NEW YORK – With labor markets still soft and businesses unable to increase prices, the Fed is likely to keep monetary policy accommodative in order to continue to spur recover, Federal Reserve Bank of Boston President & Chief Executive Officer Eric S. Rosengren said today.
“Our research and analysis at the Boston Fed suggests that with significant capacity in labor markets, wages and salaries and the ability of businesses to increase prices are all likely to be restrained, resulting in little immediate inflationary pressures,” he told a Connecticut Economic Summit in Hartford, according to prepared text of his remarks, which were released by the Fed. “In my view this should allow for accommodative monetary policy to continue to support the economy until the underlying demand of consumers and businesses becomes self-sustaining.”
Financial markets have improved from a year ago, Rosengren added. “Interest spreads reflecting a `panic premium’ on risk have narrowed to more normal levels, markets have resumed much more normal trading patterns, and the Federal Reserve is likely to be able to wind down many of its emergency lending facilities without any adverse impacts, as soon as next month – as the Federal Open Market Committee affirmed in its statement last month.”
However, the economic recovery hasn’t been strong, with growth still quite slow. “It seems to me that growth will be positive, but slow enough that unemployment remains much higher than I would like,” he said. “I would be happy if in hindsight it is clear I have been too pessimistic. But as I see it, the economy faces three significant `headwinds.’”
First, Rosengren said, the banking crisis has abated, but problems in the system remain, which has traditionally held back growth. Banks have loaned less money and businesses are reluctant to add debt to their balance sheets.
Next, consumers, in addition to businesses, will also hold back on spending. “Consumption will continue to be subdued, as consumers are fully aware that housing prices are well off their peak, unemployment rates are high, and home foreclosures are continuing. Consumer caution and the desire to rebuild savings will likely result in some increase in the savings rate, which is of course good in the long run but dampens growth in the short term,” Rosengren noted.
“The third headwind involves the fact that recessions this severe have broader ramifications for labor markets,” he said. “Workers become discouraged and leave the labor force, while the skills of workers that are unemployed for long periods may atrophy, and new entrants in the labor market often have to settle for jobs at levels below what they would be offered in a more robust economy.”
In fact, he suggested, most Americans gauge economic prospects by job growth rather than growth in GDP. The last two economic recoveries featured slower “employment response” than the two prior recoveries. “And unfortunately the financial headwinds, lingering labor market problems, and a cautious attitude of consumers and businesses in the wake of the financial crisis make it likely that recovery in employment terms will also be slow this time,” he said.
