Acting to Avoid a Great Stagnation

Eric S. RosengrenPresident & CEO

Federal Reserve Bank of Boston

Open Classroom SeriesNortheastern UniversityBoston, Massachusetts

September 26, 2012

www.bos.frb.org

Avoiding a Great Stagnation

Historians use “Great” to reflect success – e.g., Alexander the Great

Economists use “Great” to reflect difficult episodes and policy that contributes or fails to alleviate – e.g., Great Depression, Great Recession

Forceful action necessary – and being taken – to avoid a Great Stagnation

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What Would Constitute A Great Stagnation?

Policymakers accepting as inevitable a slow growth economy and underutilized economic resources

Allowing high unemployment to become a more permanent feature of the economy

Policy only reacting to large negative shocks; accepting slow growth that makes little progress in returning to full employment

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Acting to Avoid It: Our Monetary Policy Response to Global Slowdown

Seek faster growth than has occurred or is likely to occur without action Asset purchases (agency mortgage-backed and Treasury

securities) More open-ended focus on economic outcomes rather than

calendar dates or amounts purchased Communicating that we anticipate low short-term rates likely to be

warranted at least through mid-2015; accommodative until recovery is sustainable

Context of price stability; assessment of costs, efficacy

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Our Monetary Policy Response Continued…

Unconventional policy has risks, but they are preferable to the risk of another year or more of economic stagnation

My rationale for policy change…

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Real-World Example of Stagnation

Japan and Europe have both suffered long periods of slow growth

Today I will focus on Japan – despite some key differences from the U.S. Demographics – Japanese population’s average age is rapidly

rising Slow response to banking problems

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Figure 1Japan’s Real Gross Domestic Product

Source: Cabinet Office of Japan / Haver Analytics

1980:Q1 - 2012:Q2

0

200

400

600

800

1980:Q1 1984:Q1 1988:Q1 1992:Q1 1996:Q1 2000:Q1 2004:Q1 2008:Q1 2012:Q1

Trillions of Chained 2005 Yen, Seasonally Adjusted Annual Rate

Real GDP

Trend Line Estimated Over Period 1980 - 1990

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Figure 2U.S. Real Gross Domestic Product

Source: BEA, NBER / Haver Analytics

1980:Q1 - 2012:Q2

0

0

0

1

1

1

0

4

8

12

16

1980:Q1 1984:Q1 1988:Q1 1992:Q1 1996:Q1 2000:Q1 2004:Q1 2008:Q1 2012:Q1

Recession

Trillions of Chained 2005 Dollars, Seasonally Adjusted Annual Rate

Real GDP

Trend Line

Causes of Slow Growth

Not unusual after a financial crisis

Let’s look at a few factors (not enough time for a detailed discussion)

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Figure 3Growth in Real GDP and Real GDP Excluding

Housing and Government Spending

Source: BEA, NBER / Haver Analytics

2009:Q2 - 2012:Q2

98

100

102

104

106

108

2009:Q2 2009:Q4 2010:Q2 2010:Q4 2011:Q2 2011:Q4 2012:Q2

Index, 2009:Q2=100

Real GDP(Average Annual Growth of 2.21%)

Real GDP Excluding Residential Investment and Government Spending

(Average Annual Growth of 2.45%)

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Figure 4Housing Starts

Source: Bureau of the Census, NBER / Haver Analytics

1980:Q1 - 2012:Q2

0

0

0

1

1

1

0

500

1,000

1,500

2,000

2,500

2000:Q1 2002:Q1 2004:Q1 2006:Q1 2008:Q1 2010:Q1 2012:Q1

Recession

Thousands of Units, Seasonally Adjusted Annual Rate

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Figure 5Growth in Real State and Local

Government Spending

Source: BEA, NBER / Haver Analytics

2000:Q1 - 2012:Q2

0

0

0

1

1

1

-6

-4

-2

0

2

4

6

2000:Q1 2002:Q1 2004:Q1 2006:Q1 2008:Q1 2010:Q1 2012:Q1

Recession

Percent Change from Year Earlier

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Figure 6Change in Real GDP from

U.S. Business Cycle Peak by Country

Source: BEA, CAO, Eurostat, ONS, INSEE, StatCan / Haver Analytics

2007:Q4 - 2012:Q2

90

95

100

105

110

2007:Q4 2008:Q2 2008:Q4 2009:Q2 2009:Q4 2010:Q2 2010:Q4 2011:Q2 2011:Q4 2012:Q2

Canada France

Germany Japan

United States United Kingdom

Index, 2007:Q4=100

The Significant Costs of a Slow Recovery

Impact on those unemployed or underemployed

Temporary labor market problems can eventually become more permanent because of a slow recovery

