By Steven K. Beckner

(MNI) – Cleveland Federal Reserve Bank President Sandra Pianalto
Thursday said that “disinflationary” forces and the prospect of only
“gradual” recovery with continued high unemployment will likely continue
to warrant “exceptionally low” interest rates “for an extended period.”

Pianalto, a voting member of the Fed’s policymaking Federal Open
Market Committee, said “the time will come” when the Fed will need to
tighten monetary policy but suggested that time remains some distance
off in remarks prepared for the Bonita Springs, Florida, Chamber of
Commerce.

In contrast to past recoveries, Pianalto said she foresees “a more
gradual rate of growth, and she added, “I also expect the unemployment
rate to stay above 9% until the middle of next year.”

Pianalto said a normal pace of recovery is being stymied by two
“headwinds”: “prolonged unemployment” and a “heightened sense of caution
on the part of consumers and businesspeople.”

“Staggering as the unemployment numbers are, what is even more
troubling is how long people are remaining out of work,” she said.

Whereas in past recoveries the average duration of unemployment
peaked at 21 weeks, “today the average is already over 30 weeks,” she
noted, adding that this will tend to hurt productivity in coming years.

“Another exceptional headwind in this recession is a heightened
sense of caution, driven by a deep uncertainty about the direction of
the economy and where the ‘new normal’ or baseline might be,” Pianalto
said.

Illustrating this sense of caution, she said, “People are delaying
major purchases until their circumstances are clearer … . Consumers
remain uncomfortable making longer-term commitments, and they are saving
more.”

Pianalto said she is “seeing the same kind of cautious behavior in
large and small businesses … . We have been meeting with large numbers
of business owners over the past couple of months, and they tell us they
are not planning to hire many new workers, which just makes it more
difficult for the unemployed to find work and keeps the unemployment
rate high.”

What’s more, she said she is witnessing “the same kind of
caution … when companies consider whether to build or renovate a
building, or buy a piece of equipment. Even well-established companies,
with access to funding, are deciding in this uncertain environment to
take a wait-and-see approach.”

“This uncertainty has caused some businesses either to delay
investment or to think about investing abroad — and these are the
healthier companies,” she continued. “Many business owners are merely
trying to hold on, or are trying to find ways to finance their
businesses at a time when lenders are being more cautious.”

Given those trends, she said, “Frankly, this recovery has not been
feeling much like a recovery and will, in my opinion, proceed more
slowly than usual.”

In that climate, Pianalto suggested, there is no reason for the Fed
to worry much about inflation for awhile.

“The current weak economic environment is altering firms’ pricing
decisions,” she said. “Indeed, the incoming data on consumer prices
already point to significant downward pressures.”

The Cleveland Fed tracks two measures of inflation — the ‘trimmed
mean’ and the median consumer price index. And Pianalto said “both of
these series have been on a disinflationary path since the middle of
2008, and the prices of more than 40% of the items we track in our
market basket of consumer expenditures have been declining over the past
six 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 went on. “At this point, I expect
inflation to remain subdued, and inflation expectations in the financial
markets are pointing to stable rates over the next two to three years.”

Pianalto concluded by not just echoing but projecting forward the
FOMC’s decision last week to leave the federal funds rate target at 0 to
25 basis points and to declare that it will likely stay down “for an
extended period.”

“Combining this inflation outlook with my outlook for a gradual
recovery warrants maintaining exceptionally low levels of the federal
funds rate for an extended period,” she said.

Pianalto added that “still, the time will come when it will be
appropriate for us to begin removing some of our policy accommodation.”

“It is always a challenge to get the timing right, because our
policy decisions have to be forward looking,” she said. “And the process
will be more complicated than usual this time.” But she said the Fed
has developed tools to “carefully manage the size and composition of our
balance sheet.”

“Due to the unusual nature of this process, it will also be
important to communicate as clearly as possible both our outlook for the
economy and inflation and our strategy for removing our policy
accommodation,” she said. “Clarity will help avoid adding monetary
policy uncertainty onto the already large underlying economic
uncertainties.”

** Market News International **

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