households have finally come to realize that they’ve been playing the part of the grasshopper in
Aesop’s fable: They see that our previous spending boom was financed by somewhat reckless
disregard for tomorrow by over-eager creditors feeding their desire for unsustainable leveraging
of their income and balance sheets and, for the nation as a whole, by increases in overseas
borrowing. That reality has been largely absorbed, and consumer spending is growing again—
albeit from a lower base and at a slower pace. I doubt it will recover its previous vigor for some
time to come. I expect that the strong bounce-back in consumer demand that we’ve come to
expect in recoveries past will be absent this time around as Americans recalibrate the proportion
of their income and wealth that they need to save versus what they need to consume. We need

3

Exports did contribute almost 1.5 percentage points to growth in the third quarter, reversing a recent string of four
consecutive negative contributions—but net exports remained a drag.
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not become a nation as parsimonious as William Miles, but we are going to have to be more antthan grasshopper-like in our behavior.4
With a likely subpar showing from household spending, one other candidate as a source of
growth is government spending. We should be hesitant to become overly dependent on it. As
consumer credit conditions gradually improve, any boost the economy gets from growth in
government purchases will increasingly be offset by reductions in household spending—people
will save to meet a higher prospective tax burden.
Unfortunately, this prospect of an uneven and comparatively weak recovery—in combination
with excess capacity and uncertainty about the impact of new government initiatives and
regulation—is taking its toll on business confidence. Firms are hesitant to add plant and
equipment. In my surveys of corporate CEOs with significant capex wherewithal—a personal
survey I conduct religiously before every FOMC meeting—it appears that those who are
beginning to budget expanding plant and equipment are less inclined to do so here at home and
more interested in doing so abroad in areas they consider to have greater risk-adjusted profit
potential.
Most painfully, they remain hesitant to add labor. I’m sure you all saw the headlines last
Friday—despite a continuing decline in payroll losses and initial unemployment claims, the
jobless rate in this country has officially reached a 26-year high of 10.2 percent, not counting
those who have given up looking for work. Far fewer of you likely saw the latest numbers on
labor productivity: According to the Bureau of Labor Statistics release last week, nonfarm labor
productivity increased at an annualized rate of 9.5 percent in the third quarter. That is the highest
quarterly increase we’ve seen in six years.
What does this tell us? After a prolonged period of payroll growth, firms are using this downturn
to reorganize and retool. To control costs and preserve margins that can cushion the top line,
employers are learning to do more with less. They are squeezing all the productivity they can
from their employees. You can get a snapshot of this in the recent round of earnings releases by
the 453 of the S&P 500 companies that have reported third quarter performance thus far:
Earnings for these companies were down 10 percent year-over-year. But top-line growth—total
revenue growth—was down 14 percent. As long as this condition obtains, companies can hardly
be expected to add to payrolls.
This is not surprising if you think about it. Before the crisis, we had a long period of economic
expansion and easy access to money. Historically, the longer the expansion or period of
prosperity, the more complacent businesses become. A growing economy, like sailing in a
following sea and pleasant weather for days on end, weakens the discipline to run a tight ship.
But once a storm strikes, captains of industry have no choice but to batten down the hatches and
reef their sails. The more intense the storm, the longer it takes for the inefficiencies incurred
during the previous expansions to recede from memory, even after fair weather returns. I would
think that in this recovery period the willingness to rehire or expand capital expenditures will be
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Of course, there are alternative versions of Aesop’s fable. In 1924, W. Somerset Maugham wrote a story titled
“The Ant and the Grasshopper” about two brothers: one a hard worker and a saver and the other not. In the end, the
“grasshopper” brother marries a rich widow who ups and dies and leaves him a fortune. In the 1988 film Things
Change, the character played by Don Ameche recites a version where the grasshopper eats the ant.
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long in coming. Chastised by recent experience, businesses will continue to run tight ships, with
all resources, including labor, being driven to maximum efficiency.
It may be some time before significant job growth occurs and even longer before we see
meaningful declines in the unemployment rate.
So we have a mixed picture for economic growth down the road, despite the pickup we’ve seen
lately. What are the implications of all this for monetary policy?
With financial-market conditions normalizing—if not yet fully normal—most of the special
programs that the Federal Reserve introduced last winter to backstop bank and nonbank credit
have either already unwound or are rapidly doing so. For example, the special facility we put in
place to revive the commercial paper market when it succumbed to paralysis last year—a facility
that expanded our balance sheet by $350 billion at its peak usage level—has fallen to under $10
billion as the market has been restored. As to the longer-lived asset purchases we have made,
now that mortgage-finance spreads have narrowed, our purchases of mortgage-backed securities
(MBS) are tapering off. We expect those transactions—which will total up to $1.25 trillion—to
be executed by the end of next year’s first quarter.
A legacy of MBS acquisitions is a Fed balance sheet that has more than doubled in size. This
