Some highlights from the just released Philly Fed president's speech, bringing yet more hawkishness into the equation:
- Says stronger rebound in economy, inflation may require aggressive policy action
- Must not be too sanguine in believing time to tighten is long way off
- Recovery will continue at a moderate pace
- US economy growing 3.5% annually this year and next
- Prospects in labour markets have improved in recent months
- Expects inflation to be about 2% over the course of 2011... so not the 8.3% which is the accurate number? Odd.
From Recession to Expansion: A Policymaker’s Perspective (PDF)
Presented by Charles I. Plosser, President and Chief Executive Officer, Federal Reserve Bank of Philadelphia
Harrisburg Regional Chamber & Capital Regional Economic Development Corporation, April 1, 2011
Thank you for inviting me to speak to you this morning. Organizations
like yours make important contributions to the growth and development
of the regional economy, so I am delighted to have this opportunity to
speak to you about the economic outlook this morning.
I was interested to learn that the Harrisburg Regional Chamber
received its formal charter as a Chamber of Commerce in 1913 — the same
year Congress passed the Federal Reserve Act establishing the Federal
Reserve System. In 1914, the Federal Reserve Bank of Philadelphia
received its charter as a part of this nation’s decentralized central
bank. Both of our organizations have seen a great deal of economic
development and economic challenges over the course of the last century.
This morning I would like to discuss our nation’s economic recovery
from recession to expansion and my outlook for growth and inflation. I
will also discuss the challenges policymakers face in the current
As always, I speak for myself, and my views do not necessarily
reflect those of the Federal Reserve Board or my colleagues on the FOMC.
Our economy is on track for a sustained recovery from the worst
financial and economic crisis since the Great Depression. The recovery,
which officially began in mid-2009, is nearing the two-year mark, and we
are now on a much firmer footing than we were last summer.
If you recall, the first half of last year had its twists and
turns. While real gross domestic product (GDP) grew at a fairly strong
pace of 3¾ percent in the first quarter of 2010, the economy slowed to
growth of 1¾ percent in the second quarter. The strength in the first
quarter reflected a strong contribution from inventories. After cutting
their inventories over the prior two years as sales plummeted, firms
began to rebuild inventories in the first quarter of last year in
anticipation of the strengthening economic recovery. We saw swings in
housing sales in the first half of last year as the homeowner tax
credits brought sales forward. But just as the economy was beginning to
strengthen, concerns over European sovereign debt led some observers to
worry about a possible double-dip recession.
These fears passed, and after emerging from what I’ve been calling
the summer doldrums, the economy showed renewed vigor and, by the end
of the year, had once again picked up momentum. According to the revised
estimate issued last week, real GDP grew at a 3.1 percent annual rate
in the fourth quarter, up from 2.6 percent in the third quarter. This
meant that growth for the full year of 2010 was just under 3 percent.
For this year and next, I expect growth will pick up to about 3½
percent annually. I believe overall strength in some sectors will more
than offset persistent weaknesses in others so that the recovery will be
sustained and become more broad-based. Improvement in household and
business balance sheets, spending on software and equipment, and better
labor market conditions will all support moderate growth overall.
Perhaps the brightest spot in the economy is manufacturing. Results from the Philadelphia Fed’s Business Outlook Survey of manufacturers,
which is a useful barometer of national trends in manufacturing, have
steadily improved in recent months. In fact, in March, the survey’s
broadest measure of manufacturing conditions increased to its highest reading since 1984.
Survey indicators of new orders and shipments are also at high levels.
Future activity, measured by how firms think business will be six months
from now, also remains high. Thus, I expect business spending will
continue to show strength.
Consumer spending, which makes up about 70 percent of GDP in the
U.S., has also expanded. Households continue to pay down debt and
rebuild some of the net worth that was destroyed during the recession
due to falling house and stock values. However, for consumers to
contribute more to the continued expansion of the economy, job growth
needs to strengthen.
The good news is that there are signs that labor market conditions
are improving. While initial estimates of January job growth looked
anemic, this may have had more to do with the terrible weather during
the Bureau of Labor Statistics’ survey period. In February payroll job
growth improved substantially, with firms adding about 192,000 jobs. The
January job numbers were also revised up somewhat. Taken together, the
first two months of the year saw an increase of a quarter of a million
jobs, a pickup from the pace of job growth in 2010.
Another sign of improvement is the decline in the unemployment
rate over recent months. The unemployment rate fell to 8.9 percent in
February. While this is still an elevated level, it is down nearly 1
percentage point since its peak in November and it is at its lowest
level in nearly two years. I do not want to downplay the pain that many
households are going through with family members out of work. But I take
these declines in unemployment as a positive sign that conditions in
the labor market are improving.
