Fed’s Dudley Sees Significant Impediments to Economic Growth

Federal Reserve Bank of New York President William C. Dudley said the U.S. economy will probably slow this year while confronting risks “skewed to the downside.”

“It is unlikely that the faster growth experienced in the fourth quarter of 2011 will be matched in the first half of 2012,” Dudley said today in remarks in New York. “In addition to the temporary nature of some of the recent improvement, there are significant impediments to a robust recovery.”

The policy-setting Federal Open Market Committee this week voted to extend its pledge to keep interest rates low until at least late 2014, compared with a previous date of mid-2013. Chairman Ben S. Bernanke said on Jan. 25 that the Fed is weighing additional stimulus to bring down the 8.5 percent unemployment rate, including another round of bond buying.

The economy expanded less than forecast in the fourth quarter as consumers curbed spending and government agencies cut back. Gross domestic product, the value of all goods and services produced, climbed at a 2.8 percent annual pace following a 1.8 percent gain in the prior quarter. It was the fastest rate of increase since the second quarter of 2010.

“Monetary policy has done and will continue to do its part in supporting the recovery -- but it is not all-powerful,” Dudley said. “Other complementary policy actions in housing, fiscal policy and structural adjustment or rebalancing of the economy will be essential if we are to achieve the best available recovery.”

Primary Risk

Stocks fell after the GDP report. The Standard & Poor’s 500 index of stocks declined 0.3 percent to 1,314.69 at 12:43 p.m. in New York. The yield on the benchmark 10-year Treasury note was little changed at 1.93 percent.

Policy makers decided to extend their rate pledge this week after assessing their economic outlook, Dudley said.

“The unemployment rate was going to remain quite high in an environment where inflation pressures were subsiding,” Dudley said in response to questions from reporters after his speech.

An “outright decline of the labor force” means that the “decline in the unemployment rate may overstate the improvement in labor market conditions,” Dudley said. Joblessness fell to 8.5 percent in December, the lowest in almost three years.

The main risk to growth is “uncertainty as to how events in Europe will unfold,” Dudley said. Also, “more contractionary” fiscal policies and the “depressed housing market” are likely to impede economic expansion, he said.

Falling Prices

“The ongoing weakness in housing makes achieving a vigorous economic recovery more difficult for several reasons,” including the resulting damage to consumer wealth, he said. “The big drop in house prices has made it more difficult for borrowers to refinance, undercutting some of monetary policy’s ability to support demand.”

Dudley in a Jan. 6 speech called on the government to remove obstacles to refinancing, suggesting that Fannie Mae and Freddie Mac reduce the principal of the loans they guarantee. Republican Senator Bob Corker of Tennessee called Dudley’s suggestion “absolutely egregious.”

“I was talking about issues that were basically impairing the ability of monetary policy to support economic activity,” Dudley said in response to questions from reporters. “My goal here was not to cause any sort of controversy,” it was to create a “discussion” and “deeper examination.”

‘Stronger Note’

While “recent data suggest that the U.S. economy ended 2011 on a somewhat stronger note,” the “amount of slack in the economy remains substantial,” Dudley said.

“This large amount of slack is putting downward pressure on trend inflation,” Dudley said. “Inflation has retreated and may be headed down further.”

Richmond Fed President Jeffrey Lacker dissented from the central bank’s Jan. 25 pledge to keep interest rates low through late 2014. The Fed may need to raise rates before then to prevent an increase in inflation, he said today.

“I expect that as economic expansion continues, even if only at a moderate pace, the federal funds rate will need to rise in order to prevent the emergence of inflationary pressures,” Lacker said in a statement on the Richmond Fed’s website.

The Fed this week set a long-term goal of 2 percent inflation, and forecast that price increases will fall short of that target this year and next. The personal consumption expenditures price index climbed 2.5 percent for the 12 months ending in November.

Inflation Forecast

Inflation will range from 1.4 percent to 1.8 percent this year, and from 1.4 percent to 2 percent in 2013, Fed officials predicted. In November, they projected inflation of 1.4 percent to 2 percent in 2012, and 1.5 percent to 2 percent next year.

Dudley said that inflation is likely to slow this year as commodity prices have abated and economic growth declines. The U.S. probably won’t confront a “bubble of inflation,” he said.

“The pace of recovery remains sluggish by historical standards and is likely to slow somewhat in early 2012,” Dudley said. “Thus, unemployment, both nationally and locally, is likely to remain unacceptably high for some time. Also, inflation is likely to be below our objective for several years.”



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