NEW YORK – High unemployment and low inflation warrant “exceptionally low levels of the federal funds rate for an extended period of time,” Federal Reserve Bank of Cleveland President and CEO Sandra Pianalto said today.
However, she noted, much uncertainty exists, so it will be necessary to monitor economic conditions closely going forward.
“For the next couple of years, I expect employment levels to remain well below what I would consider full employment. Similarly, I expect inflation to only gradually drift up from its currently low level but nonetheless remain subdued, Pianalto told the Economic Club of Pittsburgh, according to prepared text of her remarks, which were released by the Fed. “In my view, this outlook warrants exceptionally low levels of the federal funds rate for an extended period of time. That said, there is more uncertainty than usual around my outlook, so it will be critical to monitor incoming information and respond as necessary to promote economic recovery and price stability.”
Pianalto said the recovery will be slow because of prolonged unemployment and extreme caution being shown by both consumers and business owners. The job losses in this recession, she added, have been “more severe” than typical during a downturn.
“Typically, during a recession, for each 1 percent that GDP falls, the unemployment rate ticks up by about seven-tenths of a percentage point. In this recession, GDP fell by 4 percent, so you would expect unemployment to rise by a little less than three percentage points. Unfortunately, it shot up by more than five percentage points, which means an extra one-and-a-half million people lost their jobs compared with our historical experience,” she said.
Another factor is the length of unemployment, with nearly half of those not working today having been out of work for at least six months, which makes it harder to find a job.
“The second powerful headwind in this recession is a heightened sense of caution, driven by a deep uncertainty about where the `new normal’ or baseline might be,” Pianalto said. “This has led many people to delay major purchases until their circumstances are clearer. While home sales have risen slightly as of late, overall sales have fallen by more than two million since 2006. Car sales are also still down to an annualized rate of under 12 million instead of the 16 million or more seen in the years before the downturn.”
Businesses are refusing to hire more people “until there’s more clarity about how the recovery is going to progress and about policies relating to health care, energy, the environment, and taxes.”
Inflation will remain subdued, she said, because current inflation in the short-term has “momentum on the side of disinflation,” as core inflation has fallen during the past year. “Core inflation measures are fairly good predictors of near-term inflation because inflation itself tends to move sluggishly,” she noted.
Also, unit labor costs should be low as “wages are likely to be restrained by the unemployment situation -- labor supply far exceeds labor demand. Combining rising productivity with restrained wages causes the cost of producing goods and services to fall. In fact, the data show that labor costs have fallen by nearly 5 percent since the fourth quarter of 2008, and many of my business contacts continue to talk about wage and price reductions, not increases,” Pianalto said.
Finally, inflation expectations remain near 2%, so inflation shouldn’t be a problem going forward.