expanded balance sheet has as its counterpart a greatly elevated level of bank reserves. Banks,
seeking liquidity and avoiding risk, have so far been content to let their reserves sit at the Federal
Reserve, earning a modicum of interest. Ultimately, as confidence returns, these funds will be
used to support an expansion in bank lending, increasing the velocity of base money in our
economy. That would not necessarily be a bad thing, within limits, given all the idle resources in
the economy at present. Of course, the Fed must be wary that velocity does not explode and
create inflation pressures resulting from too much money chasing too few goods and services. If
credit growth at some point threatens to become excessive, we have the tools to rein it in,
ranging from selling the assets we have acquired so as to suck up excess money, to adjusting the
rate we pay on excess reserves, to utilizing other techniques such as large-scale reverse
repurchase agreements, or “repos,” to even raising the Fed funds rate.
The press and the markets are eager to know when we might undertake a tightening in policy.
The answer to this question is … “It depends.” Our mandate is to pursue the maximum level of
employment consistent with long-term price stability. So, when and how rapidly we reduce our
accommodative policy must depend on fine judgments about how quickly the real economy gets
back on track without jeopardizing our longer-run price-stability goal. As noted in our most
recent statement, the FOMC will consider a variety of economic indicators—including resource
slack, inflation trends and inflation expectations—when making this decision. But for the
foreseeable future, the FOMC considers policy to be appropriately calibrated to the times.
My own judgment—based partly on available estimates of slack, but also on the behavior of
prices, and informed by the anecdotal input I receive monthly from business leaders as to their
intentions—is that inflation is likely to remain subdued for some time, and thus our current
policy is appropriate. Of course, I recognize that our measures of slack and our understanding of
the determinants of inflation are uncertain. And agile business leaders can change plans on a
dime. Being what some believe to be the most hawkish member of the FOMC, I am very
Reagan-esque in my evaluation of inflationary potential: I trust but continually seek to verify that
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inflation is not raising its ugly head. So, as I’ve always done, I will keep a close eye on price
developments as they unfold.
Right now, I see more immediate deflationary pressures than inflationary ones. Yet I am fully
aware that the law of unintended consequences is always lurking in the shadows. For instance,
having spent a few years early in my banking career as a foreign exchange advisor to investors
and corporations, I am particularly mindful of the risks we run by stating in FOMC statements
that we expect to maintain the Fed funds rate at “exceptionally low levels” for “an extended
period.” This could fuel the “carry” trade, whereby speculators—assuming U.S. rates will remain
unchanged over a reasonable time horizon—can borrow plentiful amounts of dollars cheaply and
invest them in securities denominated in other currencies that yield more or offer greater returns,
in the process driving those securities and currencies to prices beyond their equilibrium levels.
Were this to become a disorderly influence, I would expect the FOMC and other authorities to
craft an appropriate remedy.
Tom, here is the bottom line: The Federal Reserve has done what it can to prevent Depression
2.0 and the deflation that one would have expected might accompany economic collapse. It will
take some time, in my opinion, to get back on a steady pathway to a pace of growth that will
result in significant job creation. We are in for a long slog. We had a snapback in growth in the
third quarter and can expect that will continue in the current quarter. But looking into 2010 and
perhaps to 2011, the most likely outcome is for growth to be suboptimal, unemployment to
remain a vexing problem and inflation to remain subdued.
Mind you, you should take economic forecasts—even my own—with a big grain of salt. Jamie
Galbraith’s dad, John Kenneth Galbraith, may have been more right than econometricians like to
think when he said that “the only function of economic forecasting is to make astrology look
respectable.”
Nobel Prize-winning economist Kenneth Arrow has his own perspective on forecasting. During
World War II, he served as a weather officer in the U.S. Army Air Corps and worked with
individuals who were charged with the particularly difficult task of producing month-ahead
weather forecasts. As Arrow and his team reviewed these predictions, they confirmed
statistically what you and I might just as easily have guessed: The Corps’ weather forecasts were
no more accurate than random rolls of a die.
Understandably, the forecasters asked to be relieved of this seemingly futile duty. Arrow’s
recollection of his superiors’ response was priceless:
“The commanding general is well aware that the forecasts are no good. However, he needs them
for planning purposes.”
Tom asked me to provide you tonight with my forecast for the economy. This evening, I have
done as asked, drawing upon the models and judgment of the Federal Reserve, which are among
the most complex and comprehensive in the world. But we cannot lose sight of the unfortunate
fact that, despite our best efforts, no one can precisely predict the future. While we know where
the economy has been and believe we understand the gearing of the economy as well as anybody
can, we cannot know with certainty where it’s headed. That said, I hope my musings this evening
have been better than “no good” and are of some assistance to you for your planning purposes.
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Thank you for listening. Now, in the tradition that is hallmark of Federal Reserve officials, I
would be happy to avoid answering any questions you might have.

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