Slow Growth Ahead
Data releases over the past month leave no doubt that economic growth has slowed to a snail’s pace. Second quarter GDP growth was revised down to a 1.6% annual rate. Orders for durable goods other than transportation equipment fell sharply, and included an abrupt decline in a critical component—orders for nondefense capital goods other than aircraft. Existing home sales plummeted, falling to the lowest level since the series began in 1999, and the ISM index for non-manufacturing registered an unexpected decline in August.
Fears that a double-dip recession might be in the immediate offing were allayed, however, by the August employment report. Jobs were created in the private sector for the 8th consecutive month, and employment levels for the previous two months were revised up significantly. But job creation was insufficient to prevent a rise in the unemployment rate, and unless economic growth picks up, further increases in unemployment are likely.
A rate of growth well below the economy’s long-term potential rate of expansion (probably around 2-1/2 %) is worrisome not just because it implies rising unemployment, but because an unexpected shock occurring in such an environment could send the economy reeling. While there is nothing of that kind on the horizon at the moment, the economy will remain in a precarious position until something comes along to stimulate more vigorous expansion.
Fed Chairman Ben Bernanke set forth the Fed’s expectations for the economic outlook in a recent speech at Jackson Hole. Acknowledging that near-term growth would probably be at “… a relatively modest pace,” Bernanke held out hope for a pickup in activity next year. He noted that financial conditions remain supportive; banks are a bit more willing to lend; consumer balance sheets are improving, as are budgets of state and local governments; and business investment in equipment and software should continue to provide support for economic growth. The case for the economy emerging from the current soft patch next year is quite plausible, and this month’s forecast anticipates a resumption of trend-like growth in 2011. Doubts are bound to remain, however, until that forecast becomes a reality.
The Obama Administration is scrambling to find something that will encourage stronger growth, particularly something that will improve the environment for job creation. Increasingly, it appears that all of the Bush tax cuts are likely to be extended, despite the Administration’s vocal opposition. A temporary payroll tax holiday is an option discussed in the press that would offer hope of stimulating hiring, but would increase the federal deficit in the near term and raise concerns about the long-run solvency of the Social Security system. Given the public’s concerns about the size of government and the growing burden of debt, fiscal policy appears to be hamstrung; if the economy needs help, it will have to come principally from the Federal Reserve.
Bernanke’s speech at Jackson Hole indicated that the Fed has been weighing the available options to invigorate the economy should additional stimulus be needed. He dismissed the notion of raising the Fed’s medium-term inflation target, and expressed doubts about the efficacy of lowering the interest rate paid on excess reserves. The live options are modifying the “extended period” language and expanding the Fed’s balance sheet by purchasing long-term securities.
The bar for the Fed to begin an aggressive use of quantitative easing will probably be set relatively high. Bernanke’s speech argues that the success the Fed achieved in reducing long-term interest rates in the first use of quantitative easing stemmed from the fact that the Fed’s purchases were large enough to reduce the outstanding stock of long-term issues available to private investors. Accordingly. lowering long-term rates further would likely require a willingness to resume purchases on a vast scale--buying $1 trillion or more in long-term securities and increasing the size of the Fed’s balance sheet to more than $3 trillion.
Such a policy action would be difficult for many Federal Open Market Committee (FOMC) members to swallow. As Bernanke acknowledged, the impact of another round of quantitative easing on long-term interest rates, and through that route on aggregate demand, is uncertain. Conditions in financial markets have improved markedly since the first round of quantitative easing was initiated in late 2008, hence the effects of a new round on long-term interest rates might be considerably less. The uncertain benefits have to be balanced against the possible costs of reducing the confidence of the public in the Fed’s ability to transition back to a normal posture of monetary policy without triggering a new round of inflation and rising inflation expectations.
Modifying its communications strategy—that is, changing the “extended period” language in ways that encourage investors to postpone the expected date of the first tightening of monetary policy—would be easier for most members of the FOMC to accept. Communicating its intentions to markets is, after all, an integral part of conventional monetary policy. It has been used by the Fed and by other central banks around the world for many years, and is widely accepted by FOMC members as an appropriate tool for the Fed to employ.
If the economy continues to show signs of growing during the second half of this year at the relatively modest pace that Chairman Bernanke expects, a change in the “extended period” language will probably be on the table. What form the change in language might take is hard to guess. One possibility would be to promise to keep the funds rate unchanged on the condition that the inflation rate stays below a specific numerical target.
Either of the two options the Fed might employ to help stimulate the economy would work by lowering long-term interest rates. But these interest rates are now as low as they have been since the early 1960s, and whether still lower rates would encourage businesses and individuals to step up their rate of borrowing and spending is an open question. But this is the only ammunition remaining to the Fed and will have to be used aggressively if the economy does not recover on its own.
