WASHINGTON (MNI) – The following is the second and final section of
the text of Atlanta Federal Reserve Bank President Dennis Lockhart’s
remarks prepared for the Pensacola West Suburban Rotary Club Thursday:
Greece
A third concern arises from the daily headlines, and this is Greece
and the European Union’s (EU) handling of the Greek fiscal crisis. The
news has alternated between comforting and disquieting almost on a
day-to-day basis. The Greek sovereign debt story is a concern because it
feeds anxiety about another shock to the global banking
system-particularly European banks-as well as the potential of a broad
retreat from sovereign debt exposure affecting interest rates and
recovery prospects here in the United States.
The latest news is that EU leaders have agreed to a backstop plan
— a combination of EU bilateral loans and International Monetary Fund
assistance — that will be implemented if Greece runs out of
market-oriented fund-raising options.
Recently, the concern has centered on a potential bank liquidity
crisis. Depositor and investor focus has expanded from the public sector
alone to more general Greek exposure. At the moment, it is unclear how
threatening these liquidity problems are.
The Greek fiscal crisis is unfolding in real time and remains, at
this juncture, unpredictable. So far the problem has been isolated to
Greece even though there are other countries under serious fiscal debt
stress. A generalized investor retreat from sovereign debt has not
materialized. The Greek drama has not threatened U.S. Treasury auctions,
and the U.S. banking system has very limited direct exposure. However,
the financial crisis has taught us that we can’t be relaxed about
stresses in financial markets, no matter how distant and isolated they
appear to be.
For that reason, the situation should be watched carefully.
State and local fiscal stresses
Closer to home, there is appropriate concern about our own fiscal
stresses and their possible negative effect on the recovery. I’m
referring to fiscal problems at the state and local government levels in
particular. The government sector overall makes up about 20 percent of
GDP. State and municipal governments represent about 12 percent of GDP.
State and municipal governments across the country are now
implementing painful spending cuts and tax increases to close large
budget gaps. The federal stimulus package, rainy day funds, and lowered
contributions to pensions and other accounting adjustments have
forestalled some of these cuts. But now — with a lag — the potential
drag on local economies is materializing.
States still had budget gaps in excess of 10 percent for fiscal
year 2010. As federal government aid to states is waning, states are
working to close an additional 11 percent gap in the coming fiscal year
and project shortfalls of a similar magnitude in 2012.
At the same time, cities confronted budget gaps of roughly 3
percent last year, according to a survey conducted by the National
League of Cities. Because of lags in adjustments to the property tax
digest and continuing declines in funding from state governments, cities
aren’t expected to begin recovery until 2012.
Despite these challenging problems, I see state and local
government belt tightening as a long-term drag on the recovery with
varied effects at the regional, state, and local level, but not an
outsized near-tem vulnerability. Fiscal adjustment is occurring,
fortunately, in the context of a now growing private economy. Adjustment
will proceed but shouldn’t imperil broad improvement of economic
conditions.
Private spending
Private spending will certainly have a big impact on the fate of
the recovery. Private spending has two dimensions: personal consumption
and business investment spending. The confidence that underpins consumer
behavior is linked to employment conditions and household wealth. Growth
prospects and the degree of medium-term uncertainty shape business
spending.
As regards the factors influencing consumer spending, unemployment
rose last fall to above 10 percent, the highest since the 1981-82
recession. Declines in home values and equity prices put significant
pressure on the balance sheets of consumers. Through the fourth quarter
of 2009, the net worth of households was about 18 percent below its peak
in the second quarter of 2007.
While consumer spending contracted sharply during the recession,
the consumer is coming back. Real personal consumption expenditures
(PCE) rose in February for the fifth consecutive month.
Much depends on the labor market. Income follows employment, and
consumer spending follows income. The jobs picture seems to be gradually
strengthening. The private sector added nearly 50,000 jobs monthly on
average during the first quarter of 2010, but, clearly, stronger growth
is needed to bring down the unemployment rate.
Recent data also suggest that the second component of private
spending — business investment — is likely to continue growing.
Spending on equipment and software grew at a solid pace in the fourth
quarter, and durable goods orders, which are forward looking, suggest
continued expansion.
For the general economy, I’m encouraged by growth in both
categories of private spending. However, powerful forces are still
restraining consumption and investment spending, and consequently I
don’t think it’s realistic to expect spectacular growth in either in the
coming year. But I do expect solid advances in private spending to be
one of the key economic stories of 2010.
Inflation
My final concern is the risk of a surge in inflation and its
advance warning, inflation expectations. Understand this is not in my
forecast, but the concern is that unwelcome price developments could
limit the Fed’s ability to provide policy support for a gradual
recovery.
As the global economy has moved into recovery, the prices of
energy, metals, and other raw material commodities have risen. These
market movements have led some analysts to fear greater pressure of
pass-through of commodity price increases, which could add a cost-push
dynamic to the inflation picture.
While some categories of prices have gone up, aggregate measures of
prices are indicating disinflation and not rising inflation. For
example, yesterday’s Consumer Price Index (CPI) report indicated that
retail price growth remains in check. The overall index for last month
rose 2.3 percent on a year-over-year basis and the core CPI was up just
1.1 percent.
Additionally, large amounts of resource slack have given businesses
little pricing power, and underlying wage and price trends have
continued to ease. Our directors and business contacts around the
Southeast have confirmed anecdotally this view on current inflation
pressures.
Despite the lack of evidence of current inflationary pressures,
some have expressed concern about the potential inflationary
consequences of the Fed’s very aggressive monetary measures taken in
response to the financial crisis and recession. As a result of those
measures, the Fed’s balance sheet more than doubled in size.
Discussion among market participants and Fed observers has focused
in recent months on whether the Fed can engineer a policy exit, that is,
an optimal shrinking of the balance sheet. Much planning, market
testing, and consultation has already been performed in anticipation of
an eventual exit. I am very confident that the Federal Reserve will be
able to manage the normalization of its balance sheet with appropriate
timing and pace. I do not expect inflation to change the course of
economic recovery over my forecast horizon.
So far, the public seems to agree. The stability of long-term
inflation expectations, in my view, is signaling confidence in the Fed’s
ability to conduct a successful exit from stimulative policies.
Monetary policy comments
Let me close with some thoughts on the implications of the views
I’ve expressed for the stance of monetary policy.
As a central banker, I keep a worry list. A good part of this talk
has been a survey of my concerns. These points of vulnerability have
been identified in recent months and weeks by many other public
officials and commentators. Such public recognition of a problem, a
risk, a vulnerability often sets in motion focused efforts to address it
by a variety of relevant actors. And often the outcome is better than
the original estimates of potential impact precisely because the problem
is being worked.
Given the current state of the economy, I am very comfortable
taking a personal position that is neither sanguine about these
potential torpedoes nor unduly alarmist or defeatist. I take comfort
that each big problem that is actionable is being addressed, and the
recovery is moving forward. As I said earlier, so far so good.
Having said that, I believe the recovery requires continued support
of accommodative monetary policy. I think there is risk associated with
starting a process of tightening too soon. In my view, the strong
medicine of low rates should remain in place to facilitate adjustment
processes that are by their nature gradual.
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** Market News International Washington Bureau: 202-371-2121 **
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