NEW YORK – Economic recovery will be moderate this year with some strengthening next year, but we will not see a V-shaped recovery that typically follows a deep recession, Federal Reserve Board Vice Chairman Donald L. Kohn said today.
Tight credit conditions and impaired securitization markets despite improved financial conditions will slow the recovery, Kohn told the National Association for Business Economics, according to text of his speech, released by the Fed.
Also, “difficult conditions in labor markets and the consequent implications for household incomes are important reasons for my expectation that the recovery in overall economic activity moving into next year will be restrained.” He said unemployment rates could hit 10%.
“The substantial rise in the unemployment rate and the plunge in capacity utilization suggest that the margin of slack in labor and product markets is considerable,” he added. “The resulting competitive pressures on workers and firms have contributed to a substantial decline in inflation, with both headline and core personal consumption expenditures (PCE) prices decelerating significantly over the past year. Although this year's backup in energy prices has boosted headline consumer price inflation, the levels of broad measures of consumer prices are still below where they were a year ago.” Also, weak demand have kept prices down.
“Even as the economy begins to recover, substantial slack in resource utilization is likely to continue to damp cost pressures and maintain a competitive pricing environment,” he said. “I expect that the persistence of economic slack, accompanied by stable longer-term inflation expectations, will keep inflation subdued for some time. Indeed, if inflation expectations were to begin to ratchet down toward the actual inflation rates that we have experienced recently, inflation could move appreciably lower.”
The increase in housing starts in the next year, Kohn said, will be “relatively subdued,” while excess capacity in the business sector will also tamp the recovery. Inflation will remain subdued, he added, with “the risk of further declines in underlying rates of inflation will be greater than the risk of increases” for awhile. “That outlook rests importantly on two judgments: First, that the economy will be producing well below its potential for some time, which will directly restrain production costs and profit margins; and second, that inflation expectations are more likely to fall than rise over time as the level of real activity remains persistently less than its potential and actual inflation remains low.”
The FOMC expects unusually low levels of interest rates for an extended period, Kohn noted, but, he warned the panel will “be looking carefully at any evidence that portends a potential pick up of inflation.”
While uncertainty about the economy is not as great as it was several months ago, “uncertainty remains quite high; we are still in largely uncharted waters when it comes to fully understanding how our economy will recover from the severe recession and financial disruptions of the past several years and how that recovery and inflation will be affected by the extraordinary actions we took,” he said. “We need to base policy on our best estimate of the evolution of inflation and output relative to our objectives, but we also need to be ready to adjust our plans if events don't turn out as predicted in either direction. We have the tools to exit our unusual policies when the time comes. And we must act well before demand pressures or inflation expectations threaten price stability.”
