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Emerging from Recession: Implications for Growth, Inflation, and Monetary Policy :: October 1, 2009 :: Federal Reserve Bank of Cleveland home | news & media | careers | site map FEDERAL RESERVE BANK o f CLEVELAND A bout U Tours For the Public News & Media Com munit y D e velopm ent S tream ing Media Forefront M agazine Speakers Bureau I Our IRegion I Research I Ban kin g I Learning Center Savings Bonds Home > For th e Public > News and Media > Speeches > 2009 > Emerging from Recession: Implications for Grow th,... [O s h a r e J VS > ...] Emerging from Recession: Implications for Growth, Inflation, and Monetary Policy Introduction W hen I la s t sp o k e in N ew York, d u rin g th e firs t q u a r te r o f la s t y e a r, th e w o rs t o f th e fin a n c ia l crisis w as s till a h e a d o f us. I’m d e lig h te d to b e a b le to s p e a k to you th is e v e n in g a b o u t th e c o n to u rs o f a re c o v e ry . Additional Information Sandra Pianalto P resident and CEO, Federal Reserve Bank o f Cleveland Market News International N ew York, N ew York October 1, 2009 In d e e d , th e m e d ia is fu ll o f s to rie s th e s e d ays a b o u t ho w th e ec o n o m y is e m e rg in g fro m re c e ssio n , an d w h e th e r w e w ill h a v e a Vsh a p e d , U -sh a p e d , o r W -sh a p e d re c o v e ry . I am n o t a big fa n o f using le tte r s to d e s c r ib e e c o n o m ic c o n d itio n s, b u t I do d e t e c t a s e n s e o f o p tim ism a b o u t th e e c o n o m y t h a t I w a s n o t h e a rin g a fe w m o n th s ag o . W ith o u t q u e s tio n , th is has b e e n a s e v e r e re c e ssio n . Its d e p th ca n b e m e a s u re d n o t ju s t by th e e c o n o m ic d a t a b u t also by th e pain it h as in flic te d on p e o p le a n d b u sin e sse s a c ro ss th e n a tio n . In my re m a rk s th is e v e n in g , I w ill c o m m e n t on c u r r e n t e c o n o m ic co n d itio n s, a n d I w ill e x p la in w hy I th in k o u r e c o n o m ic re c o v e ry w ill b e g ra d u a l a n d b u m p y . I w ill c o n c lu d e w ith so m e th o u g h ts on w h a t th is g ra d u a l p a th to re c o v e ry m ay m e a n fo r in fla tio n a n d m o n e ta ry policy. P le a se n o te t h a t th e v iew s I e x p re s s to d a y a r e my ow n an d do n o t n e c e s sa rily r e f le c t th e v iew s o f my c o lle a g u e s in th e F e d e ra l R eserv e S y stem . Economic Conditions are Improving, but This Recession Has Been Severe L e t’s s t a r t w ith a q u ic k look a t c u r r e n t e c o n o m ic c o n d itio n s . W e a re se e in g e a rly signs t h a t th e e c o n o m y is e m e rg in g fro m its s te e p d e c lin e . I am c e r ta in ly p le a s e d a n d e n c o u ra g e d to s e e th e s e signs. N early a y e a r ago, w h e n I sp o k e in C le v e la n d , I s e t o u t th e t h r e e c o n d itio n s t h a t I w o u ld n e e d to s e e as e v id e n c e t h a t o u r e c o n o m y is s ta rtin g to re c o v e r. F irst, b an ks w o u ld h a v e to beg in le n d in g to o n e a n o th e r a g a in , an d c r e d it m a rk e ts w o u ld h a v e to o p e r a te w ith o u t e x tra o rd in a r y in v o lv e m e n t fro m th e F e d e ra l R eserv e a n d th e T re a su ry . S eco n d , h o m e p ric e s w o u ld n e e d to s ta b iliz e . And th ird , th e v e ry low tra d in g v o lu m e s in th e p riv a te m a rk e ts fo r m o rtg a g e s, s tu d e n t lo a n s, an d a u to loans w o u ld h a v e to p ick up. A lthough w e s till h av e a long w ay to go, w e h av e s e e n so m e p ro g re ss r e c e n tly on all th r e e o f th e s e fro n ts . In te rb a n k le n d in g h as b e e n r e e s ta b lis h e d as fin a n c ia l in s