With all of the news coverage of the earthquake in Japan, the media has been letting stories slip that normally would have received at least modest coverage. This is one item that I noticed on the weekend but I hadn't had an opportunity to write up anything until today.
On March 11, 2011, the President of the New York Federal Reserve William Dudley gave a breakfast speech at the Queens Chamber of Commerce and the Queens Economic Development Corporation. Mr. Dudley opened his speech by giving a brief synopsis of the history of the Federal Reserve and the objectives of the central bank. Here's what he had to say about both issues:
"Each Reserve Bank is distinct, with its own charter and a board of directors drawn from its district, but overseen by the Board of Governors. The law that created the Federal Reserve made the central bank independent so that policymakers could make decisions about monetary policy in the national interest, somewhat insulated from political pressure. However, the Fed is accountable to Congress.
Congress has set an explicit objective for monetary policy: To pursue the highest level of employment consistent with price stability. This objective is often referred to as our "dual mandate," because it combines two goals: high employment, and low and stable inflation. In order to promote these objectives, we also pay close attention to financial stability, because without financial stability, it is very hard to achieve our goals for jobs and inflation." (my bold)
Wonderful motherhood statements, aren't they? I feel all warm and cosy.
Here's what Mr. Dudley had to say about the economy:
"I am pleased to say that the economic outlook has improved considerably in the past six months. Despite this, we are still very far away from achieving our dual mandate of maximum sustainable employment and price stability. Faster progress toward these objectives would be very welcome." (my bold)
No kidding, Mr. Dudley. I’m certain that the unemployed, those whose mortgages are under water and those who are undergoing foreclosure would whole-heartedly agree.
Here's what he had to say about the moribund employment picture:
"With respect to the labor market, last Friday’s report helps resolve some conflicting signals. On one hand, the unemployment rate has fallen sharply over the past three months, dropping to 8.9 percent from 9.8 percent two months earlier. On the other hand, payroll employment gains had been very modest and were not consistent with a sustained drop in the unemployment rate.
Last Friday we learned that the economy added 192,000 jobs in February, and estimates of previous job growth were adjusted upward modestly. Particularly encouraging is the growth of manufacturing jobs. Over the past year we have added factory jobs at the fastest pace since the 1990s...
Although there is still uncertainty over the timing and speed of the labor market recovery, I do expect that job growth will increase considerably more rapidly in the coming months. We should welcome this. A substantial pickup is sorely needed. Even if we were to generate growth of 300,000 jobs per month, we would still likely have considerable slack in the labor market at the end of 2012." (my bold)
Once again, stating the obvious to the obviously not unemployed listeners at the breakfast business meeting.
At this juncture, Mr. Dudley gives three reasons why the economy is "showing signs of life". I'll just deal with the first two reasons:
"First, household and financial institution balance sheets continue to improve. On the household side, the 2008-09 rise in the saving rate appears to have stabilized in the 5 percent to 6 percent range. Meanwhile, the amount of money they need to service their debt (for mortgages, cars, credit cards, etc.) has fallen sharply to levels that prevailed during the mid-1990s. Debt service has been pushed lower by a combination of debt repayment, refinancing at lower interest rates and debt write-offs. Financial institutions have strengthened their balance sheets by retaining earnings and by issuing equity. As a result, some measures of bank credit are beginning to expand again." (my bold)
It seems rather interesting that central bankers think that it's a good thing that debt servicing charges have been pushed lower by both refinancing at lower interest rates and debt write-offs. What happens when interest rates rise as the European Central Bank projects? As well, a bit of common sense would tell us that lowered debt servicing charges resulting from increased debt write-offs by lenders is probably not a particularly good thing! But then, it could be just me.
"Second, monetary policy and fiscal policy have provided support to the recovery. On the monetary policy side, we at the Fed have maintained unusually low levels of short-term interest rates and engaged in large-scale asset purchases. These measures have fostered a sharp improvement in financial market conditions. On the fiscal side (that is, government spending and taxes), the economy has been supported by the shift in policy to help support growth. In particular, the temporary reduction in payroll taxes could have a particularly strong impact on growth during the first part of the year."
