WASHINGTON (MNI) – The following is the text of a speech delivered
by Richmond Federal Reserve Bank President Jeffrey Lacker to the
University of Baltimore’s Merrick School of Business Thursday night:
It’s a pleasure to speak on the economy today. Like many of you, I
almost dread picking up a newspaper in the morning and seeing headlines
about natural disasters and new outbreaks of fighting around the world.
And even when the subject is the economy, the news is full of risks,
surging oil prices and a broken Federal budget. I don’t want to minimize
these risks, which are real. But I also don’t want to lose sight of an
economy that is firmly in recovery mode, and the fundamentals for future
growth are strong. Before we look at the economic outlook in more
detail, I would like to emphasize that these remarks are my own and the
views expressed are not necessarily shared by my colleagues in the
Federal Reserve System. I am grateful to Roy Webb and Andy Bauer for
assistance in preparing this speech.
Let me begin by setting the stage. In 2008 and through the first
half of 2009, we experienced the worst recession since the Great
Depression. We saw growth turn positive again in July 2009. Our best
measure of overall economic activity, gross domestic product or GDP,
increased at a modest 2.9 percent annual rate over the next six
quarters. Many observers were disappointed with that modest growth,
which was barely above the long-run trend rate that results from
population growth and productivity growth. But at least real GDP has
improved, since its level is now above its previous peak in the fourth
quarter of 2007. Other important indicators of growth have not
recovered. The number of employees on nonfarm payrolls has risen by 1.4
million persons in the last 15 months, but that increase is dwarfed by
the 8.7 million jobs that were lost in the previous two years. It’s fair
to say that we have a ways to go before we will fully recover from what
many are calling the Great Recession.
A natural question is whether growth could be stronger. After all,
we can remember other times when the recovery from a recession was much
more rapid than this current recovery. Consider the recoveries from the
other two deep recessions in the postwar period, the recessions of
1981-82 and 1974-75. In the first six quarters after those recessions
ended, real GDP growth averaged a 6.3 percent annual rate. Accompanying
that output growth, job growth averaged 4.5 million persons in those two
recoveries.
Two factors account for much of the sluggishness of this first
stage of the recovery. The most obvious is the collapse of housing
construction. We built too many houses in the boom years from 1995 to
2005, and many of those houses are now vacant and are pretty good
substitutes for new construction. As a consequence, residential
investment fell by 57 percent from the end of the housing boom to the
end of the recession, and has fallen further in this recovery. In
contrast, residential investment increased an average of 40 percent in
the first year of recovery following the two recessions I mentioned
earlier.
While housing is the most obvious factor dampening this recovery,
residential investment accounts for only 2.4 percent of GDP at this
point. A much larger factor is consumer spending, which accounts for
over 70 percent of GDP. In the first five quarters of this recovery,
consumer expenditures increased at an annual rate just below 2 percent.
This is in contrast to the two other recessions, where household
spending grew by an average of 6- percent in the first year of
expansion.
Thus a key to the outlook is consumer behavior. At over two-thirds
of GDP, it is impossible to imagine a robust recovery without a
substantial advance in consumer spending. And it is easy to understand
why consumers were cautious at the beginning of the recovery. A large
number of households experienced unemployment during the recession, and
many more were uncertain about their job security. Wage growth fell
during the recession. Housing prices declined, in many cases
unexpectedly, significantly reducing the value of housing equity on the
consumer balance sheet. Stock prices declined sharply during the
recession. It should not be too surprising that consumers responded to
this adversity by deferring nonessential spending and rebuilding their
balance sheets. That behavior is reflected in statistics such as
personal saving, which was slightly below 2 percent of income in
mid-2007 but was slightly above 6 percent of income at the end of the
recession.
Some important fundamentals underlying household spending plans
have improved significantly since the recession’s end. New claims for
unemployment insurance have trended down since last summer. The
unemployment rate has fallen by 1.3 percentage points from its peak, and
as a result, those who are employed have reason to be more confident in
their job security. Employment has picked up, with growth in the last
two months averaging slightly better than 200,000 jobs per month. The
employment components of the Institute for Supply Management’s monthly
surveys of manufacturing and nonmanufacturing activity are at extremely
high levels, signaling broad gains in labor market conditions. The stock
market has more than doubled from its recession low point, and the net
worth of households has increased by $8 trillion since early 2009. As
these fundamentals have improved, so has consumer spending. Retail sales
rose 5.2 percent in the first year of recovery, and in the next nine
months improved at a 9.9 percent annualized growth rate.
I would stress that this higher pace of consumer spending is
solidly grounded in improving fundamentals. Thus I expect robust growth
to persist, as consumers see continuing improvements in job markets,
incomes and wealth. Moreover, households have deferred nonessential
spending for several years and a stock of pent-up demand has built up;
as they gain confidence, it is likely they will draw down that stock and
boost spending as a result.
Thus I see consumer spending as an important part of the recovery,
but there are other areas of strength as well. Exports of goods and
services have risen 18 percent since the end of the recession, adding 2
percent to real GDP growth. Yes, exports fell in February, as reported
yesterday by the U.S. Bureau of Economic Analysis, but they remain well
ahead of the fourth quarter’s pace. Moreover, the key fundamental factor
for export demand is growth abroad, and here the prospects are
excellent. Although growth in the highly industrialized economies has
been similar to domestic growth, many less developed economies are
growing very rapidly. Especially notable are the two most populous
countries; China’s GDP grew 9.7 percent last year and India’s GDP grew
8.3 percent. Again, this growth is solidly based, as these countries are
deploying a large labor base more effectively. Japan’s growth miracle
following World War II lasted for several decades, and the current crop
of rapidly growing economies can look forward to several decades on the
fast track. As they grow, they will buy more of our products. Consumers
who join their middle class will buy goods we make that were formerly
luxuries, from pharmaceuticals to motion pictures. Demand for our
agricultural products will rise. Most importantly, newly industrializing
economies will want to acquire more capital goods in order to allow
workers to move into more productive activities. For all of these
reasons, export demand is likely to contribute strongly to U.S. growth
for the foreseeable future as we produce goods and services that the
world wants to buy, especially the most rapidly growing parts of the
world.
Business expansion also should make a significant contribution to
growth this year. Investment in equipment and software has grown 22
percent since the end of the recession. Opportunities to streamline
business processes and reduce costs through productivity-enhancing
investments appear to be widespread. The pickup in demand growth also is
providing further encouragement for capital spending plans. All told,
the economy has a lot going for it.
At the same time, there are still substantial challenges ahead.
Housing activity remains depressed. Given the large inventory of vacant
homes and the ongoing foreclosure wave, home prices are likely to remain
under pressure, and the best case for residential construction would be
a slow, uneven advance.
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** Market News International Washington Bureau: 202-371-2121
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