titu tio n s h av e a c q u ire d m o re in fo rm a tio n http://www.clevelandfed.org/For_the_Public/News_and_Media/Speeches/2009/Pianalto_20091001.cfm[4/29/2014 2:00:03 PM] Emerging from Recession: Implications for Growth, Inflation, and Monetary Policy :: October 1, 2009 :: Federal Reserve Bank of Cleveland a b o u t th e h e a lth o f th e ir c o u n te r p a r tie s a n d re g a in e d c o n fid e n c e in o n e a n o th e r . W e h av e also s e e n a sig n ific a n t d ro p in LIBOR r a te s . C o n fid e n c e r e tu r n e d , in p a r t, as th e f e d e r a l g o v e rn m e n t a n d m any fin a n c ia l in s titu tio n s th e m s e lv e s to o k a c tio n s to b o ls te r c a p ita l on b a n k s’ b a la n c e s h e e ts . W e a r e o ff to a p ro m isin g s ta r t , b u t b ro a d e r c r e d it m a rk e t c o n d itio n s re m a in tig h t, a n d th e le v e l o f o v e ra ll le n d in g c o n tin u e s to c o n tr a c t. Also, so m e fin a n c ia l m a rk e ts an d in s titu tio n s s till h av e s u b s ta n tia l s u p p o r t fro m th e F e d e ra l R eserv e an d th e T re asu ry . On th e h o using f ro n t, a f t e r m o re th a n a y e a r o f d e c lin e s , all m a jo r in d ic e s o f h o using p ric e s h a v e r e c e n tly b eg u n to h e a d h ig h e r. W e h av e e v e n s e e n so m e g ro w th in n e w sin g le -fa m ily h o m e s ta r ts . Of c o u rse , th is has c o m e w ith c o n s id e ra b le g o v e rn m e n t s u p p o rt. T he f ir s t- tim e h o m e b u y e r ta x c r e d it has d raw n in n e w b u y ers, b u t m uch o f th e p u rc h a se a c tiv ity has b e e n c o n c e n tr a te d in le s s-e x p e n s iv e h o m e s. M ore g e n e ra lly , th e housing m a rk e t now d e p e n d s on a b ro ad a rra y o f s u p p o r t fro m th e f e d e r a l g o v e rn m e n t, an d it is n o t y e t c le a r h o w soon th e m a rk e t w ill b e a b le to s ta n d on its ow n f e e t. F inally, w e h a v e s e e n so m e lim ite d su c c e ss in th e m a rk e ts fo r a s s e tb a c k e d s e c u r itie s . A fte r tra d in g n e a rly c a m e to a h a lt fo r s e c u ritiz e d a u to m o b ile , c r e d it c a r d , a n d s tu d e n t loans la s t w in te r, tra d in g v o lu m e s h a v e im p ro v e d o v e r th e sp rin g a n d su m m e r, d u e in p a r t to th e su c c e ss o f th e T erm A sse t-B ac k ed L ending F acility , o r TALF. T h e se e n c o u ra g in g d e v e lo p m e n ts a r e having a p o sitiv e im p a c t on th e b r o a d e r e c o n o m y . I h av e no d o u b t e v e ry o n e in th is room w a s re lie v e d to s e e s e c o n d - q u a r te r GDP dow n by less th a n 1 p e r c e n t, a n d a t th is p o in t m o st p r iv a te - s e c to r f o re c a s ts sh o w a c tu a l gains in th ir d - q u a r te r GDP. I w o u ld n o t b e s u rp rise d to fin d t h a t w h e n w e look b a c k a y e a r fro m now , w e w ill s e e t h a t m id -su m m e r m a rk e d th e e n d o f th is re c e ssio n . B ut it is f a r to o e a rly to c e le b r a te . O ur e c o n o m y h as, w ith o u t q u e s tio n , ta k e n a sta g g e rin g blow . Even as th e se c o n d q u a r te r b eg an th is y e a r , it w a s f a r fro m c le a r t h a t o u r e c o n o m y w as a n y w h e re n e a r a tu rn in g p o in t, d e s p ite th e s u b s ta n tia l c o n trib u tio n o f m any in n o v a tiv e m o n e ta ry a n d fisc a l p ro g ra m s. My c o lle a g u e J a n e t Y ellen, p r e s id e n t o f th e F e d e ra l R e serv e Bank o f San F ran cisco , c o m p a re d th e e c o n o m y to a h o sp ita l p a t ie n t w ho w a s in th e in te n s iv e c a r e u n it an d o n ly g ra d u a lly sta b iliz in g . And m a k e no m is ta k e —o u r e c o n o m y w as in c r itic