Bernanke Speaks: Modest Growth Ahead?

In comments made today Bernanke has given a cautiously optimistic view of the economic outlook. I emphasize the word cautious.

Allow me to summarize:

• The economy grew about 3.5% in the third quarter, breaking a four quarter span of decline.
• Bernanke sides with the optimists in arguing that this growth came from sufficiently diverse sources that it is likely to continue even when the inventory adjustment subsides, and the effects of temporary government actions such as the ‘cash for clunkers’ and first time home owner credit programs dissipate.
• So he sees the economy growing throughout 2010.
• Nonetheless there are big risks: obviously unemployment is too high, and the flow of credit too weak.
• Unemployment has started to end its free fall. The economy is shedding about 220,000 jobs a month now rather than the 560,000 a month common at the beginning of the year. The economy needs to add about 100,000 jobs a month just to keep up with population growth, so we are a long way from reaching a tipping point where jobs become more abundant.
• Unemployment has hit the young particularly hard with the unemployment rate in that category reaching over 19%. This is very damaging long term since it means that younger workers are being denied a chance to develop skills and gain experience that we will need in the future. This imposes a ‘hidden’ cost on the economy as the delayed development of such workers will slow productivity growth down the line.
• On the other hand: current productivity is growing at very high rates: by about 5.5% this year. This is largely due to employers making surviving workers do more work; and to the shorter work week: average hours worked per week have now shrunk to about 33, the lowest since World War II.
• The actions taken to bail out the banks worked in that the crisis in the credit markets has eased – as measured by things such as risk spreads. However, banks are lending less. The level of consumer debt has now fallen for the first time since 1951. Lending terms have been tightened significantly although there is evidence that the tightening is at an end. In general banks remain cautious and are likely to stay that way for some time – especially in view of the oncoming commercial real estate refinancing problem.
• Because of the probable damage done to bank balance sheets by the commercial real estate refinancing problem, the TARP and TALF programs should remain in place at least through next year.
• There is no upward pressure on inflation presently. The economy is awash with spare capacity so the are few resource constraints – production bottlenecks are a normal source of price pressure during the early stages of a recovery – and the bond market seems quiescent: the expected inflation rate being built into bond prices is well within the limits the Fed sees as prudent [ the Fed has an upper limit of about 2% per year in mind].
• The dollar is likely to weaken some more, although the current flux in exchange markets is probably not going to last much longer. The Fed remains committed to a ‘strong’ dollar as part of an approach to international financial stability.
• Taking the state of the credit markets, the low expected rate of inflation, and the outlook for the dollar into account and then setting those against the need for ongoing support until the economy is securely on a growth track, the Fed sees no reason to raise rates in the near future. Indeed there is every chance rates will remain very low for an ‘extended’ period.

OK.

That’s what he said. Is there anything of note in those statements?

Not really.

Bernanke is solidly in the pragmatic-but-optimistic camp. He clearly acknowledges that there remain significant downside risks next year, but he argues that the central tendency of the economy is modest growth. However he wants us to note that the variability is mostly on the potential negative side: the combination of weak credit and weak labor markets could well threaten growth and push us back into recession. He thinks a second downturn is unlikely, but that the threat remains.

As for inflation and interest rates: Bernanke sees a quiet time ahead. Since inflation is not an immediate threat – notwithstanding the hysteria in some media outlets – there is no need to lift rates. On the contrary: given the weakness in domestic demand the bias is still to maintain the very low, and thus stimulative, level of rates for a long time.

As for the dollar: he ‘soft shoes’ around that one. I suspect he would like to see a little more devaluation to help lift exports and thus support growth. He probably doesn’t mind a steady decline in the dollar’s value. What he wants to avoid is anything precipitous. That would force his hand and could potentially threaten the recovery. So he ends up talking pablum about a ‘strong’ dollar without saying what that would look like.

Overall his view seems to fit with where I think things are going. I am less upbeat about next year because i am less sure than Bernanke is about the sufficiency of the current burst of growth: I see much more of the third and fourth quarters coming from stimulus and inventory adjustments, and thus less from ongoing sustainable growth.

The difference?

He puts growth next year in the low 2% range; whereas I am still in the 1.5% range.

No big deal, as long as credit and jobs don’t cause any ripples. My outlook just has less room for maneuver and thus more chance for a downward shift.