Monetary policy is moving slowly and cautiously towards normalization. Signs of improvement—falling unemployment, better financial conditions, and abating headwinds—indicate the United States is changing from extraordinary economic times back to ordinary ones. Risks to the recovery’s momentum linger, and “normalizing†should not be confused with “tightening.†Monetary policy will remain highly accommodative for some time. Overall, however, the outlook is positive.
The following is adapted from a presentation by the president and CEO of the Federal Reserve Bank of San Francisco to the Association of Trade and Forfaiting in the Americas in San Francisco on May 22, 2014.
For the past five years, monetary policy in the United States has reflected the extraordinary economic times we were in: interest rates held at essentially zero, multiple rounds of quantitative easing, and a lot more talk from the Fed about our intentions.
Now, thankfully, the extraordinary is turning back into the ordinary, and we are starting down a path towards normalization, both for the economy and monetary policy. We’ll venture down this path slowly, and monetary policy will remain highly accommodative for some time. But I am happy to say that we are on the road back to normal. I’d like to give an overview today of the economic outlook and its implications for monetary policy.
A sustained recovery
Winston Churchill once said, “I always avoid prophesying beforehand, because it is a much better policy to prophesy after the event has already taken place,†and that’s good advice. But I’m going to ignore it and go ahead and say that the outlook is, overall, quite good. While the winter wasn’t too kind to many parts of the country, and it looks like growth in real GDP stalled in the first quarter, things are looking positive for the rest of the year.
The severe weather in parts of the country accounts for some, though not all, of that first-quarter weakness. By some estimates, weather conditions reduced GDP growth by as much as 1½ percentage points. Most of the other factors depressing first-quarter growth appear to be temporary and more recent economic indicators point to substantial underlying momentum. In particular, consumer spending has rebounded from winter lulls.
The jobs numbers are also encouraging. Following weak jobs data during the worst winter months, employment gains bounced back up to average nearly a quarter-million jobs per month from February through April. This rebound in employment growth is evidence that businesses view the winter’s inactivity as temporary. Taking a longer view, over the past year, the U.S. economy has added nearly 2.4 million jobs. This has helped reduce the unemployment rate to 6.3%.
Despite all this good news, there is one area of concern, which is housing. Historically, most recessions have been followed by housing revivals, which significantly boosted the early stages of recovery. I therefore expected housing to be a much stronger tailwind by now. While home construction and sales showed substantial momentum in 2012 and the first half of 2013, the wind has been taken out of the sails since then. Much of the slowdown in housing market activity appears to be due to last year’s jump in mortgage interest rates. Although that is unlikely to reverse, other factors driving this sector should improve, and I remain cautiously optimistic about the outlook for housing over the next few years.
One source of the as-yet unrealized demand for housing is the number of adults living with their parents. The recession saw a substantial increase in the percentage of Americans forced to move back home, or unable to make it out in the first place (Rudebusch 2014). As job growth continues, huge numbers of these young people are likely to move out—a relief to both them and their parents, I should think—and many will buy homes.
Homes are also still pretty affordable. Household incomes are growing, mortgage interest rates—despite last year’s jump—are still low, and in most areas of the country home prices have remained well below their pre-recession peaks. And while those prices are still relatively low, they are continuing to rise.
Together, these various signs indicate that the disappointing data are likely temporary, and housing should begin to provide the support to the recovery we’ve been waiting for.