Employment growth in the Third District
has not been as strong as in the nation as a whole, but the
unemployment rate was also not as high. Pennsylvania job growth has been
somewhat stronger than in the rest of the Third District. February
numbers showed a net gain of nearly 24,000 jobs in the state, with an
unemployment rate of 8.0 percent, compared to 8.9 percent for the U.S.
The Harrisburg-Carlisle MSA, aided by public-sector employment, has an
even lower unemployment rate. January numbers, our most up-to-date MSA
numbers, showed an unemployment rate of 7.1 percent, nearly 1 percentage
point lower than for the state as a whole and nearly 2 percentage
points lower than for the nation.*
We will get another read on national employment later this morning
when the March numbers are released. As the economy strengthens this
year, I expect that businesses will continue to add to their payrolls
and that we will see modest declines in the unemployment rate, reaching
8½ percent by the end of this year, and in the 7 to 8 percent range by
the end of 2012.
Residential and commercial real estate sectors remain weak, but I
do not believe that weakness in these sectors will prevent a broader
economic recovery. Indeed, the nonresidential real estate sector is
likely to improve as the overall economy gains ground.
The tragic events in Japan and the potential for sharply higher
oil prices given the turmoil in the Middle East and North Africa pose
some risk to our recovery. Yet, I believe the risks are small and short
term, assuming Japan is able to stabilize its nuclear reactors and
political unrest in the Middle East does not dramatically disrupt Saudi
Arabia, the region’s largest oil producer.
Just a few months ago, inflation had been running slightly below
the 1½ to 2 percent range that most policymakers would prefer. In fact, a
deceleration in inflation rates last year led some economists to
believe there was a significant risk of a sustained deflation. I was not
one of them. Such fears have now abated, and rather than deflation,
some economists have become concerned about accelerating inflation due
to the rise in oil prices we have seen this year and the strong increase
in other commodity prices we have experienced since the summer.
My forecast is that inflation will be about 2 percent over the
course of the next year. Many people ask me which measures of inflation I
watch. The fact is that I watch several measures, including the prices
paid and prices received indexes in the Philadelphia Fed’s own monthly
Business Outlook Survey. In February, the prices paid and prices
received indexes hit their highest levels in three years, and in March,
prices received continue to move up and prices paid stay at a very high
level. My sense is that as the recovery continues to pick up steam and
firms become more convinced that increases in demand will be sustained,
they will feel more confident that they can pass through price increases
and have them stick.
The February consumer price index increased to 2.1 percent year
over year. Core inflation, excluding food and energy, rose to 1.1
Some fear that the strong rise in commodity and energy prices will
lead to a more general sustained inflation. Yet, at the end of the day,
such price shocks don’t create sustained inflation, monetary policy
does. If we look back to the lessons of the 1970s, we see that it is not
the price of oil that caused the Great Inflation, but a monetary policy
stance that was too accommodative. In an attempt to cushion the economy
from the effects of higher oil prices, accommodative policy allowed the
large increase in oil prices to be passed along in the form of general
increases in prices, or greater inflation. As people and firms lost
confidence that the central bank would keep inflation low, they began to
expect higher inflation and those expectations influenced their
decisions, making it that much harder to reverse the rise. Thus, it was
accommodative monetary policy in response to high oil prices that caused
the rise in general inflation, not the high oil prices per se. As much
as we may wish it to be so, easing monetary policy cannot eliminate the
real adjustments that businesses and households must make in the face of
rising oil or commodity prices. These are lessons that we cannot
As you know, Congress set the goals of monetary policy in the
Federal Reserve Act, which states that the Fed should conduct policy to
“promote effectively the goals of maximum employment, stable prices, and
moderate long-term interest rates.” Since moderate long-term interest
rates generally result when prices are stable and the economy is
operating at full employment, it is often said that Congress has given
the Fed a dual mandate.
Many economists understand that monetary policy can best
contribute to maximum employment and moderate long-term interest rates
by ensuring price stability over the longer run. Price stability is also
critical in promoting financial stability.
Committing to a stated goal to keep inflation low and stable can
help to reduce market uncertainty and enhance the credibility and
transparency of our central bank. That is why I have long advocated that
the Fed make explicit its commitment to a numerical inflation
objective. Numerical inflation objectives are fairly common among major
central banks around the world, and many academics and students of
central banking regard adopting such an objective as best practice.
Establishing and communicating an explicit numerical objective
would be particularly valuable as we exit our current very accommodative
monetary policy stance. An explicit commitment to a low and stable
inflation rate should help reassure the public that we will exit in a
way that is consistent with that goal. This should help keep
expectations of inflation well anchored as we carefully choreograph an
end to our accommodative monetary policy.
