In a speech today in Hartford, Boston Fed President Eric Rosengren said that despite recent improvements in economic conditions, "we remain far from where we need to be."
"All of us who follow the economy have been waiting for the drag from fiscal austerity to wane, for consumers to regain confidence and increase demand, and for the housing market to solidify its nascent recovery," said Rosengren. "These represent the underlying drivers in most forecasts that expect 3 percent growth beginning this year – a view I share."
Improvements in conditions like these "suggest positive news for the 2014 outlook." However, with the unemployment rate at 7 percent, we remain well above Rosengren's estimate of full employment, 5.25 percent. And the total PCE inflation rate is 0.9 percent, well below the 2 percent target that the FOMC has adopted. So despite the improvements, Rosengren believes there is justification for maintaining a highly accommodative stance for monetary policy.
There are significant costs to such a slow recovery. "It poses great strains on unemployed workers (and their families)," said Rosengren. And prolonged unemployment can cause longer-lasting damage to individuals if skills atrophy, and also "leave marks" on the labor market and economy more broadly, long after the recovery is complete.
"These long-term labor markets scars, which result from a very slow recovery, lead me to believe that the Federal Reserve should remain highly accommodative and wind down our extraordinary programs only very gradually, in order to minimize the costs and risks of not returning to full employment more quickly."
Also, persistently low inflation rates can be a problem for several reasons. "First, at very low inflation rates, a sizable negative shock to the economy can result in negative inflation — deflation — which can become entrenched in expectations," said Rosengren, as occurred in Japan in the 1990s. A second concern with low inflation is that with nominal short-term interest rates bound at zero, real rates are driven higher by lower inflation, likely restraining growth.
Policymakers need to consider all the costs of a slow recovery, relative to the risk of taking actions that could hasten recovery. "As the economy continues to improve, we should reduce and ultimately remove the unusual support that the Federal Reserve's monetary policy has provided," Rosengren added. But this support should be removed only gradually. "This recovery has already been too slow, and we do not want premature tightening of monetary policy to delay the return to more normal economic conditions."