WORD ON THE STREET: The country is in the ninth quarter of a disappointing and frustrating recovery. We at the Fed were hopeful of (and many private forecasters envisioned) a modest version of a classic bounce-back after a recession. Yet over the past four quarters for which there are growth measurements, the economy has grown at only a 1.6% pace. If the economy's potential for growth is a pace of 2.5%, as many economists believe, then slack in our economy is rising, even though we are technically in recovery.
The unimpressive recovery is evident in the U.S. labor market. In July, the national unemployment rate stood at 9.1% – a percentage point below its peak, but three-tenths higher than it was last March.
This sluggishness has been blamed on a variety of temporary and more persistent headwinds. That's the term often used to describe forces that are impeding growth. Since the recession ended and expansion resumed, certain underlying ‘structural’ (or more long-term) headwinds have been recognized, but these factors were taken as reasons post-recession growth would clock in at a moderate rate in the range of 3% to 4% per annum instead of a much more robust rate typical of a rebound from a deep recession.
Very recently, awareness of and attention to the deeper long-term impediments to growth have become more acute. There is rising concern that the U.S. economy may be facing a longer period of very slow growth because of more intractable structural forces in play. These deeper impediments to growth imply structural adjustments in the economy that may take years to accomplish before the economy achieves full and well-balanced health.
In my view, there are three likely protracted and interconnected adjustment processes of significance: They are deleveraging (i.e., the reduction of total debt levels in our economy); fiscal adjustment; and financial system repair. In addition, the accumulating pressure of an aging population will affect labor-force participation and output potential.
Debt is not, in and of itself, a bad thing. Debt supports economic growth by allowing households, businesses and governments to smooth their spending and investment over time. Borrowing and lending can help facilitate the allocation of capital to productive uses in the economy. But high debt levels can also result in lower economic growth.
So let's take stock of how we got to this point. Much of the growth in debt over the last decade was in the form of real estate debt of households. During the 1990s, the amount of outstanding mortgage debt of households was relatively stable at around 45% of gross domestic product (GDP), but from 2000 to 2007, household mortgage debt increased to almost 75% of the GDP.
As long as home prices were rising, the increasing debt burden of households was not particularly problematic. But the level of household debt turned into a drag on the economy once home values began to drop. According to the Case-Shiller price index, home values have declined by over 30% since their peak in 2006.
Declining home values, along with rising unemployment, set in motion a process of deleveraging by the household sector. Household deleveraging has occurred mostly through a combination of increased savings, debt repayment and debt forgiveness.
At the same time, there has generally been less access to credit for households as a result of stricter underwriting standards. The inability to qualify for home equity loans and other forms of credit has slowed the pace at which new debt is taken on by households replacing paid-down debt. The effect is to reduce their debt burden over time. From its peak in 2009, total household debt has declined to around 90% of GDP (the lowest level since 2005), and the household savings rate has risen to about 5%.
Debt in the nonfinancial business sector also increased over the last decade, reaching a historical high of 79% of GDP in 2009. By the first quarter of 2011, nonfinancial business debt had declined to about 73% of GDP. To give you a point of reference, nonfinancial business-sector debt becomes a drag on economic growth after it increases to above 90% of the GDP.
In contrast to reductions in debt by households and businesses, government debt has surged, increasing from about 50% of the GDP prior to the recession to around 80% in the first quarter of this year.
For the economy as a whole, debt relative to GDP has barely changed. While the private sector has made notable progress in lowering its debt burden, discussions of how to reduce public debt have only just begun. The government still needs to introduce major policy changes to put public debt on a sustainable path. Demographic trends will make public debt reduction even more challenging.
It is necessary that the process of deleveraging plays itself out, which may take several more years. When economies are deleveraging, they cannot grow as rapidly as they might otherwise. It is obvious that as consumers reduce spending, they divert more of their incomes to paying off debt. This shift in consumer behavior increases the amount of capital available for financing investment. But higher rates of business investment are not likely to fully offset weakness in consumer spending for some time, as businesses continue to grapple with uncertainties about the future.
To my mind, it's becoming increasingly clear that the challenge we policymakers face is balancing appropriate policy responses for the near to medium term with what's needed for the longer term. In other words, we must continue to help the economy achieve a healthy enough cyclical recovery, especially with unemployment high and consumer spending lackluster. At the same time, we must recognize the longer-term need for directionally opposite structural adjustments, including deleveraging.
To support the recovery, low interest rates and ample liquidity help to encourage spending by consumers and businesses. Because this is an aim of policy in the near term, Fed economists, like those in the private sector, watch with intense interest the monthly data on consumption and surveys of consumer confidence.
But at the same time, there's broad acknowledgement that policy must support the long-term rebalancing required to sustain our economic health. Finding the right path through these seemingly conflicting pressures is challenging.
The situation brings to mind a quotation from F. Scott Fitzgerald's 1936 article titled ‘The Crack Up.’ He said, ‘The test of a first rate intelligence is the ability to hold two opposed ideas in mind at the same time, and still retain the ability to function.’ In a way, that's the test we policymakers must step up to in balancing short- and longer-term needs.
Against that backdrop, I would characterize the stance of monetary policy at this time as accommodative. As you know, the Federal Open Market Committee stated after its last meeting the intention to keep the policy rate at near zero for two more years. Also, the current policy is to maintain the Fed's balance-sheet scale for the foreseeable future. I support this position.
Given the weak data we've seen recently, and considering the rising concern about chronic slow growth or worse, I don't think any policy option can be ruled out at the moment. However, it is important that monetary policy not be seen as a panacea. The kinds of structural adjustments I've been discussing today take time, and I am acutely aware that pushing beyond what monetary policy can plausibly deliver runs the risk of creating new distortions and imbalances.
We may find, as economic circumstances evolve, that policy adjustments are required. In more adverse scenarios, further policy accommodation might be called for. But as of today, I am comfortable with the current stance of policy, especially considering the tensions policy must navigate between the short and long term and between recovery and the need for longer-term structural adjustments.
Dennis P. Lockhart is president and CEO of the Federal Reserve Bank of Atlanta. This article is edited and adapted from a speech delivered Aug. 31 at the Greater Lafayette Chamber of Commerce in Lafayette, La. The original text of his presentation is online.
