WORD ON THE STREET: Following the stabilization of economic activity in mid-2009, the U.S. economy is now in its seventh quarter of growth; last quarter, for the first time in this expansion, our nation's real gross domestic product (GDP) matched its pre-crisis peak. Nevertheless, job growth remains relatively weak, and the unemployment rate is still high.
In its early stages, the economic recovery was largely attributable to the stabilization of the financial system, the effects of expansionary monetary and fiscal policies, and a strong boost to production from businesses rebuilding their depleted inventories. Economic growth slowed significantly in the spring and early summer of 2010, as the impetus from inventory building and fiscal stimulus diminished and Europe's debt problems roiled global financial markets.
More recently, however, we have seen increased evidence that a self-sustaining recovery in consumer and business spending may be taking hold. Notably, real consumer spending has grown at a solid pace since last fall, and business investment in new equipment and software has continued to expand. Stronger demand, both domestic and foreign, has supported steady gains in U.S. manufacturing output.
The combination of rising household and business confidence, accommodative monetary policy and improving credit conditions seems likely to lead to a somewhat more rapid pace of economic recovery in 2011 than we saw last year. The most recent economic projections by Federal Reserve Board members and Reserve Bank presidents, prepared in conjunction with the Federal Open Market Committee (FOMC) meeting in late January, are for real GDP to increase 3.5% to 4% this year – about one-half of a percentage point higher than our projections made in November. Private forecasters' projections for 2011 are broadly consistent with those of the FOMC participants and have also moved up in recent months.
While indicators of spending and production have been encouraging, on balance, the job market has improved only slowly. Following the loss of about 8.75 million jobs from early 2008 through 2009, private-sector employment expanded by only a little more than 1 million [jobs] during 2010 – a gain barely sufficient to accommodate the inflow of recent graduates and other entrants to the labor force.
We do see some grounds for optimism about the job market over the next few quarters, including notable declines in the unemployment rate in December and January, a drop in new claims for unemployment insurance and an improvement in firms' hiring plans. Even so, if the rate of economic growth remains moderate, as projected, it could be several years before the unemployment rate has returned to a more normal level. Indeed, FOMC participants generally see the unemployment rate still in the range of 7.5% to 8% at the end of 2012. Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established.
Likewise, the housing sector remains exceptionally weak. The overhang of vacant and foreclosed houses is still weighing heavily on prices of new and existing homes, and sales and construction of new single-family homes remain depressed. Although mortgage rates are low and house prices have reached more affordable levels, many potential home buyers are still finding mortgages difficult to obtain and remain concerned about possible further declines in home values.
Inflation has declined, on balance, since the onset of the financial crisis, reflecting high levels of resource slack and stable longer-term inflation expectations. Indeed, over the 12 months ending in January, prices for all of the goods and services consumed by households (as measured by the price index for personal consumption expenditures (PCE)) increased by only 1.2% – down from 2.5% in the year-earlier period. Wage growth has slowed as well, with average hourly earnings increasing only 1.9% over the year ending in January. In combination with productivity increases, slow wage growth has implied very tight restraint on labor costs per unit of output.
FOMC participants see inflation remaining low; most project that overall inflation will be about 1.25% to 1.75% this year and in the range of 1% to 2% next year and in 2013. Private-sector forecasters generally also anticipate subdued inflation over the next few years. Measures of medium- and long-term inflation compensation derived from inflation-indexed Treasury bonds appear broadly consistent with these forecasts. Surveys of households suggest that the public's longer-term inflation expectations also remain stable.
Although overall inflation is low, since summer, we have seen significant increases in some highly visible prices, including those of gasoline and other commodities. Notably, in the past few weeks, concerns about unrest in the Middle East and North Africa and the possible effects on global oil supplies have led oil and gasoline prices to rise further. More broadly, the increases in commodity prices in recent months have largely reflected rising global demand for raw materials, particularly in some fast-growing emerging-market economies, coupled with constraints on global supply, in some cases. Commodity prices have risen significantly in terms of all major currencies, suggesting that changes in the foreign exchange value of the dollar are unlikely to have been an important driver of the increases seen in recent months.
The rate of pass-through from commodity price increases to broad indexes of U.S. consumer prices has been quite low in recent decades, partly reflecting the relatively small weight of materials inputs in total production costs as well as the stability of longer-term inflation expectations. Currently, the cost pressures from higher commodity prices are also being offset by the stability in unit labor costs. Thus, the most likely outcome is that the recent rise in commodity prices will lead to, at most, a temporary and relatively modest increase in U.S. consumer price inflation – an outlook consistent with the projections of both FOMC participants and most private forecasters.
That said, sustained rises in the prices of oil or other commodities would represent a threat both to economic growth and to overall price stability, particularly if they were to cause inflation expectations to become less well anchored. We will continue to monitor these developments closely and are prepared to respond as necessary to best support the ongoing recovery in a context of price stability.
Ben S. Bernanke is chairman of the Federal Reserve. This article was adapted from testimony Bernanke gave before the Senate Banking Committee on March 1. His complete testimony can be found here.
