The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
P L EA S E NOTE: T HIS 7 PAGE S P EE C H TE XT IS U N D E R E M B A R G O UN T IL 8:3 0 a.m. TO M OR R OW , 5/9 U.C. Berkeley Center for Real Estate and Urban Economics For delivery May 9, 1995 PROSPECTS FOR THE CALIFORNIA AND U.S. ECONOMIES I. Good morning. Today I'm going to give you my views on the 1995 economic outlook for the nation and California. A. As I was thinking about my remarks, I came across an interesting cartoon. B. It accompanied a story about the economy, inflation, and the Fed. C. 1. In the cartoon, people in party hats were throwing streamers and having a great time. 2. But in the background, there lurked a shadowy monster. 3. About the only person who noticed the monster was a sort of non nondescript, worricd-looking figure in a business suit. I think you can guess at the interpretation. 1. D. The party-goers represent people enjoying the very cjuick pace of economic growth we've had for the last several years. a. After all, economic activity expanded by a robust 3 'A percent in 1993, b. and it registered an even stronger 4 percent in 1994. 2. The monster lurking in the background, of course, is the threat of inflationary pressures. 3. And that worried person is a somewhat unflattering portrait of your typical central banker. A cartoon like this raises some interesting issues. 1. One of the first ones that comes to a lot of people's minds is whether there really is something out there— a. 2. p:\pariy\crcuc\5-8-95.2 — namely, inflation— — or whether it's just the play of shadows. 1 E. II. As a representative of that worried figure, let me tell you what's on my mind as wc chart the course of U.S. monetary policy for 1995 and beyond. I'll start with a few key principles. A. First of all, keeping inflation at low and stable rates is important: 1. B. It's the primary way that monetary policy can contribute to achieving the maximum sustainable advance in the country's economic output and the people's standard of living. Second, monetary policy doesn't produce results instantaneously. 1. In fact, it can be a little like trying to steer a fifty-thousand ton tanker: a. 2. In monetary policymaking, this is known as the problem of "long"— and I might add— "variable lags." 3. It can take anywhere from a year and a half to three years for a monetary policy action to produce results on inflation. 4. This kind of time lag means that it's dangerous to wait until the problem shows up in the inflation data— by then we'd be too late. 5. Instead, we have to antidpate problems, a. C. p: \pany\c! euc\5 -8-95.2 by looking for signs that inflationary pressures are on the rise. This brings me to my third point: the pressures for higher inflation intensify the longer the economy operates beyond its bng-nin capacity to produce goods and services. 1. D. You move the wheel, but the ship doesn't start to make the turn for a couple of miles! Two of the basic guidelines to judge whether the economy is, or will be, exceeding its long-run capacity arc measures of a. its potential growth rate b. and the so-called "natural rate of unemployment." I'd like to take a few minutes to develop these two ideas, 2 1. bccause they’re at the heart of much of the Fed’s deliberation, a. 2. and yet they can't be pinned down to decimal point accuracy. I’ll start with a definition of the potential growth rate: It's the growth rate an economy is capable of sustaining in the long run. a. For the U.S., it appears to be in the range of 2 to 3 percent per year. b. The potential growth rate is determined by a lot of factors, (1) including population growth (2) and improvements in technology and productivity, (a) c. 3. Obviously, monetary policy has little impact on these factors, so it can't determine the potential growth rate; The second key factor underlying the inflationary risks in the economy is the so-called "natural rate of unemployment." a. This is the rate the economy can sustain in the long run, and it's determined by current technology, labor market size and composition, and so forth, in today's economy. (1) E. III. such as inventions and a more skilled workforce. Currently, most economists put it in the range of 53A percent to 63A percent. An important point to take away from what I've said so far is that the Fed doesn't decide 1. what the natural rate of unemployment is, 2. or what the potential growth rate of the economy is, 3. or what the lags in monetary policy are. 4. Even though we don't control them, we must take them into account in designing policies. Now, let me put this together and apply it to the current situation. p:\party\creue\5-8-95.2 3 A. As I've indicated, the economy has grown rapidly for the past three years— 1 2. This rapid growth was great when the economy had plenty of excess capacity coming out of the 1990 recession. B. But the rapid pace lasted so long that the economy now appears to be operating beyond its long-run capacity to produce goods and services. G. The unemployment rate has fallen from a peak of about l x/* percent to 53A percent, 1. which appears to be somewhat below the natural rate. D. Signs of strain are showing up in things like manufacturing capacity utilization rates. E. So the overall picture suggests that we've overshot capacity, 1. F. so that there’s excess demand for resources in today’s economy. As a result, inflation most likely will be on the rise in the future— 1. IV. well above the long-run potential rate. — unless the economy slows down a bit. In fact, the most recent data do indicate that the economy has started to take a ’’breather,” as it were. A. B. The first quarter numbers show that growth slowed substantially— from a 5 percent pace in the fourth quarter of 1994 to 23A percent. 