a l c o n d itio n . This has b e e n th e d e e p e s t re c e ssio n sin c e th e 1 9 3 0 s , w ith th e ec o n o m y p o stin g its s h a r p e s t six -m o n th d e c lin e sin c e th e e n d o f W orld W ar II. T h e ty p ic a l re c e ssio n e n d s in a little o v e r tw o q u a r te r s a n d g e n e ra lly re c o v e rs to p re -re c e s s io n le v els o f o u tp u t in a lit tle o v e r a y e a r . As of th e e n d o f th e se c o n d q u a r te r o f th is y e a r , th e c u r r e n t re c e ssio n has la s te d n e a rly se v e n q u a r te rs . Even w ith to d a y ’s e n c o u ra g in g signs, w e h av e a lo t o f g ro u n d to m a k e up b e f o r e w e e v e n g e t b a c k to th e le v els o f o u tp u t s e e n in 2 0 0 7 . For e x a m p le , p ay ro ll e m p lo y m e n t h as d ro p p e d by m o re th a n d o u b le th e ty p ic a l a m o u n t fo r an a v e ra g e re c e ssio n . T h e u n e m p lo y m e n t r a te , w h ich ty p ic a lly in c re a s e s less th a n 2 a n d a h a lf p e r c e n ta g e p o in ts in an a v e ra g e re c e ssio n , has a lre a d y risen a b o u t 5 p e r c e n ta g e p o in ts in th is re c e ssio n , an d it is likely to c o n tin u e to clim b h ig h e r. In a d d itio n , c a p a c ity u tiliz a tio n in o u r in d u stria l s e c to r is a t a 6 0 -y e a r low . O ur e c o n o m y has a c o n s id e ra b le a m o u n t o f sla ck , an d to s tr e tc h o u r m e d ic a l an a lo g y a b it f u r th e r , re c o v e ry fro m th is c ritic a l c o n d itio n w ill r e q u ir e a long c o n v a le s c e n c e . H ere is a n o th e r w ay to th in k a b o u t how m uch g ro u n d w e h a v e to re c la im . T h e o u tp u t g a p is th e c o n v e n tio n a l m e a s u re o f th e e c o n o m y ’s c u r r e n t le v e l o f a c tiv ity c o m p a re d w ith its p o te n tia l. T he http://www.clevelandfed.org/For_the_Public/News_and_Media/Speeches/2009/Pianalto_20091001.cfm[4/29/2014 2:00:03 PM] Emerging from Recession: Implications for Growth, Inflation, and Monetary Policy :: October 1, 2009 :: Federal Reserve Bank of Cleveland m o st p o p u la r m e a s u re is p ro d u c e d by th e C o n g ressio n al B udget O ffice. Using th e CBO’s a p p ro a c h , th e c u r r e n t o u tp u t g ap is m o re th a n 7 p e r c e n t w h ic h , a g a in , is th e la rg e s t g ap sin c e th e G re a t D ep ressio n . T h a t’s a big n u m b e r, b u t m an y re s e a r c h e rs an d p o lic y m a k ers h av e q u e s tio n e d rely in g on o u tp u t g ap s to fo rm u la te p olicy, b e c a u s e th e s e g ap s a r e in h e re n tly d iffic u lt to m e a s u re a n d a r e o f te n o v e r e s tim a te d . O ne c r itic a l p ro b le m is s e le c tin g th e a p p r o p r ia te p o in t—o r b e n c h m a rk —w h e r e th e e c o n o m y is p ro d u c in g a t its fu ll p o te n tia l. For e x a m p le , if w e look b a c k ju s t a f e w y e a rs to w h e n th e e c o n o m y w as hum m ing alo n g , i t m ay b e t h a t th e o u tp u t le v els th e n w e r e a rtific ia lly in fla te d an d u n s u s ta in a b le . If t h a t ’s tr u e , i t is u n lik ely th e e c o n o m y w ill soon re tu r n to th o s e lev els, an d th e fu ll p o te n tia l o f th e e c o n o m y m ig h t n o t b e as la rg e as th e o u tp u t le v els o f a fe w y e a rs ago. Also, tr e n d p ro d u c tiv ity g ro w th —a n o th e r key a s su m p tio n in th e o u tp u t g a p —is alw ay s ev o lv in g as a r e s u lt o f n e w te c h n o lo g ie s a n d b u sin ess p ra c tic e s . B ut it is h a rd to m e a s u re th e p ro g re ss o f u n d erly in g p ro d u c tiv ity tr e n d s u n til y e a rs a f te r th e f a c t. T h e se issu es, an d o th e r s , ra ise q u e s tio n s a b o u t