NEW YORK – A moderate economic recovery in 2010 will push confidence up and ring in a stronger 2011, Federal Reserve Board Governor Elizabeth A. Duke said today.
“Combining the various factors likely to influence the path of economic activity this year, including importantly the outlook for financial markets, I expect that the economic recovery will continue at a moderate pace,” she told the Economic Forecast Forum in Raleigh, N.C., according to prepared text of her speech, which was released by the Fed. “As the year goes on, I anticipate that we will see more signs that the improvements in financial markets, credit conditions, and business sales are reinforcing each other, leading to greater confidence and improving the prospects for 2011.”
Inflation should not spike, despite a stronger economy, she said, as resource utilization remains “below historical norms for some time,” keeping cost pressures contained, and inflation expectations stable.
Providing no unexpected changes in the economy, Duke said, “conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.” Also, she added, “the Federal Reserve is committed to continue working with banks and bank holding companies to facilitate the flow of credit to consumers and businesses.”
A “wide range of tools” is available for “removing monetary policy accommodation when that becomes appropriate,” she added.
While acknowledging a decline in credit availability, Duke said, the demand for credit is also down. “My conversations with bankers in recent weeks, however, lead me to be somewhat optimistic that we may begin to see an increase in bank loans later this year. Nearly all the bankers with whom I have talked report that their business plans for 2010 are based on achieving increases in loan volumes. Most are expecting that loan losses will peak later this year, as the bottoming of the housing market becomes clearer and the economic recovery takes firmer hold. And a few bankers are beginning to report renewed competition for new loans.”
Duke noted, her outlook “depends importantly on our ability to build on the progress to date in improving the operation of financial markets and restoring the flow of credit to households and businesses.”
Stock market gains and house price stabilization boosted household wealth in the last nine months, but “household balance sheets remain weak. In 2009, household income received some temporary support from the tax cuts and transfer payments enacted with the fiscal stimulus package and from the extensions of unemployment insurance. Over the coming year, households should begin to see gains in income associated with an improvement in the labor market, and the drag on spending from past declines in real net worth should ease. As their income and balance sheets improve, consumers should have better access to credit. Favorable trends in income and employment should also bolster consumer confidence, although one risk I see to the outlook for household spending is the possibility of a rise in the personal saving rate as consumers choose to shore up their balance sheets rather than spend. While good in the long run, increased saving means consumers are providing less of a short-run boost to the economy.”
Low mortgage rates and relatively low prices will support home demand, but “the headwinds in housing and mortgage markets remain relatively strong and are likely to restrain the pace at which the residential construction sector recovers. Many of the existing homeowners who face payment problems are having trouble restructuring their loans, and the large backlog of foreclosed properties will likely take several years to resolve. Tighter standards for government-backed loans and still-restrictive credit conditions in private loan markets are also likely to slow the housing recovery. Nevertheless, with the inventory of new homes having been worked down to a relatively low level, even a gradual strengthening of demand should lead to an upturn in homebuilding.” Duke said.
Business investment should also rise this year, she added, “While firms to date seem to have been cautious about undertaking any expansion, they appear in a good position to act as confidence returns. After slashing investment and reducing costs during the recession, nonfinancial corporations have built substantial internal funds, and firms with access to capital markets have been finding them generally receptive. Corporate bond issuance for both investment-grade and high-yield issues remained quite solid through November. My expectation is that the interaction of an ongoing recovery in economic activity and improved credit conditions will over time produce a moderate acceleration in equipment and software investment.”
Commercial real estate, however, will need more time to improve and a turnaround “is likely to lag the improvement in overall economic activity.”
Another negative factor is the labor market. “Reductions in jobs and hours of work have been so deep, and the pressure to cut costs has been so strong, that businesses in the aggregate have already realized solid gains in productivity. As a result, I expect that businesses will begin to add jobs this year, but I anticipate that they will do so cautiously in order to hang on to their cost savings and efficiency gains,” she said. “Even as the unemployment rate begins to decline later this year, it likely will remain high by historical standards. Based on the experience of the last two economic recoveries, net gains of roughly 100,000 payroll jobs each month are needed to reduce the jobless rate by 0.1 percentage point. Currently, at 10 percent, the unemployment rate is almost 4 percentage points higher than its peak after the 2001 recession, and a sustained recovery will be required to reduce it significantly. Similarly, other measures of resource utilization are likely to show considerable, albeit diminishing, margins of slack for some time. In that environment, product markets will be highly competitive, businesses will have little pricing power, and the incentives to control costs will remain strong.”