Monetary Policy Challenges
Speaking of removing monetary accommodation, I’d like to discuss
some challenges we are facing in the realm of monetary policymaking.
History tells us that exiting from an accommodative policy is very
tricky. It is likely to be especially so this time around, given the
nontraditional actions we have taken.
In the last couple of years, as we have endured a financial crisis
and a severe recession, the FOMC was forced to adopt nontraditional
policies in an attempt to stabilize financial markets and the real
economy. These actions have taken us far from the traditional and
well-understood operating framework for conducting monetary policy.
The federal funds rate — the traditional instrument of monetary
policy — has been near zero for more than two years. The Fed’s balance
sheet has grown nearly three times, to more than $2.6 trillion, with a
composition heavily weighted toward long-term Treasuries and
Because we find ourselves in unfamiliar territory, it is
understandable that there is less of a consensus among economists about
the right actions to take to promote sustainable growth and price
stability. As a result, debates about policy have been robust, with
bright and talented people on every side. And it should not be
surprising — indeed, it should be reassuring — that debates within the
FOMC are similar to many that are carried out in more public forums.
A few months ago, I came across a quotation by the
not-so-well-known French essayist Joseph Joubert from two centuries ago.
It captured my belief about the importance of this honest debate so
well that I have begun to cite it — even if Joubert is not a household
name. He wrote: “It is better to debate a question without settling it
than to settle a question without debating it.” You may have also heard
me quote the American journalist Water Lippmann, who said, “Where all
men think alike, no one thinks very much.”
Healthy debate is necessary for better-informed decisions. These
debates also serve to enhance the Fed’s credibility and transparency as
an institution. We owe it to the public to communicate the thoroughness
of those discussions.
Some people have questioned whether the Fed has the tools to exit
from its extraordinary positions. The answer to that is an unequivocal
“yes.” The question is not can we do it, but will we do it at the right
time and at the right pace. Since monetary policy operates with a lag,
the Fed will need to begin removing policy accommodation before
unemployment has returned to acceptable levels. It is imperative that we
have the fortitude to exit as aggressively as necessary to prevent a
spike in inflation and its undesirable consequences down the road.
Any exit plan will use several policy tools, including raising
interest rates, shrinking the balance sheet, and altering the
composition and maturity of the assets we hold. Some would start with
raising interest rates; some would begin by shrinking the balance sheet;
others would do both.
Last week, I outlined a proposal for a systematic rule-based approach
that would involve the Fed’s selling assets from its portfolio as it
increased its policy rate, with the pace of sales dependent on the state
of the economy.
The plan would get us back to a “normal” operating environment in a
timely manner, by which I mean one where the Fed’s balance sheet is of
the size to allow the federal funds rate to be the primary policy rate
Yet, the most important element is not the formula or pace I
proposed, but that it is a plan, one that can be clearly communicated to
the markets and the public in a way that reduces uncertainty. A
systematic plan will help define not only where we are headed, but also
how we will get there.
As to when to begin exiting from accommodative policy, I will
continue to look at the data on output and employment growth and on
inflation and inflation expectations. Signs that inflation expectations
are beginning to rise or that growth rates are accelerating
significantly would suggest that it is time to begin taking our foot off
the accelerator and start heading for the exit ramp. I would add that
we should not be too sanguine in believing that such a time is a long
way off or that the process will only be gradual. A stronger rebound in
the economy or inflation than some now expect could require policy
actions to be taken sooner and more aggressively than many observers
seem to be anticipating. Allowing monetary policy to fall behind the
curve can only result in greater inflation and more economic instability
in the future.
In closing, I am optimistic that our economy is on a firmer
footing. The recovery will continue at a moderate pace. I expect annual
growth to be about 3½ percent over the next two years. Prospects in
labor markets have improved in recent months. Over the course of this
year and next, the rate of unemployment will gradually fall to somewhere
between 7 and 8 percent by the end of 2012.
The Federal Reserve remains committed to its long-run statutory
goals of promoting price stability and maximum employment. We must
carefully watch for signals of inflation and altered expectations to
ensure that monetary policy stays ahead of the curve. As we move forward
in this time of change, we will do our best to communicate clearly our
actions and the intended purpose of our policy.
I believe that the challenges the FOMC faces as it exits from the
period of extraordinary accommodation and nontraditional policies can be
reduced if we communicate a systematic plan that describes where we are
headed and how we will get there. Such a plan would be strengthened if
the FOMC adopted an explicit numerical objective for inflation, which
would help ensure that inflation expectations remain well anchored.