Dudley Says `Considerably Brighter' Outlook No Reason to Withdraw Stimulus
Federal Reserve Bank of New York President William Dudley
Andrew Harrer/Bloomberg
Federal Reserve Bank of New York President William Dudley.
Federal Reserve Bank of New York President William Dudley. Photographer: Andrew Harrer/Bloomberg
Federal Reserve Bank of New York President William Dudley said the “considerably brighter” economic outlook isn’t yet reason for the central bank to withdraw its record monetary stimulus.
“We provided additional monetary policy stimulus via the asset purchase program in order to help ensure the recovery did regain momentum,” Dudley said today in a speech in New York. “A stronger recovery with more rapid progress toward our dual mandate objectives is what we have been seeking. This is welcome and not a reason to reverse course.”
Dudley, who is also the vice chairman of the policy-setting Federal Open Market Committee, said the economy is “finally showing more signs of life” because household and financial- company balance sheets are improving, monetary and fiscal policy have “provided support” and growth overseas has led to increased demand for U.S. goods and services.
The Fed in November announced a plan to buy $600 billion of Treasuries through June in a second round of so-called quantitative easing aimed at combating too-low inflation, stimulating economic growth and creating jobs. Chairman Ben S. Bernanke plans to deliver a semiannual report on monetary policy to the Senate Banking Committee tomorrow and intends to testify before the House Financial Services Committee on March 2.
While there are “signs that core inflation is now stabilizing,” the U.S. economy needs “sustained strong employment growth in order to be certain that this virtuous circle has become firmly established,” Dudley said.
Unemployment Declines
The unemployment rate fell to 9 percent in January, its biggest two-month drop since 1958. Joblessness rose above 9 percent in May 2009, beginning the longest period of unemployment at that level or higher since monthly records began in 1948.
“We also have to be careful not to be overly optimistic about the growth outlook,” Dudley said. “The coast is not completely clear -- the healing process in the aftermath of the crisis takes time and there are still several areas of vulnerability and weakness.”
The housing industry is still “unusually weak,” state and local governments are “under stress,” and the U.S. may face “further shocks from abroad,” such as from sovereign debt markets or political events in the Middle East, Dudley said.
Boston Fed President Eric Rosengren also addressed threats to steady growth, saying today that regular “stress tests” may help financial institutions prepare for unexpected risks, such as fallout from a sovereign debt crisis or a disruption to the economy from state and local governments.
‘Better Job’
“We need to do a much better job of using so-called stress tests to challenge commonly held views, so that boards of directors and regulators of firms better understand the fundamental drivers of risks in organizations and in the financial system,” Rosengren said in a speech in Boston.
The Fed has ordered the 19 largest U.S. banks to test their capital levels against a scenario of renewed recession. Such stress-testing is mandated by the Dodd-Frank Act, signed into law by President Barack Obama in July, overhauling regulation of the financial system with the goal of reducing the risks of future financial crises.
Dudley affirmed in his speech a stance on borrowing costs that the FOMC has held since March 2009.
“Barring a sustained period of economic growth so strong that the economy’s substantial excess slack is quickly exhausted or a noteworthy rise in inflation expectations, the outlook implies that short-term interest rates are likely to remain unusually low for ‘an extended period,’” he said.
Near Zero
The FOMC has kept its benchmark interest rate near zero since December 2008.
U.S. stocks rose on improving economic data, and the benchmark 10-year Treasury note reached the highest level in almost a month as unrest in Libya drove investors to the safety of U.S. debt. The Standard & Poor’s 500 Index of stocks climbed 0.6 percent to 1,328.38 at 11:04 a.m. in New York.
“The economy can be allowed to grow rapidly for quite some time before there is a real risk that shrinking slack will result in a rise in underlying inflation,” Dudley said.
The core inflation gauge watched by the Fed, which excludes food and energy prices, increased 0.8 percent in the 12 months through December, the smallest advance since records began in 1959.
Still, oil exceeded $100 a barrel last week amid unrest in the Middle East. Regular fuel, which in January was higher than the December average, jumped to $3.29 a gallon last week, the costliest since 2008, according to AAA, the nation’s biggest motoring organization.
Political Unrest
It’s important not to “over-react” to Middle East political unrest and its impact on commodity prices, Dudley said in response to audience questions.
The extent and duration of the surge in oil prices are unclear, and if they don’t “feed through” to inflation expectations and wages, then policy makers can be “more relaxed” about their impact on the economy, he said.
Dudley said that 9 percent unemployment and industrial capacity use that’s lower than the long-term average point to “considerable” economic “slack.”
The main risk to inflation is that expectations climb, which could happen if there was a “loss of confidence” in the U.S. central bank’s ability to withdraw its record stimulus in time to ward off a surge in prices, he said.
Will to Exit
In order to address this risk, the Fed needs to “communicate effectively about its objectives” and its ability and will to exit, Dudley said.
“If inflation expectations were to become unanchored because Federal Reserve policy makers failed to communicate clearly, this would be a self-inflicted wound that would make our pursuit of the dual mandate of full employment and price stability more difficult,” Dudley said.
When the slack in the economy diminishes, the U.S. central bank will take action to “keep the economy from overheating,” Dudley said in response to audience questions.
“Once we get to the point where we can see that as likely happening,” we “will raise the interest on excess reserve rate,” he said. “This new tool is a viable tool for keeping the economy from overheating.”
To contact the reporter on this story: Caroline Salas in New York at csalas1@bloomberg.net;
To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net
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