Chairman Ben S. Bernanke
Semiannual Monetary Policy Report to the Congress
Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C.
July 21, 2010
Chairman Dodd, Senator Shelby, and members of the Committee, I am pleased to present the Federal Reserve’s semiannual Monetary Policy Report to the Congress.
Economic and Financial Developments
The economic expansion that began in the middle of last year is proceeding at a moderate pace, supported by stimulative monetary and fiscal policies. Although fiscal policy and inventory restocking will likely be providing less impetus to the recovery than they have in recent quarters, rising demand from households and businesses should help sustain growth. In particular, real consumer spending appears to have expanded at about a 2-1/2 percent annual rate in the first half of this year, with purchases of durable goods increasing especially rapidly. However, the housing market remains weak, with the overhang of vacant or foreclosed houses weighing on home prices and construction.
An important drag on household spending is the slow recovery in the labor market and the attendant uncertainty about job prospects. After two years of job losses, private payrolls expanded at an average of about 100,000 per month during the first half of this year, a pace insufficient to reduce the unemployment rate materially. In all likelihood, a significant amount of time will be required to restore the nearly 8-1/2 million jobs that were lost over 2008 and 2009. Moreover, nearly half of the unemployed have been out of work for longer than six months. Long-term unemployment not only imposes exceptional near-term hardships on workers and their families, it also erodes skills and may have long-lasting effects on workers’ employment and earnings prospects.
In the business sector, investment in equipment and software appears to have increased rapidly in the first half of the year, in part reflecting capital outlays that had been deferred during the downturn and the need of many businesses to replace aging equipment. In contrast, spending on nonresidential structures–weighed down by high vacancy rates and tight credit–has continued to contract, though some indicators suggest that the rate of decline may be slowing. Both U.S. exports and U.S. imports have been expanding, reflecting growth in the global economy and the recovery of world trade. Stronger exports have in turn helped foster growth in the U.S. manufacturing sector.
Inflation has remained low. The price index for personal consumption expenditures appears to have risen at an annual rate of less than 1 percent in the first half of the year. Although overall inflation has fluctuated, partly reflecting changes in energy prices, by a number of measures underlying inflation has trended down over the past two years. The slack in labor and product markets has damped wage and price pressures, and rapid increases in productivity have further reduced producers’ unit labor costs.
My colleagues on the Federal Open Market Committee (FOMC) and I expect continued moderate growth, a gradual decline in the unemployment rate, and subdued inflation over the next several years. In conjunction with the June FOMC meeting, Board members and Reserve Bank presidents prepared forecasts of economic growth, unemployment, and inflation for the years 2010 through 2012 and over the longer run. The forecasts are qualitatively similar to those we released in February and May, although progress in reducing unemployment is now expected to be somewhat slower than we previously projected, and near-term inflation now looks likely to be a little lower. Most FOMC participants expect real GDP growth of 3 to 3-1/2 percent in 2010, and roughly 3-1/2 to 4-1/2 percent in 2011 and 2012. The unemployment rate is expected to decline to between 7 and 7-1/2 percent by the end of 2012. Most participants viewed uncertainty about the outlook for growth and unemployment as greater than normal, and the majority saw the risks to growth as weighted to the downside. Most participants projected that inflation will average only about 1 percent in 2010 and that it will remain low during 2011 and 2012, with the risks to the inflation outlook roughly balanced.
Colin Barr at Fortune:
Asked if he feared being out of bullets should the downturn intensify, Bernanke answered no, then rattled off the Fed’s three options for adding liquidity. He added that the Fed “needs to continue to evaluate those options.”
Bernanke’s choice of words suggests he isn’t eager to look dovish in front of a Congress that under pressure to take action on the massive U.S. budget deficit – even though the yield on the 10-year Treasury note has tumbled by more than a percentage point since April, easing fears of an investor flight.
Bernanke’s stance seems to preclude the oft-rumored cut in reserve interest rates — unless the bottom absolutely falls out of the recovery.
