NEW YORK – The U.S. economy is recovering modestly, and although in the past few months it has hit “the summer doldrums,” moderate improvement should continue, according to Federal Reserve Bank of Philadelphia President and Chief Executive Officer Charles I. Plosser.
“The tail winds that helped propel the economy earlier in the year have waned,” Plosser told the Greater Vineland Chamber of Commerce according to prepared text released by the Fed. “Yet such a slowdown is not unusual in the early phases of recovery, and we should not overreact to data that can be volatile and may be revised over time.”
While “modest” and “disappointing,” Plosser said it’s not surprising that the recovery isn’t stronger. “We are emerging from one of the worst economic and financial crises in 70 years. Economists have been saying for over a year now that this recovery would be a modest one and that it would be a long climb out of a very deep hole. And as we are all painfully aware, the economy continues to face some real challenges. Most troubling is the unemployment rate, which remains high at 9.6 percent. Still, despite a downgrade in the outlook for the second half of this year, I expect we will avoid slipping back into recession. And with continued economic recovery, we will gradually return to healthier labor markets.”
Plosser said he believes the recovery is sustainable and the outlook is positive, despite growth dropping from an average of 3.5% in the first three months of the recovery to the current estimated 1.6% rate.
Turning to the local area, Plosser noted the monthly Philadelphia Fed Business Outlook Survey showed weaker manufacturing activity during the summer, and a negative reading in August was its first since July 2009. While the index improved in September, it remained negative.
“We should not read too much into monthly movements,” Plosser said. “The current activity index has, after all, dipped below zero in the midst of expansions before, notably in 2002 and 2003 as we were coming out of the last recession. On the national level, manufacturing continues to expand. However, the data suggest that the pace of activity remained sluggish over the course of the summer.”
Also, while firms are optimistic about the near future, they are not as positive as they were earlier in the year, he said.
Plosser said the slowdown was a result of three “temporary” factors. First, homebuyer tax credits drew buyers into the market, but when the credit ended, a decline ensued. Second, census workers were hired on a temporary basis, and their dismissals skewed employment. Finally, the European sovereign debt crisis “damaged the fragile confidence of financial markets. The lingering effects of these factors all contributed to our summer doldrums.”
“Monetary policy is not a magic elixir that can solve every economic ill,” Plosser warned. “Doctors must diagnose the disease correctly if they are to prescribe the correct medicine. Otherwise, they could do the patient more harm than good.”
Monetary policy can’t “fine tune employment nor can it solve the sorts of geographic, sectoral, or skill mismatches,” he said.
“Thus, it is difficult, in my view, to see how additional asset purchases by the Fed, even if they move interest rates on long-term bonds down by 10 or 20 basis points, will have much impact on the near-term outlook for employment,” he said. “Sending a signal that monetary policymakers are taking actions in an attempt to directly affect the near-term path of the unemployment rate, and then for those actions to have no demonstrable effects, would hurt the Fed’s credibility and possibly erode the effectiveness of our future actions to ensure price stability. It also risks leading the public to believe that the Fed is seeking to monetize the deficit and make it more difficult to return to normal policy when the time comes.”
While Plosser said he is “not particularly concerned about low inflation per se,” he said monetary policymakers need to keep “vigilant to ensure that neither disinflationary trends nor inflationary trends lead to an unanchoring of inflation expectations, which would undermine the return to price stability in the medium to long run.”
In the unlikely event deflationary expectations materialized, Plosser said he “would support appropriate steps to raise expectations of inflation, including, perhaps, aggressive asset purchases coupled with clear communication that our goal is to combat deflationary expectations. But for such a strategy to be successful, the public must believe that the Fed can and will act to combat those expectations. The Fed must be credible. Protecting that credibility is why, based on my current outlook, I do not support further asset purchases of any size at this time. As I said earlier, asset purchases in our current economic environment can do little if anything to speed up the return to full employment. But if the public believes that they can and is disappointed, it may have less confidence that the Fed will act to raise inflationary expectations if needed. Because I see little gain at this point, and some costs, I would prefer not to engage in further asset purchases at this time.”