th e siz e o f th e o u tp u t g ap . But p r e tty m uch an y d a t a on la b o r m a rk e ts a n d e c o n o m ic a c tiv ity p o in t to an e c o n o m y w ith a g r e a t d e a l o f sla ck . For su re , th is is a d iffic u lt tim e to b e in th e b u sin ess o f e c o n o m ic f o re c a s tin g . To p a r a p h ra s e o n e o f m y c o lle a g u e s , w e a r e looking a t f la w e d d a t a th ro u g h th e le n s o f im p e r fe c t m o d e ls. To tr y to c la rify m y p e rs p e c tiv e on th e ec o n o m y , I also sp e n d a lo t o f tim e ta lk in g w ith b u s in e s s p e o p le —th e h e a d s o f F o rtu n e 5 0 0 c o m p a n ie s , o w n e rs of sm a ll a n d m e d iu m -siz e d e n te r p r is e s , a n d CEOs fro m la rg e reg io n a l b an ks a n d sm a ll co m m u n ity b an k s. I c a n te ll you t h a t ac ro ss th e b o a rd , th e m ood o f my b u sin e ss c o n ta c ts is o n e o f c a u tio n an d u n c e r ta in ty . W hile b u sin e ss o w n e rs r e p o r t se e in g signs t h a t e c o n o m ic a c tiv ity has le v e le d o ff a f t e r a s te e p d e c lin e , th e d ro p -o ff in a c tiv ity in th e ir b u sin e sse s has b e e n so s e v e r e t h a t a n y c u r r e n t g ro w th is e a sily sw a llo w e d up by re m a in in g in v e n to rie s o r by sm a ll, in c re m e n ta l in c re a s e s in p ro d u c tio n . O bviously, m an y b u sin e sse s h av e c lo s e d , b u t m o st h av e r e d u c e d th e ir p ro d u c tio n le v els a n d h o u rs o f w o rk . B usiness o w n e rs r e p o r t t h a t th e y a r e using fu rlo u g h s a n d w ag e f re e z e s to h u n k e r dow n, w a itin g fo r th e e c o n o m y to re c o v e r, b u t m o st o f th e m w ill b e re a d y an d a b le to ra m p up o n c e d e m a n d re c o v e rs. This re a l-w o rld in fo rm a tio n su p p o rts m y co n c lu sio n t h a t th e a m o u n t o f re s o u rc e sla c k in th e e c o n o m y re m a in s s u b s ta n tia l. So, w h ile no o n e c a n b e c e r ta in a b o u t th e p re c is e siz e o f an y o u tp u t g ap , b o th d a t a a n d b u sin e ss re p o r ts in d ic a te t h a t th e c u r r e n t le v e l o f e c o n o m ic a c tiv ity re m a in s w e ll s h o r t o f its p o te n tia l. Economic Recovery Is Likely to Be Gradual and Bumpy W ith th is a m o u n t o f sla c k in th e ec o n o m y , w e w o u ld all like to s e e a s p e e d y re c o v e ry . U n fo rtu n a te ly , I e x p e c t th e r a te o f g ro w th in th e e a rly s ta g e s o f th e re c o v e ry to b e g ra d u a l an d b u m p y . I h av e se v e ra l re a so n s fo r th is v ie w . F irst, o u r fin a n c ia l sy ste m is s till f a r fro m h e a lth y . A fte r all, th e FDIC ju s t re v e a le d t h a t 4 1 5 b an k s a r e a t risk fo r fa ilu re , a n d th e l a te s t F e d e ra l R e serv e S en io r Loan O fficer O pinion Survey c o n tin u e s to r e p o r t e x tra o rd in a rily tig h t c r e d it co n d itio n s. And ju s t as b an k s a r e in th e p ro c e ss o f re p a irin g th e ir b a la n c e s h e e ts , so a r e c o n s u m e rs. W e h a v e s e e n an in c re a s e in th e sav ings r a te , a n d it a p p e a rs t h a t w e a r e m aking th e tr a n s itio n fro m a n a tio n o f s p e n d e rs to a n a tio n o f sa v e rs. Of c o u rs e , th is w ill b e a http://www.clevelandfed.org/For_the_Public/News_and_Media/Speeches/2009/Pianalto_20091001.cfm[4/29/2014 2:00:03 PM] Emerging from Recession: Implications for Growth, Inflation, and Monetary Policy :: October 1, 2009 :: Federal Reserve Bank of Cleveland b e n e fic ia l tr e n d in th e long ru n , b u t it p r e s e n ts so m e c h a lle n g e s fo r e c o n o m ic g ro w th in th e s h o r t run. W e all know t h a t th e e c o n