Additional Comments by Bernanke
Nothing can possibly be more clear
1) The FED is extremely concerned about jobs, jobs, and jobs
2) The FED is not in the least concerned about gold
3) The FED is not in the least concerned about oil
4) The FED is not concerned about the falling US$
5) The FED clearly intends to keep interest rates low
federalreserve.gov
Second speech today
At the Meetings of the American Economic Association, San Diego, California
January 4, 2004
Monetary Policy and the Economic Outlook: 2004
After several false starts, it now appears that that comeback began in earnest in the summer of 2003. As you know, the third quarter of the year displayed near-record levels of real economic growth, in the vicinity of 8 percent at an annual rate, and growth appears to have continued strong in the fourth quarter of 2003. The most heartening aspect of this vigorous expansion is that, finally, the business sector appears to have emerged from its funk. Corporate investment has been strong, particularly in equipment and software, and there are some recent signs that both inventory investment and hiring have begun to pick up.
Of course, downside risks to the economy remain: The recovery in capital investment may prove less durable than it now appears, the moderation of fiscal stimulus in the latter part of next year could adversely affect household spending, or new unfavorable shocks--geopolitical or otherwise--may yet appear. Still, the incoming data have continued for the most part to surprise on the upside, and the odds accordingly have increased that 2003 will be remembered as the year when this recovery turned the corner.
I think these predictions are broadly reasonable, and indeed I would not be surprised if the pace of real growth next year exceeded 4 percent.
More than two years after the recession trough, and following several quarters of strong growth, the historically normal pattern would be for the Fed to be well into the process of tightening policy by now. Instead, the FOMC has held its policy instrument rate, the federal funds rate, at the very low level of 1 percent. I would like to take some time now to explain why I believe this policy remains appropriate, despite its historically unusual character.
Inflation is not simply low; for my taste, it is very nearly at the bottom of the acceptable range for (measured) inflation. In contrast, in previous episodes of recovery, inflation was above the range consistent with price stability, so that a tightening of monetary policy at an earlier stage of the expansion represented the prudent response to inflation risks. Because inflation is so low today, monetary policy can afford to be more patient to ensure that the recovery is self-sustaining.
The second unusual aspect of the current situation relevant for monetary policy is the truly remarkable increase in labor productivity that firms and workers have achieved in recent years. Those productivity increases affect the inflation outlook in two related ways: first, by raising potential output and thus (for given growth in aggregate demand) the size of the output gap; and, second, by reducing the costs of production, which puts downward pressure on prices.
Labor costs account for the lion's share, about two-thirds, of the cost of producing goods and services. ......
Recently, however, labor productivity has grown even more quickly than the costs of employing workers, with the result that unit labor costs have declined in each of the past three years.
....because labor costs are such a large part of overall costs, and because capital costs have also been moderate, the business sector has enjoyed a net decline in total production costs. A decline in production costs must result in lower prices for final consumers, an increased price-cost markup for producers, or both. In practice, both have occurred in recent years: Firms have passed on part of the reduction in costs on to final consumers in the form of lower (or more slowly rising) prices, and price-cost markups (as best we can measure them) have risen well above their historical averages. To the extent that product-market competition erodes these markups, as is likely to occur over time, downward pressure will be exerted on the inflation rate, even if, as is likely, the recent declines in unit labor cost do not persist.
The third unusual factor is the persistent softness of the labor market. As I already noted, fully two years after the official recession trough, we are only just beginning to see significant gains in employment. Of course, the unemployment rate, at about 6 percent of the labor force, is not exceptionally high by historical standards, and one can debate the degree to which structural change and other factors may have affected the level of employment that can be sustained without overheating the economy. Assessing the amount of slack in the labor market is very difficult and ultimately a matter of judgment. Reasonable people can certainly disagree.
However, my sense is that, when one looks at the full range of information available, the labor market looks (if anything) weaker than a 6 percent unemployment rate suggests. For example, it appears that workers who have lost their jobs in the past couple of years have been more likely to withdraw from the labor force (rather than report themselves as unemployed) than were job losers in previous recessions. Indeed, the labor force participation rate fell sharply between 2000 and 2003, from a little over 67 percent to about 66-1/4 percent. Similarly, the ratio of employment to the working-age population, a statistic that reflects both those who become unemployed and those who leave the labor force, has fallen significantly, by 2.8 percentage points between its peak in April 2000 and its trough this past September. The tendency of recent job losers to leave the labor force likely masks some of the effects of job cuts on the unemployment rate, so that the current measured level of unemployment may understate the extent of job loss or the difficulty of finding new work. Of course, a labor market that is slack and improving only slowly is likely to produce continued slow growth in nominal wages, contributing to continued moderate growth in costs.
To summarize, then, the current economic situation has three unusual aspects, which together (in my view) rationalize the current stance of monetary policy. First, inflation is historically low, perhaps at the bottom of the acceptable range, and has recently continued its decline. Second, rapid productivity growth has led to actual declines in nominal production costs, which reduce current and future inflationary pressures. Finally, the labor market remains soft, reflecting the fact that growth in aggregate demand has been so far insufficient to absorb the increases in aggregate supply afforded by higher productivity. A soft labor market will keep a lid on the growth in the cost of employing workers. An accommodative monetary policy is needed, in my view, to support the ongoing recovery, particularly in the labor market. At the same time, the risks of policy accommodation seem low, as inflation is low and inflation pressures seem quite subdued.
