Nearly two years after the end of the recession, the country’s economy is not hitting on all cylinders. The economic recovery has been hesitant, and in recent weeks signs of another slowdown have appeared.
The economy is worrisome in three key dimensions: growth, unemployment and inflation. Let me review the recent history that led to the current state.
Looking back, growth was reasonably strong in the second half of 2009 and early 2010. The economy slumped in the middle quarters of last year and then picked up again in the final quarter. Growth was disappointing in the first quarter of this year, and recent data in the second quarter have continued to be disappointing.
Job growth needed to reduce unemployment has been similarly erratic. A few months after the recovery officially began in the summer of 2009, unemployment peaked above 10 percent. Unemployment is now down a percentage point from its peak, but most of the progress occurred from November last year through January. Since then, the unemployment rate has leveled out again around 9 percent.
Prices and inflation have also been confounding. As the economy weakened in the middle of 2010, measures of inflation expectations declined alarmingly, and concern about outright deflation rose. The Federal Open Market Committee — the Federal Reserve’s committee that sets monetary policy — reacted to the possibility of deflation with a second round of asset purchases, popularly known as QE II (quantitative easing, two). This action was taken because the interest rate the Fed uses to shape financial conditions had already been set as low as it could go.
Over the past several months, inflation measures have decidedly reversed course, raising concern among many about the risk of persistent inflation.
What should we make of such an uneven recovery?
Well, it’s not unusual. Recoveries are rarely smooth. Quarter-to-quarter fluctuations in economic activity are to be expected in a dynamic economy. Such a halting and irregular path of recovery would be expected even in the absence of external shocks. And there have been several of those this year — namely, the events in North Africa and the Middle East that affected oil prices, the re-emergence of sovereign debt stresses in Europe, and the earthquake and tsunami in Japan that have disrupted supply chains running from Japan to the U.S. Add to these factors several domestic developments such as severe weather events including tornadoes and floods, the continuing weak housing sector and the uncertainty raised by the saga of the federal debt ceiling.
I would argue that the economy has shown impressive resilience as it has continued to expand through shocks and setbacks. Further, I don’t believe recent data is reason to panic. In my view, there is no compelling reason to expect a so-called double-dip recession. Clearly there are risks that could reroute our economic future. But the economy does not appear to be headed off the rails.
As I look forward, I believe three fundamental underlying factors will have profound influence on the country’s economic performance: the restored health of the financial (especially banking) sector; stabilized fiscal underpinnings of all levels of government; and, sustained low and stable inflation. All three will contribute greatly to confidence, an essential prerequisite of steady improvement of the economy.
The financial system is on the mend. Much remains to be done, but most institutions, from the largest banks to community banks, are in far better condition today than two years back.
The fiscal situation remains very challenging. The foremost concern at the moment is the raising of the federal debt ceiling. If this is not handled responsibly, the world’s capital markets could inflict rapid and painful punishment that will be felt in both financial markets and the real economy. Main Street will not avoid the pain.
The Federal Reserve bears near exclusive responsibility, and ultimate control, over the third fundamental — inflation. Lately, the debate has focused on the question of whether the recent surge in inflation measures is temporary or persistent. I do not believe the headline inflation numbers of the past six months are indicative of the underlying trend rate of inflation. And I am cautious about tightening monetary policy in the face of the ambiguous economic circumstances we currently face. That said, I would not hesitate to support an exit from today’s highly stimulative policy if I were convinced of the onset of persistent high inflation.
The public needs to be convinced of the FOMC’s commitment to low and stable inflation. One way to strengthen the central bank’s message in this regard is the adoption of an explicit numerical objective for inflation — an inflation target — to be achieved over a medium-term horizon. Many of the participants in the FOMC have put forward the number of 2 percent or a little lower as the rate consistent with the Fed’s mandate for low and stable inflation. This amounts to a de facto inflation target.
I believe now is a good time to reaffirm in explicit terms the Fed’s commitment to delivering its exclusive piece of the package of fundamentals needed to assure a lasting recovery.
Dennis Lockhart is president and CEO of the Federal Reserve Bank of Atlanta.
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