BOSTON (MNI) – The following are the remarks of Boston Federal
Reserve Bank Pres. Eric Rosengren prepared for the South Shore Chamber
of Commerce Thursday:
Good morning and thank you for the opportunity to be with you at
the South Shore Chamber of Commerce.
As always, I would like to note that the views I express today are
my own, not necessarily those of my colleagues on the Federal Reserve’s
Board of Governors or the Federal Open Market Committee (the FOMC).
I know it’s still early morning, but allow me to start with an
observation about economists, historians, and the word “Great.”
Historians tend to use “Great” to reflect success, particularly military
success that results in territorial expansion — think Alexander the
Great or Peter the Great. In economics, “Great” is used quite
differently.
It’s usually applied to difficult episodes with serious economic
consequences — think of the Great Depression or the so-called Great
Recession. Often such an episode involves economic policymaking –
fiscal, monetary, or otherwise — that contributes to the situation or
fails to alleviate it.
I have titled this talk “Acting to Avoid a Great Stagnation” and
let me be clear, I do believe the Federal Reserve is taking appropriate
and forceful action to help the U.S. avoid a prolonged economic
stagnation.
Let me explain the terms. In my view a Great Stagnation — in
current times or any other — would be a long episode that generally
includes a willingness among policymakers to accept as inevitable, and
decline to resist, far-less-than-optimal outcomes. Such outcomes could
include higher unemployment, with the potential result that high
unemployment could become entrenched as a more permanent feature of the
economic landscape.1
What I am highlighting is the importance and appropriateness of
taking the policy actions that are necessary to improve economic
conditions much more quickly — so the period of very slow recovery that
we have been experiencing of late does not persist and become a Great
Stagnation or in fact a “Great” anything.
Unfortunately, the global economy is experiencing a slowdown, and
that slowdown is one of the significant impediments to faster growth in
the domestic economy. Failure to react to this slowdown would risk a
situation where difficult conditions prevail for long enough to become
“Great” in the economist’s sense. This could occur if policymakers of
all sorts — monetary, fiscal, economic, and financial — were to adopt
a stance of only reacting to large negative shocks, while accepting (and
declining to act against) a status quo of substantial underutilization
of resources, for an extended period of time.
This sort of scenario would be particularly tragic in the job
market, and I would note that over the course of this year there has
been no meaningful improvement in the unacceptably high level of the
U.S. unemployment rate. Fed Chairman Ben Bernanke has called this a
“grave concern” and I fully agree with him. Last week the group charged
with monetary policymaking in the U.S., the FOMC, took additional
monetary policy actions to promote faster economic growth. I fully
support the policy actions. Let me say a bit about them. First, the FOMC
noted that it anticipates that low short-term rates are likely to be
warranted at least through mid- 2015. This guidance makes clear that
monetary policy will remain accommodative for a considerable time,
likely even after labor markets improve from their current subdued
state, in order to promote a robust and sustainable recovery.
Second, given the desire to increase policy accommodation even
while the traditional policy instrument (the federal funds rate) is at
the zero lower bound, the FOMC announced plans to buy $40 billion worth
of mortgage-backed securities a month — until such time as there is
substantial ongoing improvement in labor markets. The more open-ended
nature of the action — intending to continue such purchases until labor
markets have improved — is an important change. Of course, the Fed will
do so in the context of price stability (which is the other half of the
Fed’s “dual mandate,” along with maximum sustainable employment) — and
hand in hand with a careful ongoing assessment of the program’s costs
and efficacy.
Of course policy actions such as these are unconventional, and do
entail risks. However, in my view the risks involved in pursuing these
policies are considerably smaller and more manageable than the risk of
allowing the economy to stagnate for another year or more.
The U.S. has seen a series of “false starts” during this recovery.
After earlier periods of policy accommodation the economy has improved,
but that improvement has not been sustained. These false starts have
been interrupted by both natural and manmade disasters, here and abroad.
As a consequence of these interruptions, the recovery has been painfully
slow by historical standards — resulting in our current highly-elevated
unemployment rate and an inflation rate below our objective.
Absent further policy action, most economists expect several more
years of weak labor markets and low inflation. As a consequence, it was
time for the Fed to announce stimulus that will continue until the U.S.
achieves both faster economic growth and lower unemployment, no matter
the unanticipated interruptions.
Today I would like to walk through my analysis of the economic
situation in more detail. In doing so I hope it will become clear why I
have strongly supported the kind of forceful action that the FOMC took
last week. In my view, these policies are essential to achieving a
strong sustainable recovery that is resilient, despite the inevitable
disruptions. Let me add that I am only discussing monetary policy, not
fiscal policy, since fiscal policy, though powerful, is not in the Fed’s
jurisdiction.
Avoiding a Stagnation
Figure 1 provides a powerful real-world example of the potential
for a Great Stagnation — the experience of Japan after their financial
crisis, which began in 1990. While this period is sometimes called the
“Lost Decade,” that is actually a misnomer — since the period of
stagnant growth has lasted over two decades.
There are many factors contributing to a Great Stagnation in Japan,
including a very slow realization of the need to recapitalize banks, and
a population whose average age is rapidly rising (which changes the
composition of economic activity in a country), and a substantial
slowdown in population growth. Still, it is striking that there was a
dramatic change in the growth of real GDP in Japan coinciding with the
start of their financial crisis.2 The muted policy response to the
slower growth that began during the financial crisis is partly
responsible for the fact that Japanese growth never returned to its
pre-crisis rate, or to where output would have been had the crisis not
occurred (the path illustrated by the trend line, based on growth over
the 1980-1990 period).
Figure 2 shows the level of U.S. GDP since 1980. Note that we too
have a noticeable break in the growth rate of GDP at the advent of the
recent financial crisis. However, unlike the Japanese, it appears that
we have resumed the pre-crisis growth rate. But we have not returned the
economy back to its original growth path, the only time we have failed
to do so in all ten of our other post-war recessions – including the
severe recession in 1982.
Failing to return quickly to the original trend line is much more
serious than a graph can convey. It implies a significant cumulative
loss in goods and services that should have been produced (measured as
the sum of the difference between those two lines), which in turn
implies a significant shortfall in employment relative to full
employment.
As a result, the goal of monetary and fiscal policy should be to
return the economy back to the original trend line. This means getting
faster than normal growth until resources are once again fully utilized.
A risk in not doing so is that we permanently reduce our trend growth
rate, which is what appears to have happened in Japan.
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** MNI **
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