o m y is s till losing jo b s a n d th e u n e m p lo y m e n t r a te is rising. T he la b o r m a rk e t d a t a re v e a l a la rg e le v e l o f u n d erly in g w e a k n e s s . A ccording to th e B ureau o f L abor S ta tis tic s , th e n u m b e r o f p e o p le losing jo b s has a c tu a lly d e c lin e d o v e r th e p a s t fe w m o n th s , b u t th e n u m b e r o f n e w h ires a n d jo b o p e n in g s has d ro p p e d e v e n m o re . U n fo rtu n a te ly , th e la b o r m a rk e ts w o n ’t sh o w an y la stin g p ro g re ss u n til b u sin e sse s h av e th e c o n fid e n c e to beg in hirin g a t a m o re n o rm a l r a te . F inally, th e im p ro v e m e n ts s e e n to d a y in so m e c r itic a l s e c to r s a r e tie d to s h o r t- te r m stim u lu s p ro g ra m s. A uto s a le s g o t a c le a r b o o s t from th e Cash fo r C lunkers p ro g ra m . In m y D istric t, th e e f f e c ts o f th is p ro g ra m a r e s till show ing up in h ig h e r a u to p ro d u c tio n , alo n g w ith in c re a s e d d e m a n d fo r s te e l a n d o th e r in p u ts . How long th e s e e f f e c ts w ill p e rs is t is u n c e r ta in , a n d it is s till f a r fro m c le a r w h e n n o rm al c o n s u m e r d e m a n d fo r a u to s w ill r e tu r n . S im ilarly, m y r e a l e s t a t e c o n ta c ts a r e c o n c e r n e d t h a t sa le s w ill d e c lin e o n c e th e f irs t-tim e h o m e b u y e r ta x c r e d it e x p ire s on D e c e m b e r 1. T h e se in c e n tiv e p ro g ra m s h av e b o o s te d o u tp u t in th e c u r r e n t q u a r te r —likely pulling a c tiv ity fo rw a rd in to th is y e a r —a n d le av in g a h ig h e r h u rd le fo r n e x t y e a r. W e c a n n o t b e s u re how m uch an y o f th e s e f a c to r s —o r o th e r s —w ill a f f e c t o u r re c o v e ry . B ut I th in k t h a t I am s a fe in p re d ic tin g t h a t th e r e w ill b e so m e bu m p s alo n g th e w ay . P e rh a p s th e s tr o n g e s t re a so n fo r a n tic ip a tin g a slo w re c o v e ry is th e h isto ry o f o u r p a s t re c o v e rie s . B ack in th e 1 9 5 0 s , re c e ssio n s te n d e d to b e s te e p , b u t also v e ry s h o r t, a n d th e e c o n o m y re b o u n d e d q uickly . R ecessio n s in la te r d e c a d e s , re g a rd le ss o f th e ir siz e , h ad m uch slo w e r re c o v e rie s . A slow re c o v e ry m ay, in p a r t, b e a s tr u c tu r a l f e a tu r e o f a n y c o m p le x m o d e rn econom y. My b u sin e ss c o n ta c ts re in fo rc e th e c a s e fo r a g ra d u a l a n d bum py re c o v e ry . T h ey r e p o r t t h a t th e y w ill b e v e ry c a u tio u s a b o u t ex p a n sio n p la n s, e v e n if t h a t m e a n s fo rg o in g so m e b u sin e ss o p p o r tu n itie s rig h t now . In an e f f o r t to c r e a t e e ffic ie n c ie s a n d le a n p ro c e ss e s, so m e p ro d u c e rs a r e in c re a sin g th e u se o f ju s t- in - tim e in v e n to rie s a n d m o re s p e c ia liz e d la b o r, a ll o f w h ich c o n tr ib u te to a s tr a te g ic e m p h a sis on c a u tio u s , le a n g ro w th . O bviously, I am n o t th e on ly o n e e x p e c tin g a g ra d u a l re c o v e ry . For e x a m p le , th e S urvey o f P ro fe ssio n a l F o re c a s te rs is ca llin g fo r GDP g ro w th o f rou g h ly 2 . 