By Steven K. Beckner
(MNI) – Cleveland Federal Reserve Bank President Sandra Pianalto
Tuesday said that keeping the federal funds rate “exceptionally low” for
an “extended period” remains warranted by the likelihood of “subdued”
inflation and continued high levels of unemployment.
Pianalto, a voting member of the Fed’s policymaking Federal Open
Market Committee, said, however, that it will be “critical” for the Fed
to monitor incoming data due to the high degree of “uncertainty” about
the economic outlook.
Pianalto cited two “primary headwinds” impeding a robust recovery
in remarks prepared to the Economic Club of Pittsburgh: first,
“prolonged unemployment” and second, “a heightened sense of caution on
the part of consumers and businesspeople.”
Because of these “headwinds,” she said, “our journey out of this
deep recession will be a slow one.” And therefore, she indicated she is
not inclined to support tightening monetary policy unless that outlook
changes.
Pianalto said joblessness increased much more in the recent
recession than in prior ones, rising 5 percentage points. What’s
more, she said, people have been staying out of work longer.
“About half of those who are currently unemployed have been out of
work for at least six months,” she said, adding that “the longer someone
is out of work, the harder it is to find a job” and that this leads to
lost skills that could “dampen overall economic productivity for years.”
Turning to the second “powerful headwind,” she said “a deep
uncertainty about where the ‘new normal’ or baseline might be” has bred
“a heightened sense of caution.”
Among consumers, she said, “people’s attitudes about their own
prospects have fundamentally changed.” And “this has led many people to
delay major purchases until their circumstances are clearer.”
Pianalto said “businesses are also cautious” because they have “the
same high degree of uncertainty around their projections.”
“Most business leaders say that they’re not planning significant
hiring until there’s more clarity about how the recovery is going to
progress and about policies relating to health care, energy, the
environment, and taxes,” she said. “This caution translates into fewer
job opportunities, fewer equipment purchases, fewer building projects —
and on and on.”
Pianalto said prolonged unemployment and heightened consumer and
business caution “lead me to an outlook for relatively subdued output
growth through this year and next, with unemployment rates that decline
only gradually.”
And she said those two headwinds imply continued “subdued”
inflation, although she acknowledged that “the inflation outlook is
unusually uncertain when compared with historical norms.”
“Some observers are concerned about the likelihood of much higher
inflation,” she said. “Those who support this view see the possibility
of inflation expectations rising as a result of the public’s concerns
about the Federal Reserve’s expanded balance sheet at a time of very
large federal budget deficits.”
However, Pianalto made clear she agrees with “other observers who
place more stock in arguments that support an outlook for further
disinflation.”
“In emerging from this recession, there are three key elements that
lead me to conclude inflation will remain subdued: current inflation,
labor costs, and inflation expectations,” she said.
Pianalto said “recent evidence I am seeing puts momentum on the
side of disinflation, at least in the short run.” She pointed to the
federal government’s falling core inflation measures and to the
Cleveland Fed’s own “trimmed mean” and “median CPI” gauges. She said
both “have been on a disinflationary path since the middle of 2008, and
the prices of roughly 50 percent of the items we track in our market
basket of consumer expenditures have been declining over the past three
months.”
“In this economy, companies are really holding the line on prices
to boost their sales, and they can do that profitably in part because
labor costs are so restrained,” she added.
Pianalto also noted that rising productivity growth has held down
unit labor costs, helping to restrain wage-price pressures.
“In today’s labor market, wages are likely to be restrained by the
unemployment situation — labor supply far exceeds labor demand,” she
said. “Combining rising productivity with restrained wages causes the
cost of producing goods and services to fall.”
“In fact, the data show that labor costs have fallen by nearly 5%
since the fourth quarter of 2008, and many of my business contacts
continue to talk about wage and price reductions, not increases,” she
added.
What’s more, Pianalto said inflation expectations over the medium
to longer term “have remained anchored at near 2%.”
Given that outlook, Pianalto suggested there is no need to withdraw
monetary stimulus for a good while.
“For the next couple of years, I expect employment levels to remain
well below what I would consider full employment,” she said. “Similarly,
I expect inflation to only gradually drift up from its currently low
level but nonetheless remain subdued.”
And so, she concluded, “this outlook warrants exceptionally low
levels of the federal funds rate for an extended period of time.”
But she added a caveat: “That said, there is more uncertainty than
usual around my outlook, so it will be critical to monitor incoming
information and respond as necessary to promote economic recovery and
price stability.”
** Market News International **
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