INSIGHT: US Fed chief worries that recovery could founder

14 July 2011 16:31  [Source: ICIS news]

By Joe Kamalick

WASHINGTON (ICIS)--Federal Reserve Board chairman Ben Bernanke seemed to tell two tales before a House panel this week, saying that the modest US recovery likely will sail on, but in the next breath warning of stiff headwinds that could swamp the ship.

He told the House Financial Services Committee that the US recovery continues, albeit slow and modest, but that obstacles to faster growth could keep the economy below normal for this year, with high unemployment lasting through 2012 and into 2013.

In his semi-annual report to Congress, Bernanke told the House panel that while the US economy has continued to recover since the end of the 21-month recession in June 2009, “the pace of the expansion so far this year has been modest”.

After US gross domestic product (GDP) accelerated at a rate of 2.8% in 2010, the economy slowed in the first quarter this year to a 1.8% annual growth rate, Bernanke noted. In a normal recovery, US GDP growth would be 3%-3.5%.

He cautioned that “incoming data suggest that the pace of recovery remained soft in the spring”, indicating that the Fed chairman does not expect second quarter US GDP results to be much better than the first three months of this year.

The first estimate of US second quarter GDP performance will be issued by the Commerce Department on 29 July.

“At the same time,” Bernanke said, “the unemployment rate, which had appeared to be on a downward trajectory at the turn of the year, has moved back above 9%.”

Bernanke blamed the poor growth performance on increasing prices for gasoline and foodstuffs, which have reduced consumers’ spending power, and supply problems among US automobile makers because of disruptions caused by the 11 March Japanese earthquake.

While fuel prices have moderated and the earthquake-related supply issues have diminished, the Fed chairman said that the recovery was still facing headwinds.

He noted that growth in consumer spending remains slow, even after accounting for the effects of higher fuel and food prices, the US housing sector was still depressed, credit continues to be tight for households and small businesses, and state governments have been laying off workers to meet budget shortfalls.

Bernanke said that these and other factors are likely to keep US unemployment relatively high for the next two years.

“Over time, the jobless rate will decline - albeit only slowly - toward its longer-term normal level,” Bernanke told the committee.

The normal US unemployment rate, what economists also call the “natural” jobless rate, should be about 4%.

Bernanke said that the current US jobless rate of 9.2% would likely moderate to 8.6% to 8.9% by the end of this year, then slowly slide to around 8% by the end of 2012.

However, he said, by the end of 2013 the US unemployment rate could still be as high as 7.5%, well above the so-called natural pace of 4%.

Even that fairly dour outlook assumes that consumer spending, the principal driving force of the US economy, will begin to pick up, Bernanke said.

But that is by no means assured, he indicated.

“Households report that they have little confidence in the durability of the recovery and about their own income prospects,” Bernanke said, adding: “Moreover, the ongoing weakness in home values is holding down household wealth and weighing on consumer sentiment.”

In contrast to those two statements, Bernanke said that “anticipated pickups in economic activity and job creation, together with the expected easing of price pressures, should bolster real household income, confidence and spending in the medium run”.

And, he said, “the apparent stabilisation in the prices of oil and other commodities should ease the pressure on household budgets”.

But the Fed chairman’s fairly rosy forecast seems more an expression of hope than real expectation. 

On the same day that Bernanke appeared before the House committee, the Department of Energy (DOE) said it expects oil and natural gas prices - already on the rise again - to continue to climb into 2012.

And Bernanke’s bald prediction of a pickup in job creation was starkly at odds with last Friday’s dismal employment report from the Department of Labor (DOL), showing that the nation generated only 18,000 new jobs in June, the second month in a row of next-to-nothing job creation.

The US needs to add some 150,000 new jobs each month just to accommodate workforce population growth, and the economy would have to produce about 250,000 to 300,000 new jobs each month to even begin to lower the current 9.2% unemployment rate.

In a footnote to his prepared remarks, Bernanke conceded that the Fed’s predictions for economic growth “do not incorporate the most recent economic news, including last Friday’s labour market report”.

The Fed chairman’s real feelings about near-term prospects for the recovery were perhaps better revealed in his outline for additional Fed rescue measures should the economy turn south again.

Under current circumstances, Bernanke said that the Fed, the US central bank, would keep its record-low interest rate at 0%-0.25% “for an extended period”.

But he also indicated that the Fed could take additional extraordinary steps if the already wobbly recovery appears to be foundering further.

“The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might re-emerge, implying a need for additional [Federal Reserve monetary] policy support,” he noted.

“Given the range of uncertainties about the strength of the recovery,” he said, “the Federal Reserve remains prepared to respond should economic developments indicate”.

For example, he said, the Fed could “provide more explicit guidance” about how long the central bank would keep the key federal funds interest rate at 0%-0.25%. 

In other words, if the recovery seemed at risk, the Fed could announce that it would guarantee that the record-low interest rate would be maintained for a certain number of months or quarters, and take other steps to stimulate short-term lending for business. 

The Fed also could resume purchases of US Treasury notes, which would pump more cash into the economy, and lower the rate it pays to banks on their reserves, which would encourage banks to make more cash available for business loans.

On one hand, Bernanke’s forecast for a gradual improvement in the recovery was relatively sanguine, given fairly dire recent economic indicators. But on the other hand, his outline of possible rescue steps for a faltering recovery seemed more telling.

His testimony sounded a bit like a ship’s captain cheerfully assuring passengers that all is well - and then calling for a lifeboat drill.

Paul Hodges studies key influencers shaping the chemical industry in Chemicals and the Economy

By: Joe Kamalick
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