Sense on Cents

Nothing like a cold shower from a fellow Bostonian to dose the spirits of what has been a solid 5% rally in the markets over the last week. To what do I refer? Boston Fed President Eric Rosengren sends a cold shiver across the bow of our economic landscape in a recent interview with The Wall Street Journal.

Rosengren specifically sends a note of real caution in terms of his economic outlook, concerns about deflationary trends, a lack of improvement on the jobs front, and the potential need for more quantitative easing on behalf of the Fed. This interview is relatively brief, but it provides a wealth of sense on cents. 

The WSJ writes, Boston Fed’s Rosengren, Growth Slowing, Deflation is Emerging Risk:

ON INFLATION:
“The core inflation rate is right around 1%. Given the amount of substantial excess capacity that we have in the economy, there is some risk of further disinflation. And I would say the risk of deflation has gone up and is more of a risk than I would like to see at this point.

“We’re seeing core prices continuing to decline in Japan. We’re seeing some of the peripheral [European] countries like Ireland starting to see actual declines in prices as a result in part of a fiscal austerity. We have a number of other countries in Europe that are about to embark on a substantial fiscal austerity. We don’t want to be in a situation where countries other than Japan start worrying about deflation.

“We have plenty of tools to tighten up if it turns out the economy grows faster and inflation becomes more of a concern. But it is a little uncertain how effective our tools are once the economy gets into a deflationary environment. The experience of Japan is sobering. They’ve spent a decade and a half dealing with an economy that has had falling prices and despite a variety of monetary and fiscal actions taken are still facing a deflation problem.

“It just highlights that it is not straightforward for policy makers to break out of a deflationary environment. And so if you were to look at the balance of risks and what we could do about those risks, the risk from a downside shock I would view as more of a problem than the risk of an upside shock of inflation or to the economy overall.”

ON THE ECONOMIC OUTLOOK:
“I was probably a little more pessimistic than some to start out with and… incoming data has been a little bit weaker than many had anticipated. Many private sector forecasters have been downgrading their forecasts for the second half of the year.

“If you look at final sales — which is just taking inventories out of GDP — final sales only grew by 0.8% in the first quarter and that is after two previous quarters that averaged below 2% as well. We’re getting to the point in the recovery where we wouldn’t expect as much support coming from the inventory side. If inventories start to ebb it becomes really essential for some of the other components of GDP to start to pick up at this time and there is some reason to believe that we may not get as much of a pick up as some had been anticipating earlier this year.

(I have highlighted this very point in the fabulous work produced by our Sense on Cents friend Rick Davis of Consumer Metrics Institute.)

“One reason would be the labor market weakness. The employment to population ratio has dropped in the past two months. It is now 58.5% and is well down from where we were before the recession….We’re not seeing significant signs of improvement yet.

“It looks like we’re going to see some near term fiscal restraint particularly at the state and local level, but it’s a little unclear how much restraint we might see both here and abroad. And the financial markets have become a little bit less supportive. The Libor rate has been drifting up since earlier this spring. Stock indexes have generally declined, despite the recent improvement. And credit default swaps for some of peripheral Europe remain elevated.

“When I put all of that together I become concerned that the second half is going to be a little weaker than we might have anticipated a couple of months ago and…I’m not expecting to see that much progress on the unemployment rate over the course of the second half of this year. Ideally we’d be seeing growth north of 4% in order to be really pushing the unemployment rate down from its very elevated levels and we’re not seeing growth at nearly 4% at least for the second half this year. Unfortunately, it looks like it will be a good bit slower than that. It is quite possible we’ll be in the 2% to 3% range.”

ON THE FED’S OPTIONS IF THE ECONOMY FALTERS:
“There are several policy options if we think the economy is weaker than we would like. Reinvesting [proceeds from maturing mortgage bonds] is one option. Purchasing more [securities] outright is another option. Keeping rates low for a more extended period of time than others were anticipating would be another option. There are some options available. We should be moderating what our policies are reflective of how likely it is for us to achieve our mandate over a reasonable time period … If the economy ends up much weaker than we were anticipating, we would have to consider other policy alternatives, which would include potentially reinvesting funds or potentially doing additional purchases. We shouldn’t take those options off the table if we get a much weaker outcome than we were anticipating … We should be concerned about downside risk. I’m certainly in the camp where I’m worried about downside risks and policy needs to be thinking about contingencies. Part of central banking is to think about what the risks in both directions are and what the policy response would need to be.”

ON WHAT IT WOULD TAKE TO CONVINCE HIM NEEDS TO DO MORE:
“If it looks like we’re not going to meet either element of our objective in a two- to three-ear horizon, we need to start thinking about what else we could do or what else the fiscal authorities could do. But in the absence of fiscal action we’d have to think about what more we could do … if the economy gets weaker and the inflation rate gets lower, we should be thinking about alternative policies.”

Rosengren is clearly less than enthused about the immediate slope of our economic landscape, but I appreciate his honest, direct, and informed approach. As such, he too receives immediate induction into the Sense on Cents Hall of Fame!!

LD

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