William Dudley's speech yesterday provides a good snapshot of how he looks at the US economy and how he views the likely use of monetary policy going forward. He describes some of the headwinds that are restraining the rate of recovery in the US, and he discusses some of the fundamentals that might be able to overcome the headwinds. He also reinforces the dual mandate that requires the Fed to use monetary policies to provide stable prices and stable employment. The Fed is one of the few central banks in world that has a mandate to provide employment stability as well as price stability.
Some of positive fundamentals that he lists are as follows:
Household balance sheets reflect an improved debt to disposable income ratio which is back to 2003 levels. Most of the household deleveraging has taken place.
Delinquency rates for consumer debts such as spending on durable goods, credit cards etc. is down.
Households are more creditworthy and better able to finance the purchase durable goods.
Housing starts are only 900,000 on annualized rate versus a 1.5 million rate that is suggested by demographic trends and an increase in the household formation rate.
Business investment should be stimulated by large cash reserves, positive cash flows and easier access to credit.
Some of the headwinds to growth create chicken and egg problems that might slow the growth rate. For example the slow growth in household disposable income my dampen consumer spending. Low consumer demand may limit business investment, which in turn, may limit growth in disposable income which is needed to spur consumer spending. Furthermore, the recent increase in mortgage interest rates may restrain the expected growth in the residential housing market. Fiscal policy in the US is another risk factor. Its hard to predict what actions Congress might take that will affect spending by governments.
Dudley also offered his views on the outlook for monetary policy. He argues that the Fed is data driven. It will continue to keep short term interest rates low until the unemployment rate meets a threshold of 6.5%. Since the unemployment rate is falling slowly, and it is being driven downward partially a decrease in the size of the labor market and by the increasing use of part time jobs, the Fed will be keeping rates low into 2016. The current inflation rate is below the Fed target of 2% so he is not concerned about the effect of the Fed's purchase of longer term securities on its mandate to protect against inflation.
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