NEW YORK – Many private forecasters and the Federal Open Market Committee predict real gross domestic product will grow at a 3% pace this year and 4% next year, but Federal Reserve Bank of Minneapolis President Narayana R. Kocherlakota said today he believes growth will be a little slower, averaging 3% over the next two years.
“This pessimism derives from two sources,” Kocherlakota told the Allied Executives Business & Economic Outlook Symposium in Minneapolis, according to prepared text of his remarks, which were release by the Fed. First, his bank’s statistical forecasting model calls for growth around 2.5% a year, and the banking sectors ongoing woes.
Additionally, “there is a great deal of uncertainty related to major policy initiatives under consideration in Washington.” He said, “I view this kind of political uncertainty as problematic for the prospects of rapid recovery.”
Also, if banks don’t start lending, it “would curtail the recovery. Even worse, as we saw in the thrift crisis of the 1980s, in the presence of deposit insurance, banks that are near failure have strong incentives to make poor loans. This outcome would be even worse for the economy,” Kocherlakota said.
Turning to the labor markets, he said, “many macroeconomists now believe that the true cost of a recession is not the fall in GDP per se, but the associated increase in the risk of people becoming, and staying, unemployed.”
He said, “The outlook for unemployment is not comforting. Though unemployment has fallen somewhat, forecasts remain uniformly troubling. Unemployment is notoriously slow to recover, and it has been especially slow to decline after the last two milder recessions of 1990-91 and 2000-01. I would be highly surprised if unemployment were below 9% by the end of 2010 or below 8% by the end of 2011.
“Looking at data on job flows is even more disturbing. Much has been made in the media about how employment losses are stabilizing, as if this portends inevitable job growth. However, the source of this stabilization is problematic. Beginning in the fall of 2007, unemployment started to rise. This increase in unemployment came about because firms started to cut back on hiring, and so workers could not find jobs. Firm hiring rates continued to fall and hit their low point in early 2009, where they have remained. Why then have employment losses slowed? The reason is that the rate of layoffs and quits—what economists call the separation rate—has slowed. But declines in the separation rate cannot be viewed as a robust source of employment growth. To get a true expansion in employment and in the economy, the hiring rate has to pick up—and we have yet to see evidence that it will do so in the immediate future,” he said.
Perhaps the only positive in the economy is that inflation has been relatively tame. But, he warned, “Deposit institutions are holding over a trillion dollars of excess reserves (that is, over 15 times what they are required to hold given their deposits). These excess reserves create the potential for high inflation. Suppose that households believe that prices will rise. They would then demand more deposits to use for transactions. Banks can readily accommodate this extra demand, because they are holding so many excess reserves. These extra deposits become extra money chasing the same amount of goods and so generate upward pressure on prices. The households’ inflationary expectations would, in fact, become self-fulfilling.”
Federal government debt held by the private sector increased 30% since the start of 2008. “This debt can only be paid by tax collections or by the Federal Reserve’s debt monetization (that is, by printing dollars to pay off the obligations incurred by Congress),” Kocherlakota said. “If households begin to expect that the latter will be true—even if it is not—their inflationary expectations will rise as well.” But, he called this scenario “unlikely.”
