If the U.S. economy needs more stimulus, resuming the Federal Reserve's MBS purchase program “would probably be the best course of action,” according to San Francisco Federal Reserve President John Williams.
Speaking to the Chartered Financial Analysts Society of Hawaii's annual economic forecast dinner in Honolulu, Williams said the Fed may need to do more, “if the recovery falters or if inflation stays well below 2%,” according to a copy of his prepared remarks.
“Our statutory mandate is to achieve maximum employment and price stability. We are far short of maximum employment. And I expect inflation to fall this year below the 2% level that we view as consistent with our mandate,” Williams said. “This is clearly a situation in which we have to keep applying monetary policy stimulus vigorously.”
The Federal Open Market Committee (FOMC) has kept intrabank lending rates close to zero since 2008, but when that wasn't enough, the Fed has had to look for alternative ways to stimulate the economy. That included the purchase of more than $1.75 trillion in longer-term securities issued by the U.S. government and mortgage agencies, lowering the cost of borrowing across the board, “from mortgages, to business loans, to corporate debt,” Williams said.
The FOMC's public announcements that it expects to keep the federal funds rate exceptionally low at least through late 2014 “tells investors that short-term interest rates are likely to stay low for a long time, which then gets passed through to longer-term rates,” Williams said, but is not an absolute commitment to keep rates near zero. “It's simply the FOMC's current judgment about the best future course of policy. If the economic outlook changes, then the guidance could change too,” he said.
“Let me emphasize that the unusually stimulatory monetary policy now in place won't last forever. Eventually we will cut back the size of our securities holdings and raise our unusually low interest rate target,” he continued. “We've thought hard and communicated frequently about how to exit from these special conditions. The key point is that the economy currently needs an extraordinarily supportive policy. But we'll reverse course when the time comes to remove this support.”
Williams said that household finances, housing and credit are the forces holding back the economy's recovery and are likely to hold down spending growth for some time. “But let me emphasize, though—overall, things are getting better.”
When housing prices collapsed, American household wealth also plunged by about $6.5 trillion—more than 40% of the total size of the U.S. economy, Williams said. “Many people went from feeling rich to feeling poor, with neither the means nor the will to spend,” he said. Consumers began to deleverage, and the household saving rate climbed to about 6% of income from about 1% since the recession began.
Households are gradually repairing their finances and while higher saving is healthy in the long run, “in the near term, it puts a brake on spending and slows growth.”
The millions of real estate owned properties and preforeclosure shadow inventory “are acting like a weight keeping home prices from rising. The result is that new home construction and sales are still near the lowest levels recorded since the early 1960s.” Still, the housing sector “appears to have stabilized and is showing some signs of life,” Williams said.
In addition, consumer spending, which accounts for nearly 70% of all economic activity, is steadily growing and gross domestic product grew 2.25% in the second half of 2011. Williams predicted that GDP will grow another 2.25% in 2012, followed by growth of 2.75% in 2013.
While unemployment has declined by about 75 basis points over the past four months, Williams said his GDP projections won't keep bringing the unemployment rate down quickly. He expects unemployment to remain above 8% into next year and still be well over 7% for several years to come.
Meanwhile, tight credit is also slowing recovery. “Consumers who lack gold-plated credit scores and cash for a hefty down payment find it tough to get a mortgage,” Williams said. “That limits home sales and refinancing.”
“Fortunately, there are signs that credit conditions are easing a bit,” he added. “Already, corporations that can sell securities have great access to capital.”
“The policy actions the Fed takes will depend on how economic conditions develop. If circumstances change, our policies will adapt,” he said. “No matter the circumstances, I assure you that we at the Fed are doing everything we can to achieve the goals of maximum employment and stable prices.”
