Speaking to a crowd at the University of California, Santa Barbara, on Sept. 3, Dallas Federal Reserve Bank President Richard Fisher said that with businesses across the country dealing with overcapacity, deflation is still a greater worry to the U.S. economy than inflation.
Fisher, who was invited to speak at UCSB by the Laboratory for Aggregate Economics and Finance, went on to echo the words of Federal Reserve Chairman Ben Bernanke, telling the crowd that while the worst of the recession may well be over, businesses and consumers should expect “a gradual recovery.”
Minutes from the Fed’s Aug. 11 to 12 meeting showed that other officials there also believe that the economy is “likely to recover only slowly during the second half of this year,” and that it is still “vulnerable to adverse shocks.” At that meeting, the Fed left its key interest rate near 0 percent and made no move to reel in some of the more than $1 trillion in cheap credit it has pumped into the economy – both moves that come with inflationary risks should the economy rapidly recover.
Yet Fisher, a notorious and self-described “inflation hawk,” echoed the Fed’s sentiments, saying that “rebuilding will take some time” and that business around the country are still “suffering from shock.” He said for now, at least, his concerns about inflation are subdued.
Deflation not inflation
Prior to the onset of the recession, businesses were bulking up on capacity and payroll and the economy was leaning towards inflationary prices, Fisher said. Now, it’s dealing with excess production capacity and inventories, which help to keep prices down.
“There is an overabundance in every sector of the economy,” Fisher said. “The CEOs that I survey are struggling to deal with excess capacity – they’re pushing on a string to move things along.”
As the economy moves towards that gradual recovery, businesses will continue to deal with excess inventories by cutting prices, he said. “For the immediate future the risk to price stability is a deflationary risk, not an inflationary risk.”
Spending and investment
Fisher said that residential investment, inventory investment and consumer spending each subtracted more than a percentage point from GDP growth during the first quarter of 2009.
Household spending, the leading driver of GDP growth, has suffered its biggest two-quarter drop since 1947 – a direct reflection of consumer concerns over employment prospects, Fisher said. But, while that may seem like a dismal figure, it may also mean that the “worst is over for household consumption” as consumers adjust their spending again to more positive economic forecasts.
Both businesses and consumers may have made a fundamental shift in their spending patterns, choosing to save rather than spend more of their incomes, Fisher said.
“Households and businesses will focus on shoring up their savings and balance sheets rather than spending money. For consumption, that translates into a slow crawl out of purgatory.”
Federal stimulus efforts have changed the makeup of the GDP equation as well, Fisher said. While government spending has constituted about one-third of the GDP equation for some time, it has now increased to about 40 percent of GDP. “It dislocated the equation we were all so familiar with,” he said.
The U.S. Labor Department released its monthly job market report on Sept. 4, putting the national unemployment rate at 9.7 percent in August – up from 9.4 percent in July. Although job losses have moderated in recent months, the U.S. has lost 6.9 million jobs since December 2007.
Fisher said that to shore up profits, firms will continue to focus on cost control, “most painfully by shedding workers and driving those who remain on the payroll to higher levels of productivity.”
But, as he pointed out, unemployment is often a lagging indicator of economic recovery. “I do think it will be some time before we get back to net job creation,” he said.
Costs of recovery
Fisher praised federal monetary and fiscal stimulus for helping to revive the economy, but warned of the long-term effects of a government-financed recovery.
“Government stabilization measures almost certainly come with a real long-term price tag – in California you know that – higher tax rates, greater collective indebtedness and the prospect of higher interest rates driven by the government’s issuance of debt,” he said.
“The major challenge facing U.S. fiscal authorities is meeting the need for near-term economic stimulus while pursuing a practicable plan to stabilize the government’s debt-finance obligations,” he said.