NEW YORK – While obstacles remain to recovery, Federal Reserve Bank of Cleveland President Sandra Pianalto said Tuesday the U.S. is near price stability, but remains far from the 6% unemployment rate she views as full employment.
“In my view we are close to price stability, which I define as an inflation rate of 2% over the medium term. But the economy remains far away from full employment,” she told the Chamber of Commerce in Wooster, Ohio, according to prepared text released by the Fed. “According to my outlook, an unemployment rate of 6% will take longer to reach, perhaps even four or five years. Sooner, of course, would be better for everyone, but I want to be on a path toward full employment that doesn’t create an inflation problem down the road. Keep in mind that, inflation over the longer run is primarily determined by monetary policy, whereas the maximum level of employment is largely determined by nonmonetary factors that may change over time.”
Accommodative monetary policy has helped, but the recovery “has been frustratingly slow,” she said. Still, obstacles continue to hold back growth. “Housing markets continue to be depressed. The government sector has been reducing spending and employment. Add to the mix that Europe could well be headed for recession, which will negatively affect our exports,” Pianalto said.
Also, uncertainty is a restraining factor. Pianalto said business leaders “tell me that uncertainty is making them more cautious. There are uncertainties regarding the resolution of federal, state, and local budget problems, which will translate into tax and spending issues. Then there are also regulatory uncertainties: healthcare, environmental, and financial reform, to name just a few.”
But it’s weak demand that keeps businesses from hiring and expanding. “Indeed, consumer spending has been much softer than normal in a recovery period. It has grown only about half as much in this recovery as it did in previous recoveries,” she said.
Still Pianalto sees moderate recovery to continue, with GDP growth near 2.5% this year and 3% next, with inflation below 2% in the first half of this year.
Noting that the Fed’s goal is not zero unemployment, which, she said is unattainable, but rather the “natural rate of unemployment.”
“My staff and I currently estimate that the natural rate of unemployment is somewhere around 6%,” she said. “Given my current outlook for economic growth of 2.5% for this year and 3% for next year, it is going to take four to five years to reach that rate.”
The long time span to reach the natural rate of unemployment results from the nation still having a high level of unemployment, slow growth restrains job creation, and matching workers with available jobs takes longer.
“Even if we continue to generate 200,000 jobs each month, as we did in December, it would still be four years before we reached 6% unemployment,” Pianalto said. “And that estimate assumes that the many people who stopped looking for work in the recession will not return to the labor force. If they do, as is typical when times get better, four years may be a conservative estimate.”
Pianalto said monetary policy actions take effect with a lag, and first impact spending, then output, employment and finally inflation. “Consequently, as a policymaker I recognize the different lags at work as monetary policy affects the economy, as well as what monetary policy can and cannot do. Therefore it is important to form views about how the future is likely to unfold.” The Fed does this through economic models and speaking to businesses.
“As we all know from our own first-hand experiences, our current economic circumstances are remarkably unusual, and that fact requires us to conduct monetary policy differently,” she said. The federal funds rate has been near zero since early 2008. As a result, “easing monetary conditions further required us to employ some different techniques,” including “purchasing large quantities of U.S. Treasury securities and mortgage-backed securities guaranteed by Fannie Mae and Freddie Mac.”
These alternate strategies “may not be as efficient” as lowering the fed funds rate, but will still get the job done. “Even though we have introduced some new techniques, we are still operating to achieve the same dual mandate of stable prices and maximum employment, we still have to make policy decisions based on forecasts, and we still have to wait for the effects of monetary policy to work their way through the economy.”
Addressing the belief that “today’s economic problems are fundamentally non-monetary, and therefore, policy solutions should be nonmonetary,” Pianalto said, policymakers must analyze what monetary policy cando, and the benefits and costs.
“In today’s monetary policy environment, it is a lot harder to calibrate exactly how accommodative monetary policy actually is as compared with the norms I am used to from before the financial crisis,” Pianalto said. “While it is true that the federal funds rate has been near zero for some time, some economic policy models indicate that monetary policy should be even more accommodative than it is today. And this is true even after accounting for the large scale asset programs the FOMC has initiated to compensate for the fact that the federal funds rate cannot go below zero.
“I have supported our policy decisions, and there is evidence that they have been effective. For example, an analysis published early last year by Federal Reserve Bank of San Francisco President John Williams and several economists at the Federal Reserve Board concludes that by the end of this year the expansion of the Federal Reserve's securities holdings since late 2008 results in an unemployment rate that is 1½ percentage points lower than what it would have been absent the purchases. They also conclude that the asset purchases most likely prevented the U.S. economy from falling into deflation,” she said.
She said she will continue weighing the costs and benefits of further policy actions and is “confident the Federal Reserve is making the most of its tools to move the economy in the right direction.”