This article can be found at: http://www.mbaa.org/NewsandMedia/PressCenter/73915.htm
Slow Growth Ahead
Data releases over the past month leave no doubt that economic growth has slowed to a snail’s pace. Second quarter GDP growth was revised down to a 1.6% annual rate. Orders for durable goods other than transportation equipment fell sharply, and included an abrupt decline in a critical component—orders for nondefense capital goods other than aircraft. Existing home sales plummeted, falling to the lowest level since the series began in 1999, and the ISM index for non-manufacturing registered an unexpected decline in August.
Fears that a double-dip recession might be in the immediate offing were allayed, however, by the August employment report. Jobs were created in the private sector for the 8th consecutive month, and employment levels for the previous two months were revised up significantly. But job creation was insufficient to prevent a rise in the unemployment rate, and unless economic growth picks up, further increases in unemployment are likely.
A rate of growth well below the economy’s long-term potential rate of expansion (probably around 2-1/2 %) is worrisome not just because it implies rising unemployment, but because an unexpected shock occurring in such an environment could send the economy reeling. While there is nothing of that kind on the horizon at the moment, the economy will remain in a precarious position until something comes along to stimulate more vigorous expansion.
Fed Chairman Ben Bernanke set forth the Fed’s expectations for the economic outlook in a recent speech at Jackson Hole. Acknowledging that near-term growth would probably be at “… a relatively modest pace,” Bernanke held out hope for a pickup in activity next year. He noted that financial conditions remain supportive; banks are a bit more willing to lend; consumer balance sheets are improving, as are budgets of state and local governments; and business investment in equipment and software should continue to provide support for economic growth. The case for the economy emerging from the current soft patch next year is quite plausible, and this month’s forecast anticipates a resumption of trend-like growth in 2011. Doubts are bound to remain, however, until that forecast becomes a reality.
The Obama Administration is scrambling to find something that will encourage stronger growth, particularly something that will improve the environment for job creation. Increasingly, it appears that all of the Bush tax cuts are likely to be extended, despite the Administration’s vocal opposition. A temporary payroll tax holiday is an option discussed in the press that would offer hope of stimulating hiring, but would increase the federal deficit in the near term and raise concerns about the long-run solvency of the Social Security system. Given the public’s concerns about the size of government and the growing burden of debt, fiscal policy appears to be hamstrung; if the economy needs help, it will have to come principally from the Federal Reserve.
Bernanke’s speech at Jackson Hole indicated that the Fed has been weighing the available options to invigorate the economy should additional stimulus be needed. He dismissed the notion of raising the Fed’s medium-term inflation target, and expressed doubts about the efficacy of lowering the interest rate paid on excess reserves. The live options are modifying the “extended period” language and expanding the Fed’s balance sheet by purchasing long-term securities.
The bar for the Fed to begin an aggressive use of quantitative easing will probably be set relatively high. Bernanke’s speech argues that the success the Fed achieved in reducing long-term interest rates in the first use of quantitative easing stemmed from the fact that the Fed’s purchases were large enough to reduce the outstanding stock of long-term issues available to private investors. Accordingly. lowering long-term rates further would likely require a willingness to resume purchases on a vast scale--buying $1 trillion or more in long-term securities and increasing the size of the Fed’s balance sheet to more than $3 trillion.
Such a policy action would be difficult for many Federal Open Market Committee (FOMC) members to swallow. As Bernanke acknowledged, the impact of another round of quantitative easing on long-term interest rates, and through that route on aggregate demand, is uncertain. Conditions in financial markets have improved markedly since the first round of quantitative easing was initiated in late 2008, hence the effects of a new round on long-term interest rates might be considerably less. The uncertain benefits have to be balanced against the possible costs of reducing the confidence of the public in the Fed’s ability to transition back to a normal posture of monetary policy without triggering a new round of inflation and rising inflation expectations.
Modifying its communications strategy—that is, changing the “extended period” language in ways that encourage investors to postpone the expected date of the first tightening of monetary policy—would be easier for most members of the FOMC to accept. Communicating its intentions to markets is, after all, an integral part of conventional monetary policy. It has been used by the Fed and by other central banks around the world for many years, and is widely accepted by FOMC members as an appropriate tool for the Fed to employ.
If the economy continues to show signs of growing during the second half of this year at the relatively modest pace that Chairman Bernanke expects, a change in the “extended period” language will probably be on the table. What form the change in language might take is hard to guess. One possibility would be to promise to keep the funds rate unchanged on the condition that the inflation rate stays below a specific numerical target.
Either of the two options the Fed might employ to help stimulate the economy would work by lowering long-term interest rates. But these interest rates are now as low as they have been since the early 1960s, and whether still lower rates would encourage businesses and individuals to step up their rate of borrowing and spending is an open question. But this is the only ammunition remaining to the Fed and will have to be used aggressively if the economy does not recover on its own.