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Figure 7Employment-to-Population* Ratio

Source: BLS, NBER / Haver Analytics

January 2000 - August 2012

0

0

0

1

1

1

56

58

60

62

64

66

Jan-2000 Jan-2002 Jan-2004 Jan-2006 Jan-2008 Jan-2010 Jan-2012

Recession

Percent

*Includes population 16 years and older

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Figure 8Long-Term Unemployment

Source: BLS, NBER / Haver Analytics

January 1980 - August 2012

0

0

0

1

1

1

0

10

20

30

40

50

Jan-1980 Jan-1984 Jan-1988 Jan-1992 Jan-1996 Jan-2000 Jan-2004 Jan-2008 Jan-2012

Recession

Percent

Percent of unemployed out of work for 27 weeks or more

What Should Monetary Policymakers Do?

Conventional response – lower short-term rates… not possible at the zero lower bound

Unconventional responses More costs Impact less certain Still, not a reason to avoid necessary actions

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Figure 9Japan’s Central Bank Assets and Inflation Rate

Source: Japanese Ministry of Internal Affairs and Communications, Bank of Japan / Haver Analytics

1990:Q1 - 2012:Q2

0

40

80

120

160

1990:Q1 1993:Q1 1996:Q1 1999:Q1 2002:Q1 2005:Q1 2008:Q1 2011:Q1

Trillions of Yen

Total Assets of Bank of Japan

-3.0

0.0

3.0

6.0

1990:Q1 1993:Q1 1996:Q1 1999:Q1 2002:Q1 2005:Q1 2008:Q1 2011:Q1

Percent Change from Year Earlier

Consumer Price Index for Japan

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Figure 10Federal Reserve System Assets and U.S.

Inflation Rate

Source: Federal Reserve Board / Haver Analytics

January 1990 - July 2012

0

0

0

1

1

1

0.0

1.0

2.0

3.0

4.0

Jan-1990 Jan-1993 Jan-1996 Jan-1999 Jan-2002 Jan-2005 Jan-2008 Jan-2011Recession

Trillions of Dollars

Federal Reserve System Assets

0

0

0

1

1

1

-2.0

0.0

2.0

4.0

6.0

Jan-1990 Jan-1993 Jan-1996 Jan-1999 Jan-2002 Jan-2005 Jan-2008 Jan-2011

Percent Change from Year Earlier

Personal Consumption Expenditure Price Index

FOMC Announcement

Asset purchases

$40 billion per month of agency Mortgage-Backed Securities (MBS)

Continued exchange of short-term Treasury securities for an equal amount of long-term securities through the end of the year – $45 billion per month – via the maturity extension program begun in June

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Announcement Continued…

Plan is more open-ended – continue purchases until there has been sustained improvement in labor markets – end based on economic outcomes, not a set purchase amount or a date

Committee expects the highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens – currently anticipate low rates are likely to be warranted at least through mid-2015

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Figure 11Financial Market Response to FOMC Announcement

Source: Federal Reserve Board, Bank of America Merrill Lynch, WSJ, Bloomberg / Haver Analytics

August 1, 2012 - September 14, 2012

September FOMC

Statement

Day After FOMC

Statement

Chairman Bernanke’s

Jackson HoleSpeech

PreviousFOMC

Statement

9/12 - 9/13 9/12 - 9/14 8/30 - 9/14 7/31 - 9/14

S&P 500(Percent Change) +1.6% +2.0% +4.7% +6.3%

Exchange Rate:Euros Per Dollar

(Percent Change)-0.1% -1.9% -4.9% -6.3%

5-7-Year Investment-Grade Corporate Bond Yield

(Change in Basis Points)-4.4 bp -3.8 bp -5.4 bp -12.9 bp

Yield on 30-Year FNMA Current Coupon MBS

(Change in Basis Points)-24.4 bp -12.5 bp -12.1 bp -1.7 bp

Conclusion

Action intended to promote faster growth and return to full employment more quickly

But monetary policy is not a panacea – large shocks can be mitigated, but likely not offset

While policy will quicken recovery – it still will take time This underlines the importance of forceful and timely action

necessary to avoid the dubious title of “Great”

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