1. The deceleration in spending was especially evident in housing and consumer durables. 2. Since both of these sectors are sensitive to interest rates, this is exactly where a slowdown induced by tighter monetary policy would be expected to show up. So far in the second quarter, we have only the April employment report, which suggested considerable weakness. 1. p:\pariy\creue\5-8-95.2 But we should keep in mind that monthly numbers tend to be very volatile. 4 C. 2. In addition, the Labor Department indicated that April's employment was held down by a potentially large seasonal distortion. 3. So the most we can say on this basis is that it looks like the economic slowdown has continued into this quarter. These developments are consistent with analysis at the San Francisco Bank, 1. D. V. which suggests that the tighter monetary policy put in place last year will have its main restraining effects throughout 1995. But let me emphasize a couple of important points. 1. Since we appear to have overshot capacity, we'll need moderate growth for more than just a quarter or two to avoid higher inflation. 2. In addition, it's the longer-run average rate of growth that the Fed will be focusing on, not any one quarter's performance. a. Real GDP growth tends to be volatile from quarter to quarter. b. So a sustained period in which economic growth averages a moderate rate (1) may include some individual quarters that are weak— as this one may be— (2) and others that are quite strong. Now, with the national economy slowing, people have been concerned about what's going to happen to California. A. Looking at the average historical pattern suggests that California's growth rate would probably moderate by about the same amount as the nation's. B. But California's current business cycle has been very unusual. C. p:\parry\crcue\5-8-95.2 1. The state has been "out of sync" with the national economy, 2. and that's affecting the dynamics of the state's recovery. California's economy got out of sync when it had to absorb severe shocks to sectors like defense, aerospace, and construction. 5 1. 1). E.. As a result, the state went into a deep downturn that lasted more than three times as long as the national recession. In addition, the recovery has been slow in building momentum. 1. According to the payroll employment numbers, California ranked 47th among the states in the number of jobs created over the past year. 2. And while California’s unemployment rate dropped about 1V2 percentage points in the last year, 3. it’s still well above the national rate. Data for the first quarter suggest several areas of weakness, in part reflecting the severe weather we've had. 1. 2. For example, compared to performance in the fourth quarter of 1994, a. construction employment fell almost half a percent, b. residential building fell off sharply, c. and January home sales were off 16 percent from December. Not only were builders and home buyers less active— a. F. G. Although the weather has cleared, I think we still need to view these first quarter figures with some caution, because California sunny or not— still faces a number of challenges. 'These include: 1. further cutbacks in defense and aerospace jobs, 2. problems with state and local budgets, 3. and the developments affecting trade with Mexico. But there also are definitely some positive features. 1. p:\parry\crcue\5-8-95.2 — but retail shoppers also pulled back, spending almost 3 percent less in January than December. For example, dynamic sectors— like business services, entertainment, and tourism, among others—are experiencing impressive employment gains. 6 2. H. These positive features have the potential to mitigate the impact of a slower national economy; 1. VI. Furthermore, the relatively high unemployment rate means that the state can expand without facing widespread bottlenecks in labor and product markets. and they help explain why the consensus forecast is for California to maintain a moderate pace of recovery in 1995. Let me conclude with a quick overview of the economic outlook. A. 1?. Overall, the Fed's actions to slow the national economy to a sustainable pace may be taking hold. 1. 1995 should show continued, but slower growth, 2. and that should help contain inflationary pressures. 3. Furthermore, the general feeling is that the California economy can continue to grow despite the national slowdown. These generally desirable trends don't mean, of course, that now the Fed can just sit back and relax. 1. The appropriate policy requires frequent re-assessment and re adjustment. C. However, the steps we've taken so far are consistent with our primary goal to foster stable, sustainable growth with low inflation. D. Finally, if we are to follow a course of gradually declining inflation in 1996 and beyond, we will need to maintain a firm grip on the policy lever. wc 1648 p:\parry\creue\5-8-95.2 7
@FedFRASER