NEW YORK (MNI) – The following are excerpts from the remarks of New
York Federal Reserve Bank President William Dudley prepared Monday for
Fordham University’s Gabelli School of Business:

Put simply, growth in 2011 has been disappointing. We entered the
year with some momentum, spurred by fiscal and monetary policy stimulus.
GDP-the output of the U.S. economy-grew at a 3 percent annual rate from
mid-2009 through 2010. While hardly a blistering pace, this growth was
sufficient to add nearly 1 million jobs and reduce the unemployment rate
by a half percentage point during 2010. Then, during the first half of
2011, growth slowed abruptly to a 0.8 percent annual rate. Job growth
slowed so much that the unemployment rate rose back up to 9.1 percent.

Growth slowed partly because of temporary factors. As these factors
have subsided, growth has picked up. At the moment, the consensus
expectation for growth of real GDP in the third quarter-the first
estimate of which we’ll see on Thursday morning-is for an annual rate of
2.4 percent. But this is still quite disappointing relative to what we’d
like to see or what we normally might expect at this stage in the
economic recovery process.

Looking forward, I regard continued modest growth as the most
likely outcome. This sluggishness convinces me that other, more
persistent factors must also be holding back economic growth. And, given
the depressed level of household and business confidence and the
fragility evident in financial markets, I would also conclude that there
remain significant downside risks.

It is worth taking a moment to elaborate on these points. First,
what are the temporary factors that slowed growth in early 2011? Of the
items noted in the published notes from our FOMC meetings, two bear
special mention:

–Energy and commodity prices rose sharply over the six-month
period ending in May 2011. This sapped households’ real purchasing power
here and abroad, so they responded by both consuming less and cutting
savings.

–April’s tragic earthquake and tsunami in Japan disrupted many
global supply chains. For example, many automobiles assembled in the
United States contain Japanese-made parts. When Japan was unable to
produce these parts, U.S. vehicle production and sales slowed. I am
certain that parts shortages also affected other sectors here and
abroad.

These temporary factors are now waning. Energy prices are no longer
rising rapidly. Manufacturing growth has rebounded. Sales of cars and
light trucks have begun to recover. In addition, business investment in
new equipment and software is expanding, business investment in
nonresidential buildings is recovering, and export growth remains
healthy.

Nonetheless, the economy clearly entered the second half of 2011
with only modest forward momentum. What are the factors that are
preventing a more vigorous recovery? I’ll call attention to four:

–First, problems in the housing market are a serious impediment to
a stronger economic recovery. Residential construction — which
typically boosts economic activity during a recovery — is at a
standstill. Moreover, many homeowners are now consuming less because the
decline in house prices reduced their wealth and they are concerned that
the decline in home values and wealth may not be over. Mortgage rates
are at record lows and house prices no longer appear overvalued on
affordability measures. But obstacles to refinancing and access to
credit for home purchases are limiting the support provided by low rates
to house prices and consumption. Meanwhile, the large supply of
foreclosed homes for sale-and the prospect that unemployment and
negative equity will continue to feed the foreclosure pipeline-continues
to put downward pressure on home values. The risk of further house price
declines in turn discourages would-be buyers from entering the market.
Continued house price declines could lead to even more defaults,
foreclosures and distress sales, undermining wealth, confidence and
spending. Breaking this vicious cycle is one of the most pressing issues
facing policymakers.

–Next, cutbacks in employment and spending by state and local
governments intensified in 2011 and are likely to continue. Since
mid-2008, state and local governments have shed 600,000 jobs. Spending
adjusted for price increases is down by more than 2 percent in the past
year, led by cuts in investments, such as spending on roads and bridges.
Looking forward, states are likely to cut spending further as the
federal government stimulus aid to states peters out.

–In addition, by law now on the books, the federal
government will soon end much of the support it has been providing to
the economy through stimulus programs. In 2012, certain investment
incentives, emergency unemployment benefits and the reduction in
employee payroll taxes will all expire. These changes will likely lead
households to consume less and businesses to invest less for a while.
Furthermore, the new Budget Control Act calls for more sharp cuts in
federal spending. Our nation needs to get its public finances in order.
Done correctly, with a focus on the long term, this could support
confidence and growth. But it will be very important to avoid excessive
short- term cutbacks or tax increases that could harm the recovery.

–Finally, the sovereign debt crisis in Europe has weakened the
outlook for global growth and with it, U.S. exports. These problems have
also contributed to pressures in financial markets globally that have
resulted in a decline in stock market wealth. In addition, some
financial institutions are facing pressures to cut back lending. To
date, these effects have been much more acute in Europe than in the
United States, but there are spillovers to our nation, and we need to
monitor them carefully.

Thus, our economy continues to face some serious headwinds.

Without robust growth, the economy is more vulnerable to negative
shocks, which unfortunately seem to keep coming. It is like riding a
bicycle-at a slow speed, the bicycle wobbles and the risk of falling
rises. Politics here and abroad have not helped. The intense debate
around raising the debt ceiling and the subsequent downgrading of the
federal debt took a toll on household and business confidence. More
recently, the difficulties in Europe, along with lower U.S. growth
prospects made investors less inclined to take risks. So, we saw a major
stock market sell-off and widening credit spreads. All these events
increase the downside risks to the growth outlook.

Let me turn now to the inflation outlook. As you may know, the FOMC
has two charges: we are asked to promote stable prices as well as
sustainable growth. This has been a tough year for both parts of our
mandate. We’ve already discussed how unemployment is too high and the
challenges in reducing it. At the same time, inflation has risen more
than expected. Nevertheless, because monetary policy works with a lag,
we have to make policy based not on where inflation is today, but where
it is headed in the future. I believe that underlying fundamentals will
help to subdue inflation over the next few quarters.

As of August, the 12-month change for a broad measure of consumer
prices was 2.9 percent, almost double the 12-month change the year
before. However, the bulk of that increase was due directly to the
run-up of energy and other commodity prices that are very volatile,
which means they bounce around a lot.

Measures of the underlying rate of inflation have moved up too, but
by less and to levels broadly consistent with price stability. It is
important to remember that a year ago many experts were worried that
deflation-meaning a persistent, widespread decline in prices-might take
hold. Deflation tends to inhibit growth because families and companies
have a harder time paying down debt and tend to defer investments and
purchases when prices and wages are falling. Avoiding outright deflation
is a very good thing.

Some non-commodity prices have increased a bit more than expected
over the past months, but I expect those to subside, as well. Rising
rents for housing are likely be constrained by the large supply of
vacant homes. Likewise, the surge in prices of apparel and new vehicles
should soon be over.

Thus, barring more energy price jumps, which futures markets do not
anticipate, I expect the inflation rate to fall late this year and next.
All the fundamentals point in that direction. Many people are out of
work, so wage pressures are unlikely to rise. Corporate profit margins
are quite high, likely prompting greater price competition going
forward. Moreover, households’ inflation expectations remain well
anchored. This last point is of critical importance. It is much harder
to keep inflation in check if people begin to expect higher inflation.
By the same token, low and stable inflation expectations help us to
deliver low and stable inflation.

-more- (1 of 2)

** Market News International New York Newsroom: 212-669-6430 **

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,MAUDS$]