Nothing like a little self-inflicted pat on the back for all the good things that are springing forth from his boss's QE2 program. And yes, lowering taxes is a good thing, unless of course you want to cut a $1.65 trillion deficit and reduce a $14.1 trillion debt.
Now Mr. Dudley gets to the "meat of the matter", the dreaded and haunting spectre of inflationary/deflationary pressures in the economy:
"On the inflation side of the ledger, there are some signs that core inflation is now stabilizing after falling for several years. At the Fed, we track core inflation (which excludes the volatile food and energy prices) because experience and research tell us that core inflation provides the best measure of whether overall inflationary pressures are building up or subsiding. Core inflation has proven quite reliable in predicting future total, or “headline” inflation rates. At the moment, both headline and core inflation remain below levels consistent with our dual mandate objectives—which most members of the FOMC consider to be 2 percent or a bit less on the personal consumption expenditures (PCE) measure. (my bold)
Recent evidence shows that the large amount of slack in the economy has contributed to declining inflation over the past couple of years. I expect this slack to continue to dampen price pressures in the near term. Inflation expectations are well-anchored today and we intend to keep it that way…
...Commodity price pressures are pushing measures of headline inflation above measures of core inflation, which, as I mentioned, exclude food and energy prices. You may have concerns that the rise in commodity prices will turn out to be persistent and, if so, how this might impact the inflation outlook."
When Mr. Dudley refers to "the amount of slack in the economy', he is actually referring to the fact that the economy is not working at its full capacity. Basically, it is only because the economy is weak that producers have been unable to pass along the full impact of higher input and commodity prices to consumers.
As we all know (at least those of us that live in the real world, well away from the alternate reality that central bankers seem to live in), the cost of living is rising particularly when it comes to feeding our families. In fact, the United Nations Food and Agricultural Organization Food Price Index reached its highest level in its 21 year history in February 2011. But, since the Federal Reserve strips off the volatile food and energy components of what households spend, they live in a reality where prices are stable. Apparently, central bankers can live without food and fuel unlike the sweaty masses of humanity. Seemingly, the Fed can make inflation look non-existent if they remove the two components that suffer from the greatest price volatility. Quite the sleight of hand!
Here is Mr. Dudley’s conclusion:
"Thus, while rising commodity prices may be giving some of you a bad headache, they are not likely to lead to a sustained rise in inflation to levels inconsistent with our dual mandate. We will have to ensure, however, that these pressures do not cause inflation expectations to become unanchored. If that were to occur, that would be a troublesome development that would complicate the pursuit of our dual mandate of high employment and low and stable inflation."
It's nice to think that a central banker might be a tad concerned that high and rising commodity prices were causing some cranial discomfort to those Americans who live on Main Street, isn't it?
The floor was then opened for a question and answer session. This was probably a tactical error on Mr. Dudley's part. He was asked a substantial number of questions about food price inflation. One of the audience members asked Mr. Dudley the following question, "When was the last time, sir, that you went grocery shopping?". Mr. Dudley made a valiant effort to explain, as he had said during his speech (if anyone had been listening), that the Federal Reserve strips out the volatile food and energy sector from their inflation calculations. He went on to explain that certainly, food prices are rising but, at the same time, the prices of other things are declining and that you have to balance the prices of all things. He went on to provide an example, "Today you can buy an iPad 2 that costs the same as an iPad 1 that is twice as powerful...". So, basically, the Federal Reserve is telling us that if you want to save yourself some money, go ahead and buy that iPad 2 with its increased computing horsepower, you'll get more for your money and spare yourself the experience of spending more and more of your income on food since food doesn’t really matter anyway!
If there’s one lesson to be learned from this, it's that central bankers should never go off their talking points when dealing with the sweaty masses.