NEW YORK – Uncertainty from several fronts will push down GDP growth and prevent a V-shaped recovery, Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said today.
Calling for GDP near 3% this quarter and around 3.5% for the next two years, Kocherlakota said a tax increase necessary to offset the rise in public debt, bank lending woes furthered by uncertainty over financial regulatory reform, and the crisis in Europe will all spark uncertainty that will damp GDP growth.
Labor market news, Kocherlakota told the Eau Claire Area Chamber of Commerce, according to prepared text of his remarks, which were released by the Fed, is “confusing” as jobs seemingly were created, yet the jobless rate rose.
“So, what happened in April is that the growth rate of the labor force was actually faster than the growth rate of the employed,” he said. “My own tentative interpretation is that both of these pieces of information—the increase in the number of jobs and the increase in the size of the labor force—actually indicate that the labor market is starting to function better. Of course, our eventual goal is to have the extra searchers also be able to find jobs. On that score, I believe that the recovery will be slower than we would like. I would be surprised if unemployment were to fall below 9 percent before the end of 2010 or below 8 percent by the end of 2011. There were many big surprises during the past recession, but I believe that the remarkable increase in labor productivity was one of the most important. The growth in productivity has allowed firms to expand production without commensurate increases in hiring.”
Inflation provided good news, Kocherlakota said, with a 1.5% annualized rate of inflation in the first quarter expected to be maintained throughout the year, and remaining under 2% for the next five years.
With the Fed funds rate target near zero, Kocherlakota joked, “This means that the question, `What’s going to happen to interest rates?’ is an even less interesting one to use at cocktail parties than usual.” But he interpreted the FOMC’s statement about “exceptionally low levels of the federal funds rate for an extended period” to mean “We’re keeping interest rates low to keep unemployment from going any higher, and we feel safe in doing so because there seems to be little threat of inflation.”
He added, “I think that most or maybe even all of the members of the FOMC and the other presidents agree that current conditions necessitate interest rates near zero.”
But turning to “an extended period,” Kocherlakota said, “There has been some public disagreement about this forecast, and it is one reason given by the president of the Federal Reserve Bank of Kansas City for his dissenting from the statement at the last three meetings.
“As for my own view, had I been a voter, I would have voted in favor of the FOMC statement in April. I do think that readers of the FOMC statement should pay very careful attention to its explicit conditionality. The statement says that the committee will raise interest rates if economic conditions change appropriately—whether that’s in three weeks, three months, or three years.”
As for the mortgage-backed securities on the Fed’s balance sheet, Kocherlakota said, they are not a credit risk, but “expose us to interest rate risk and prepayment risk.”
Also, the Fed doesn’t “want to be seen as a long-term prop for the housing sector,” he said. Many of the MBSs in the Fed portfolio won’t mature for 30 years, and even with prepayment “we’ve estimated in Minneapolis that even 20 years out, the Fed is likely to have something like $250 billion of MBS holdings. This means that if we want to normalize our balance sheet sometime in the next two decades, we will need to sell some of our MBS holdings. Doing so is challenging—we want to be careful not to cause large jumps in long-term interest rates, and especially not in mortgage rates. But I believe that we can do so, as long as we commit to a sufficiently slow pace of sales. I’m optimistic that we can get MBSs off our balance sheet by 2020 at the very latest.”
In the past two and a half years the federal debt in private hands has risen more than 50%, he said. “This extra debt can only be paid in one of two ways. First, Congress can cut spending or raise taxes. Second, the Fed can print extra money to pay off extra obligations and thereby create inflation.
“So, we rely on Congress to do its job and practice fiscal responsibility if we are to be able to do ours,” he added.
