NEW YORK – Accommodative monetary policy will need to be reversed “eventually,” but it could take a “couple years” for a return to normal, according to Federal Reserve Bank of Chicago President and Chief Executive Officer Charles L. Evans.
“Currently, [monetary] policy is, appropriately, very accommodative. But, eventually, we will have to return to a more normal stance,” Evans said in a speech at the University Club of Chicago, according to prepared text of his remarks, which were released by the Fed. “Judging the appropriate timing and pace for reducing accommodation poses a significant challenge for policymakers over the next couple years. On the one hand, removing too much accommodation prematurely could inhibit the recovery. On the other hand, as I noted, if the Fed leaves the current level of accommodation in place too long, inflationary pressures will eventually build. The Fed’s decisions will be based on careful monitoring of business activity and keeping an alert eye out for signs of changes in the inflation outlook. In addition, the FOMC is making sure that it has the technical tools it will need when it decides to reduce monetary accommodation. Overall, I am confident that monetary policy will both support economic growth and bring and keep inflation near my guideline of 2 percent over the medium term.”
In questioning by reporters after the speech, Evans estimated there would be no rate hikes for the next three to four Federal Open Market Committee meetings, about six months, with the caveat that it depends on the inflation outlook and the economy.
Turning to the European crisis, Evans said, the strife could affect the U.S. since it will reduce European demand for U.S. goods, which are relatively more expensive than before due to a stronger dollar versus the Euro. Conversely, European imports are cheaper for U.S. consumers, “lowering U.S. net exports, which, all else being equal, would tend to reduce the outlook for U.S. GDP growth.”
But, he added, this shouldn’t be too traumatic since Europe accounts for only about 15% of U.S. exports.
More generally, Evans said the U.S. economy is recovering and should continue to do so, with real gross domestic product growth near 3.5% this year. “In fact, we have been hearing many more upbeat business reports over the past several months, and have nudged up our outlook accordingly.”
Despite that growth, Evans said, “we still need to experience a good deal of growth before we return to the more normal pace of economic activity and levels of unemployment that we enjoyed in late 2007. And the 3.5% percent pace of growth I anticipate is quite moderate given the severity of the recession. To offer some perspective, in the first year and a half following the deep 1981 to 1982 recession, growth averaged nearly 8%.”
While businesses and consumers have started spending more, housing remains weak. Labor markets also have yet to bounce back. “In general, many measures of economic activity show improvement early in a recovery well before the jobs picture starts to get better,” he said. “This was especially true following the two previous recessions. I am concerned that this may be the case during this expansion as well. As the economy entered the most recent recession, businesses quickly cut their work forces. And even as the economy grew during the second half of 2009, job destruction outpaced the extremely low levels of hiring.”
But recent modest improvement in the jobs picture indicate businesses remain cautious about adding permanent staffing. “But they can increase output for only so long without adding to payrolls. As the recovery progresses and businesses become more confident in the future, employment will increase on a more consistently solid basis,” and signs point to that turning point being near.
Tighter lending standards also prevent the economy from stronger growth. Evans said, “I expect banking conditions to improve and better support growth, but this is likely to take some time.”
But, stronger growth than expected is possible. “While I’ve mentioned a number of factors that we think will dampen growth, we could be surprised on the upside,” Evans said. “Increases in confidence could turn into higher spending sooner than we now think. And productivity growth has remained strong. Technology continues to advance, and firms continue to create new products and find new ways to produce more efficiently. These factors will lead to higher incomes in the longer term. And even over the shorter term, the higher profits and incomes generated by productivity can help restructure balance sheets and support spending.”