These arguments notwithstanding, I realize that some remain unconvinced that the FOMC is pursuing the right course. Citing factors such as the rise in commodity prices and the decline of the dollar, a number of observers have warned that the Federal Reserve's policies risk re-igniting inflation. ..... I believe that low inflation and well-anchored inflation expectations are critical to maintaining economic stability in the short run. Price stability is of utmost importance to the nation's economic health, and I believe that the FOMC will do whatever is necessary to be sure that inflation remains well contained.
With that preface, I will address briefly a few concerns of those who worry that inflation is poised to rise, beginning with the recent behavior of commodity prices.
A number of commodity price indexes have indeed risen sharply over the past couple of years, including a large jump in the past several months. This acceleration has been broadly mirrored in the behavior of the core producer price indexes (PPIs) for crude and intermediate materials, probably the best and most comprehensive measures of prices at early stages of processing. Specifically, over the past two years, the twelve-month change in the core PPI for crude materials has risen rather dramatically, from -9.4 percent to 17.1 percent, and the twelve-month change in the core PPI for intermediate materials has risen from -1.3 percent to 1.8 percent. Do these developments imply a significant increase in inflation risk at the level of the final consumer?
The answer is almost certainly not. Two points should be made. First, the recent movements in commodity prices are hardly surprising; they are in fact quite normal for this stage of the business cycle. The acceleration in the core PPI for crude materials that we have seen is about what should have been expected, given the increases that have occurred recently in both domestic and worldwide economic activity.4 The increase in the demand for commodities from China alone has been substantial; for example, that country's share of world copper consumption is estimated to have risen from less than 5 percent in 1990 to 20 percent in 2003. The much more moderate acceleration in intermediate goods prices can likewise be traced to the increase in economic activity, with some additional effect coming from the decline in the dollar and the indirect impact of increases in energy prices.
Second, the direct effects of commodity price inflation on consumer inflation are empirically minuscule, both because raw materials costs are a small portion of total cost and because part of any increase in the cost of materials tends to be absorbed in the margins of final goods producers and distributors. ....... In short, rising commodity prices are a better signal of strengthening economic activity than of inflation at the consumer level.
Two specific commodity prices that often command attention are the prices of gold and crude petroleum. The price of gold has increased roughly 60 percent since its low in April 2001, from about $255 per ounce to about $410 per ounce. A portion of that increase simply reflects dollar depreciation, which I will discuss momentarily. Gold also represents a safe haven investment, however, and I agree that there have been periods in the past when the fear that drove investors into gold was the fear of inflation. But gold prices also respond to geopolitical tensions; these tensions have certainly heightened since 2001 and, in my view, can account for the bulk of the recent increase in the real price of gold.
Oil prices are relatively high, in the range of $33/barrel, but they have been elevated for most of the past four years, despite a broadly disinflationary environment. According to futures markets, oil prices are expected to decline gradually over the next two years, despite accelerating economic activity, as new supplies are brought on line. Of course, there is considerable uncertainty about what the price of oil will do, given the possibility of supply disruptions. But if it follows the course projected by the futures market, the price of oil should have a modest disinflationary effect on overall consumer prices in the next couple of years.
Let me turn now to the recent depreciation of the dollar and its implications for inflation. The dollar has fallen dramatically against some major currencies, notably the euro, against which the dollar has declined roughly 30 percent from its recent peak in the first quarter of 2002. However, looking at movements of the dollar against a single currency can be misleading about overall trends; broader measures of dollar strength show somewhat less of a decline. For example, an index of the dollar's real value against the currencies of important U.S. trading partners, weighted by trade shares, has fallen only about 12 percent from its peak in the first quarter of 2002. Notably, this broader index of dollar value remains about 7 percent above its average value in the 1990s and 17 percent above the low it reached in the second quarter of 1995.
Moreover, the direct effects of dollar depreciation on inflation, like those of commodity price increases, appear to be relatively small. In part, the small effect reflects the modest weight of imports in the consumer's basket of goods and services. Perhaps more importantly, however, the evidence suggests that foreign producers tend to absorb most of the effect of changes in the value of the dollar rather than "passing through" these effects to the prices they charge U.S. consumers. A reasonable estimate of the portion of changes in the value of the dollar passed through to U.S. consumers is about 30 percent. The extent of passthrough also appears to have declined over time, suggesting that foreign producers also lack "pricing power" in the current low-inflation environment in the United States. Overall, on rough estimates, a 10 percent decline in the broad value of the dollar would be expected to add between one and three tenths to the level of core consumer prices (not the inflation rate), spread out over a period of time.
I haven't said anything yet about the rate of growth of the money supply, another indicator that is sometimes cited by those concerned about inflation, largely because there is not too much to say.
To summarize, 2003 seems to have marked the turning point for the U. S. economy, and we have reason to be optimistic that 2004 will see even more growth and continued progress in reducing unemployment.
The Federal Reserve enters 2004 with monetary policy that is unusually accommodative in historical terms, relative to the stage of the business cycle. That accommodation is justified, I believe, by the current very low level of inflation, and by the productivity gains and the weakness in the labor market, both of which suggest that inflation is likely to remain subdued. In my view, weighing the relative costs of the upside and downside risks also favors accommodation; in particular, it is important that we ensure, as best we can, that the current expansion will become self-sustaining and that the inflation rate does not fall further.
On the other side, as I have already noted, the achievement of price stability must not and will not be jeopardized. We at the Federal Reserve will closely monitor developments in prices and wages, as well as conditions in the labor market and the broader economy, for any sign of incipient inflation. We will also look at the information that can be drawn from surveys and financial markets about inflation expectations. For now, I believe that the Federal Reserve has the luxury of being patient. However, I am also confident that, when the time comes, the Fed will act to ensure that inflation remains firmly under control. |
