NEW YORK – Despite recent improvement economic growth “remains disappointingly slow,” with continued “significant downside risks” and should growth slow greatly, “more policy accommodation could be advisable,” Federal Reserve Bank of Boston President and Chief Executive Officer Eric S. Rosengren said Tuesday, adding monetary policy should remain accommodative until the Fed’s dual mandate can be met in the near future.
“…Financial-market and economic conditions have been improving since the start of the year,” Rosengren told the National Institute of Economic and Social Research, according to prepared text of his remarks, released by the Fed. “Central banks have played an important role in encouraging more economic growth. In the United States, accommodative monetary policy has been essential to improving financial conditions, but growth remains disappointingly slow to date, and significant downside risks remain. Should growth slow down more than is expected, more policy accommodation could be advisable.”
Without better real GDP growth and decreased jobless rates, Rosengren said, “monetary policy may need to be more accommodative.” With unemployment too high and inflation likely to be below 2%, there remains “room for flexibility in the response of monetary policy as we receive additional information on current economic conditions.”
“Even if growth should improve more than expected in the U.S., the country will likely remain far from what anyone would consider full employment – so in my view policy accommodation should only be removed once it is clear that the Fed’s dual mandate can be achieved within a reasonable period of time.”
While the labor market has improved, spending data remain “very weak,” he said. Some would say that with improved job conditions, spending will follow, yet if one looks at spending, they could conclude that labor and financial market improvements can’t be sustained with 2% growth in the economy.
“It may take several quarters before we know which of these two perspectives is actually better reflective of the U.S. economy today,” Rosengren noted.
Central banks have taken “appropriate and necessary” actions, including foreign exchange swap line agreements and the use of non-traditional monetary policy tools. “However, many of these actions were ultimately necessary because supervisory and regulatory frameworks were not sufficiently macro-prudential,” he said, that is they didn’t “focus on risks, vulnerabilities, or dependencies that potentially could affect the financial system as a whole – versus just the safety and soundness of individual institutions. Ideally, central banks should not need to take actions to support continued financial intermediation, because financial institutions should be sufficiently resilient to ensure that even unusual financial-market stress would not impair effective intermediation. Recent events have highlighted that we remain far from achieving that goal.”
The settling of the European financial situation has lifted “some significant, imminent, downside ‘tail’ risks,” Rosengren said, “However, my enthusiasm is tempered by the challenges still facing Europe.”
States and local government spending has dropped, and also there’s been “unusually weak residential investment” even though interest rates are quite low.
Rosengren foresees 2% growth in real final sales for the first quarter “only slightly better than the average during the U.S. recovery to date.” Housing remains weak, and recent improvement “is likely to be subdued relative to historical experience.”
Labor market growth has been surprisingly stronger than it should be, but some of the drop in the jobless rate is due to workers leaving the labor force.
“Furthermore, only in recent months has the employment-to-population ratio improved and the payroll employment growth clearly exceeded the normal growth rate of the labor force. So the U.S. remains well below the employment levels that would be viewed as consistent with the maximum sustainable employment aspect of the Federal Reserve’s so-called dual mandate,” he said.
Turning to inflation, Rosengren noted the recent spike in oil prices, which he expects to be temporary, and he foresees total personal consumption expenditure inflation, and core personal consumption expenditure inflation to be below 2% through next year, assuming “Middle East tensions do not result in another sharp spike in oil prices.”
The Fed’s increased balance sheet has not significantly increased the money supply, he said, since “banks have not been lending out their holdings of excess reserves,” therefore, it “has not been inflationary, given the subdued bank lending environment.”
As for challenges to the economy, Rosengren pointed to geo-political risks that could oil price increases; “unsustainable” budget deficits in countries, including the United States; and “the continued fragility in our financial infrastructure.”
Regarding the financial infrastructure, Rosengren said the recession was fueled by the financial sector’s structure. A “structural flaw,” the dependence on short-term funding, remains, he added.
“Specifically, wholesale funding utilized by large global banks dried up during the financial crisis. As large banks sought to reduce their exposure to counterparties of concern, the term of loans made in the marketplace decreased, and the cost of short-term credit spiked,” he said. “And many of the problems were occurring outside of traditional depository institutions.”
The result, besides firms failing was “a run on prime funds, which in turn further impaired short-term credit markets.”
While he said he backs “significant reforms … being contemplated by the U.S. Securities and Exchange Commission,” Rosengren added, “money market funds will continue to be a potentially unstable source of U.S. dollar funding. From a financial stability perspective, we need to recognize the possibility of a deterioration in the ability or willingness of the money market funds to keep providing a dependable source of funds to counterparties.”
Rosengren said, “we need to get to the point of having a more resilient financial infrastructure that does not require central bank interventions during times of stress.”