5 p e r c e n t n e x t y e a r a n d n e a rly 3 p e r c e n t in 2 0 1 1 . If th is tw o -y e a r f o r e c a s t p an s o u t, it w o u ld ta k e us u n til 2011 ju s t to g e t b a c k to o u r 2 0 0 7 le v e l o f e c o n o m ic a c tiv ity . A g ra d u a l re c o v e ry follow ing a s e v e r e re c e ssio n w o u ld s till le a v e th e e c o n o m y s h o r t o f m axim um s u s ta in a b le g ro w th fo r a c o n s id e ra b le p e rio d o f tim e . Inflation: An Uncertain Environment with Balanced Risks In th is u n c e rta in w o rld o f e n c o u ra g in g signs b u t p e r s is te n t e c o n o m ic sla ck , I s till g e t a sk e d q u e s tio n s a b o u t th e e m e r g e n c e o f in fla tio n . G iven my e x p e c ta tio n o f a g ra d u a l re c o v e ry an d given th e s h e e r a m o u n t o f sla c k in th e e c o n o m y , you m ig h t e x p e c t m e to c o n c lu d e t h a t in fla tio n is n o t a t all a risk, o r e v e n t h a t w e a r e a t risk fo r f u r th e r d isin fla tio n . B ut m y v iew s on in fla tio n a r e m o re n u a n c e d . E co n o m ists h av e d if f e r e n t v iew s on w h e th e r sla c k in th e e c o n o m y w ill lim it p ric e in c re a s e s , o r how re lia b le a n d la rg e th e c o r r e la tio n b e tw e e n o u tp u t http://www.clevelandfed.org/For_the_Public/News_and_Media/Speeches/2009/Pianalto_20091001.cfm[4/29/2014 2:00:03 PM] Emerging from Recession: Implications for Growth, Inflation, and Monetary Policy :: October 1, 2009 :: Federal Reserve Bank of Cleveland g ap s an d th e r a te o f in fla tio n a c tu a lly is. T h o se w h o re g a rd th e re la tio n s h ip as sig n ific a n t te n d to d is c o u n t th e p r o s p e c t o f rising in fla tio n , w h ile o th e rs say it is a m isle a d in g in d ic a to r a n d p o in t to th e 1 9 7 0 s , w h e n a la rg e o u tp u t g ap c o e x is te d w ith high in fla tio n . C h a rles G o o d h a rt, fo rm e rly o f th e Bank o f E ngland, o ffe rs o n e rea so n w h y th e re la tio n s h ip b e tw e e n th e o u tp u t g ap an d in fla tio n is su ch a c h a lle n g e to m e a s u re . He a rg u e s t h a t c e n tr a l b a n k a c tio n s to re d u c e in fla tio n w o u ld in h e re n tly w e a k e n th e c o rre la tio n s b e tw e e n in fla tio n an d th e o u tp u t g a p . T h e re a so n is t h a t c e n tr a l b a n k a c tio n s to slo w in fla tio n ty p ic a lly slo w th e r a te o f e c o n o m ic g ro w th , th u s in c re a sin g th e o u tp u t g a p . So, w h ile th e o u tp u t g ap m ig h t s till b e d a m p e n in g th e in fla tio n r a te , th e c e n tr a l b a n k ’s a c tio n s c a n lim it th e u se fu ln e ss o f th e o u tp u t g ap in p re d ic tin g in fla tio n . D esp ite all o f th e v ary in g o p in io n s a b o u t th e re la tiv e sig n ific a n c e of s la c k in th e e c o n o m y an d its e f f e c ts on in fla tio n , I do s e e ta n g ib le e v id e n c e su g g e stin g t h a t in fla tio n w ill re m a in s u b d u e d . W age p re ssu re s a r e b ein g h eld dow n in th is e n v iro n m e n t. In r e c e n t p ro d u c tiv ity r e p o r ts , u n it la b o r c o s ts h av e slip p e d in to n e g a tiv e te r r ito r y , a n d th e e m p lo y m e n t c o s t in d e x h as s te a d ily d e c lin e d sin c e th e re c e ssio n b e g a n . Also, e c o n o m is ts a t th e F e d e ra l R e serv e Bank o f C lev e lan d h av e p ro v id ed m e w ith tw o p a r tic u la r p ie c e s o f re s e a r c h t h a t h av e h e lp e d to g u id e m y in fla tio n p e r s p e c tiv e . O ne o f m y e c o n o m is ts, alo n g w ith his c o lle a g u e a t th e F e d e ra l R e serv e Bank o f A tla n ta , has b e e n e x a m in in g th e d e ta ile d p ric e d a t a by s p littin g th e c o n s u m e r m a rk e t b a s k e t in th e CPI a c c o rd in g to w h e th e r th e p ric e s fo r goods an d s e rv ic e s a r e stic k y o r fle x ib le . Sticky p ric e s, su ch as th e c o s t o f fo o d in r e s ta u r a n ts o r h a irc u ts —d o n ’t c h a n g e v e ry o f te n . B ut fle x ib le p ric e s, su c h as th e c o s t o f fo o d a t g ro c e ry s to r e s o r th e p ric e o f u sed c a r s —te n d to ju m p a ro u n d a lo t. S tic k y -p ric e goods a n d se rv ic e s a p p e a r to b e a p a rtic u la rly in fo rm a tiv e m e a s u re o f u n d erly in g in fla tio n tr e n d s b e c a u s e th e y p r e d ic t f u tu r e in fla tio n r a te s m o re re lia b ly th a n f le x ib le - p ric e goods an d se rv ic e s . T his an a ly sis show s t h a t th e in fla tio n r a te o f s tic k y -p ric e goods an d s e rv ic e s h as s h ifte d sh a rp ly lo w e r th is y e a r . This tr e n d p o in ts to s u p p re s s e d in fla tio n r a te s fo r th e n e x t f e w q u a r te rs . T h e se c o n d p ie c e o f re s e a rc h is a m o d e l o f in fla tio n e x p e c ta tio n s th a t d o e s n o t re ly on T re a s u ry In fla tio n - P r o te c te d S e c u ritie s, o r TIPS, to e s tim a te in fla tio n e x p e c ta tio n s . In ste a d , th is m o d e l e s tim a te s e x p e c te d in fla tio n using a c o m b in a tio n o f in fla tio n d a ta , n o m in al b o n d r a te s , su rv ey m e a s u re s o f in fla tio n e x p e c ta tio n s , a n d in fla tio n sw ap s. This m o d e l show s in fla tio n e x p e c ta tio n s h o ld in g s te a d y o v e r th e tw o - to te n - y e a r ra n g e . So, in th e n e a r te r m , re s o u rc e sla c k is likely to d e p re s s c o r e in fla tio n m e a s u re s , b u t o v e r th e m ed iu m te r m , s ta b le in fla tio n e x p e c ta tio n s w ill p lay a la rg e r ro le . N e v e rth e le ss, so m e p e o p le s till b e lie v e in fla tio n is a se rio u s risk b a s e d on th e e x p a n d in g U.S. fis c a l d e fic it an d th e u n p r e c e d e n te d a c tio n s ta k e n by th e F e d e ra l R e serv e . T h e se c ritic s p o in t to th e la rg e siz e o f th e F e d e ra l R e s e rv e ’s b a la n c e s h e e t, an d th e y q u e s tio n th e FOMC’s w illin g n ess to ra ise r a te s w h e n th e tim e c o m e s to do so . T h ey also c ite c o n c e rn s t h a t th e F e d e ra l R eserv e w ill su c c u m b to p o litic a l p re s s u re , a n d m o n e tiz e th e f e d e r a l d e b t. I h av e to te ll you t h a t I do n o t s h a re th e s e v iew s. As th e m in u te s of th e r e c e n t FOMC m e e tin g s re v e a l, a v a r ie ty o f to o ls a r e b ein g d e v e lo p e d to e n s u re " th a t policy a c c o m m o d a tio n c a n u ltim a te ly b e w ith d ra w n sm o o th ly a n d a t th e a p p r o p r ia te tim e ." W ith o u t going in to all o f th e d e ta ils , I b e lie v e t h a t th e F e d e ra l R e serv e has th e to o ls n e c e s sa ry to m a n a g e th e b a la n c e s h e e t, to m a k e an y n e e d e d c h a n g e s in s h o r t- te r m in te r e s t r a te s , a n d to e n s u re t h a t o u r p u rc h a se o f http://www.clevelandfed.org/For_the_Public/News_and_Media/Speeches/2009/Pianalto_20091001.cfm[4/29/2014 2:00:03 PM] Emerging from Recession: Implications for Growth, Inflation, and Monetary Policy :: October 1, 2009 :: Federal Reserve Bank of Cleveland T re a s u ry s e c u r itie s is c o n s is te n t w ith o u r d u a l m a n d a te o f p rice s ta b ility a n d m axim um s u s ta in a b le e c o n o m ic g ro w th . W hen th e tim e c o m e s to s t a r t rem o v in g o u r policy a c c o m m o d a tio n , I am c o n fid e n t t h a t w e h av e th e to o ls a n d th e w ill to g e t th e jo b d o n e. B ut th e m e re e x is te n c e o f in fla tio n c o n c e rn s m u s t b e ta k e n se rio u sly , if fo r no o th e r re a so n th a n to p r e v e n t in fla tio n a ry e x p e c ta tio n s from b ec o m in g a se lf-fu lfillin g p ro p h e c y . G iven t h a t in fla tio n e x p e c ta tio n s a r e c r itic a l in w a g e a n d p r ic e -s e ttin g d ec isio n s, an y s h ift in u n d erly in g e