“To our minds, it would require a considerable further deterioration in the incoming data before the FOMC would realistically consider adding more stimulus to the mix,” Capital Economics analyst Paul Ashworth wrote in a note to clients Wednesday.
Even in that instance, Ashworth believes, the Fed’s first step would be to return to the policy it wound up this spring of purchasing long-dated U.S. government and agency bonds.
Annie Lowrey at The Washington Independent
Mike Shedlock at Favstocks:
Be prepared for Quantitative Easing Round 2 (QE2) and/or other misguided Fed policy decisions because Bernanke Says Fed Ready to Take Action.
Larry Kudlow at NRO:
Ben Bernanke threw a curveball today in his midterm report to Congress. The Fed view of the economy has been downgraded since its last report in February. This is not totally new news, since the June FOMC minutes reported this downgrade. However, “the majority saw the risks to growth as weighted to the downside.”
But here’s the disconnect. With no inflation and weaker growth, including stubbornly high unemployment, Bernanke mostly talked about an exit strategy that would shrink the Fed’s balance sheet by removing liquidity. This was the Fed’s bias last winter when the recovery looked stronger. Now that the recovery looks weaker, the stock market was hoping to hear Bernanke hint of an easier policy that would increase liquidity if necessary. Didn’t happen.
At one point today stocks were down 165 points, though they finished better, falling only 109 points. Gold fell $7 to $1,184, and the greenback rallied a bit. Bond rates continued to slide lower.
But I have a different view of this story. The Fed has injected $1.4 trillion of new money into the economy, of which about $1 trillion of excess reserves are unused and on deposit at the central bank. So, in other words, the economy has more liquidity than it knows what to do with. What’s the problem? All that excess money is not being used. This, I believe, is a fiscal problem, not a Fed problem.
Ryan Avent at Free Exchange at The Economist:
YESTERDAY evening, the Washington Post‘s Neil Irwin discussed the market’s reaction to expectations about Ben Bernanke’s Congressional testimony (taking place today and tomorrow):
For those of us who follow the Federal Reserve closely, it is sometimes shocking how poorly Wall Street seems to understand the central bank. The rumor Tuesday was that Ben Bernanke would, at his monetary policy testimony Wednesday, announce that the Fed is cutting its interest rate on excess bank reserves, now at a quarter percentage point, to zero.
This speculation, apparently, drove the stock market up in late trading. Yet it’s completely blinkered.
As Mr Irwin goes on to point out, Fed officials never announce policy moves in testimony, are extremely reluctant to shift policy between meetings, and have generally laid out conditions that might lead to a policy move—conditions that haven’t yet been met. And sure enough, Mr Bernanke’s prepared testimony for the Senate Banking Committee did little more than recycle the points he had previously made following the June FOMC meeting, including this bland guidance:
Of course, even as the Federal Reserve continues prudent planning for the ultimate withdrawal of extraordinary monetary policy accommodation, we also recognize that the economic outlook remains unusually uncertain. We will continue to carefully assess ongoing financial and economic developments, and we remain prepared to take further policy actions as needed to foster a return to full utilization of our nation’s productive potential in a context of price stability.
Naturally, markets flipped out, falling over 1% in the hour after the testimony was released. Beyond that, there is little to report. The Fed remains ready to act when things are worse, as things are currently not quite bad enough.
Daniel Indiviglio at The Atlantic:
Headlines are proclaiming that the stock market is down today due to Federal Reserve Chairman Ben Bernanke’s sobering Congressional testimony on the sluggish recovery. Even though headlines claiming that the stocks are down for ‘x’ reason are usually oversimplified and always annoying, Bernanke’s words likely had something to do with the market’s downward move this afternoon. Yet, anyone who follows the Fed and watched his testimony might find the market’s reaction surprising. Bernanke didn’t actually say anything that the Fed hadn’t expressed before. Had the market been ignoring Bernanke recently?