Fed's Dudley sees the Fed as the most significant cause of economic growth

New York Fed's Bill Dudly pimps the Fed's current policy to an increasingly sceptical audience.  In remarks during a briefing on regional economic conditions Monday, he states that conditions are ripe for a recovery, most notably because of all the money printing that went on at the Fed.  So now the Fed is responsible for the economic recovery, even though he acknowledges that growth will have to be much faster than it currently is. Full remarks via IMN
To provide context, let me first comment on national economic conditions. Since the Great Recession ended in 2009, the economy has grown at a modest pace. When we last met, in October, the available data showed that we hit a soft patch at mid-year. The recovery had slowed, extending the time before employment and inflation could be expected to return to levels consistent with the Federal Reserve's dual mandate. And, with the loss of economic momentum, downside risks had increased.

In order to foster greater economic momentum, reduce downside risks and speed up the return to more normal levels of unemployment and inflation, in early November the Federal Reserve announced its intention to purchase $600 billion of Treasury securities. These purchases helped to ease financial conditions, thereby stimulating economic activity.

More recently, we have seen signs of a pick-up in the pace of growth, with activity in the second half of 2010 turning out to be considerably stronger than most analysts expected. Real final sales grew at a 4 percent annual rate over the second half of 2010, up from 1 percent over the first half, led by surprisingly strong growth of consumer spending, continued strong growth of exports and slower but still healthy growth of business fixed investment.

Several notable forces combined to encourage the resumption of stronger growth. On the policy side, as I mentioned, the Federal Open Market Committee provided further stimulus through purchasing Treasury securities. This, plus the lagged effects of its previous measures, helped to improve financial conditions. Also, the Board of Governors' Senior Loan Officer Opinion Survey indicates that, while the absolute level of lending standards remains tight, banks did begin to ease standards somewhat in the second half of 2010.

The pick-up in the economy has occurred despite renewed weakness in the housing market. Home prices have softened anew and construction activity remains stuck at a very low level, likely reflecting the continued large supply of unsold homes. We believe that it will take more time, perhaps as much as another year, for enough of these homes to be bought that residential construction might begin a meaningful recovery.

On the labor front, the most recent employment report for January 2011 is quite difficult to interpret. Only 36,000 nonfarm payroll jobs were added, well below expectations. Yet, we get a very different perspective from the unemployment rate, which fell by 0.4 percentage points for the second month in a row and now stands at 9.0 percent. Job growth was undoubtedly held down by the severe winter storms that affected many major cities, including our own. The decline in the jobless rate was not an unmitigated positive, as a significant part of this decline was due to fewer people looking for work.

Thus, neither the disappointingly slow job growth nor the welcome steep drop in unemployment seems to paint the full picture. The truth lies somewhere in between. Despite the stronger job growth that we expect in the months ahead, we will continue to have a substantial amount of slack in our labor markets that will take time to absorb.

At this point, while the soft patch is over and the risk of a double dip has subsided, the economy still faces headwinds as a result of the aftermath of the financial crisis, the housing bust and the high level of unemployment that still prevails. As banks and other financial institutions seek to strengthen their balance sheets and avoid future credit losses, they may keep credit conditions tighter than normal. In addition, many consumers' borrowing options may be limited by their impaired credit histories, and the recovery is not getting the strong boost from home construction that most previous recoveries have benefited from. Furthermore, as I will discuss later, households are still feeling the financial impact of lost wealth and jobs, which makes some cautious about spending and investing.

The economy is healthier, but it is not yet well. In order to reduce joblessness significantly over the coming quarters, the economy needs to grow at a considerably faster rate than we have seen so far in this recovery.

I am happy to say that we believe that conditions are in place for such higher growth in 2011 and 2012. We entered this year with a fair amount of momentum. Business and household spending has strengthened, presumably reflecting greater confidence in the economic outlook and progress in the repair of household balance sheets. Businesses are expanding their investments in equipment and software at a healthy pace. And, their spending on nonresidential structures, such as office and factory space is no longer contracting as sharply as it was a year ago. Further support comes from the agreement by Congress and the administration to postpone some tax increases, to reduce payroll taxes temporarily and to extend unemployment benefits. In addition, our exports continue to expand, supported by strength in demand abroad, particularly in Asia.

Higher growth, a steady reduction in spare capacity in the economy and continued stability in inflation expectations should also slowly begin to reverse the recent decline in core inflation. Inflation was quite low during the second half of 2010, but we expect that to be the low point of the cycle.

In short, viewed through the lens of the Federal Reserve's dual mandatethe pursuit of the highest level of employment consistent with price stabilitythe current situation remains unsatisfactory. However, we appear now to be moving in the right direction.


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