x p e c ta tio n s has th e p o te n tia l to s h if t th e re a liz e d r a te s o f in fla tio n . Any d e s ta b iliz a tio n o f in fla tio n e x p e c ta tio n s h as to b e tr e a t e d as a m o n e ta ry policy risk. U ltim a te ly , th e risk t h a t in fla tio n e x p e c ta tio n s co u ld b e c o m e u n a n c h o re d m u st b e b a la n c e d a g a in s t th e r e a lity o f o u r slo w e m e r g e n c e fro m th is s e v e r e re c e ssio n . It is n o t su rp risin g , th e n , th a t f o r e c a s te r s a r e u n c e r ta in a b o u t how , w h e n , o r if in fla tio n w ill d e v e lo p o v e r tim e . In th e S urvey o f P ro fe ssio n a l F o re c a s te rs , fo r e x a m p le , re s p o n d e n ts a r e a s k e d to p ro v id e th e ir PCE in fla tio n o u tlo o k f o r th e f iv e -y e a r p e rio d o f 2 0 0 9 to 2 0 1 3 . A lthough you c a n s e e a fe w a v e ra g e a n n u a l in fla tio n f o re c a s ts as low as 1 p e r c e n t, an d a f e w as high as 4 p e r c e n t, th e m e d ia n re sp o n se is 2 p e r c e n t. I fin d it re a ssu rin g t h a t th e c e n tr a l te n d e n c y o f th e s e f o re c a s ts is in th e ra n g e o f 1 .7 p e r c e n t to 2 p e r c e n t—w h ich is c o n s is te n t w ith FOMC m e m b e r s ’ p r o je c tio n s fo r in fla tio n o v e r th e lo n g e r run c o n s is te n t w ith a p p r o p r ia te m o n e ta ry policy. Conclusion T h e fin a n c ia l crisis o f th e p a s t tw o y e a rs h as b e e n a h u m bling e x p e r ie n c e fo r m e as a F e d e ra l R e serv e p o lic y m a k er. N ee d less to say, th e p a s t tw o y e a rs h av e re in fo rc e d th e f a c t t h a t n o n e o f us ca n p r e d ic t th e f u tu r e w ith c e r ta in ty . W e h av e lived th ro u g h a b ru ta l re c e ssio n t h a t is on ly ju s t s ta r tin g to lo se its grip on th e e c o n o m y , an d I do n o t e x p e c t to s e e a q u ic k tu r n a ro u n d . O ur e c o n o m y m u st c o n te n d w ith a fra g ile fin a n c ia l sy ste m , a c o n s u m e r s e c to r t h a t is m o re in c lin e d to sa v e th a n to s p e n d , a la b o r m a rk e t w e a k e n e d by a lack o f b u sin e ss c o n fid e n c e , a n d th e re m o v a l o f m an y g o v e rn m e n ta l s u p p o rts fo r th e ec o n o m y . I e x p e c t to s e e a g ra d u a l an d bu m p y re c o v e ry as o u r ec o n o m y a d d re s s e s th e s e c h a lle n g e s . Still, d e s p ite so m e c o n c e rn s t h a t in fla tio n w ill b e u n le a s h e d fro m its a n c h o rs, I b e lie v e t h e r e is e n o u g h sla c k in th e e c o n o m y to k e e p in fla tio n s u b d u e d fo r so m e tim e . In th is e n v iro n m e n t, I b e lie v e t h a t m a in ta in in g th e c u r r e n t a c c o m m o d a tiv e p o licy s ta n c e h elp s to f o s te r b o th th e c o n tin u e d re c o v e ry o f o u r w e a k e n e d e c o n o m y a n d th e s ta b iliz a tio n o f in fla tio n r a te s a t le v els c o n s is te n t w ith p ric e s ta b ility . Even so, th is c o m p le x e c o n o m ic e n v iro n m e n t m ak es it im p o r ta n t to b e re a d y to r e a c t to evolving c irc u m s ta n c e s as n e c e s sa ry . T h e F e d e ra l R e se rv e ’s d u a l m a n d a te c o m p e ls us to b e e v e r-v ig ila n t a g a in s t in fla tio n a ry p re ssu re s , an d to e n s u re o u r a c tio n s p ro m o te s u s ta in a b le e c o n o m ic g ro w th in th e c o n te x t—a n d o n ly in th e c o n te x t —o f p ric e s ta b ility . Careers | Diversity | Privacy | Terms of Use | Contact Us | Feedback | RSS Feeds http://www.clevelandfed.org/For_the_Public/News_and_Media/Speeches/2009/Pianalto_20091001.cfm[4/29/2014 2:00:03 PM]
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