NEW YORK (MNI) – In remarks during a briefing on regional economic
conditions Tuesday, New York Federal Reserve Bank President William
Dudley said it is most likely the U.S. will see growth at “an even
slower rate when the third-quarter real gross domestic product (GDP)
figures are released at the end of this month.” Below is an excerpt from
his remarks:

National Economic Conditions

To provide context, let me start with a few comments about national
economic conditions. As I discussed in a recent speech, the long and
deep recession that ended in June 2009 has been followed by a very tepid
recovery. Since June 2009, economic activity has grown-but only slowly
from levels far below the productive capacity of the economy.

In recent months, the momentum of the recovery has slowed. For
example, after rising at a 3.25 percent annual rate during the second
half of 2009, there has been a progressive slowing-to a 2.75 percent
annual rate during the first half of 2010 and, most likely, to an even
slower rate when the third-quarter real gross domestic product (GDP)
figures are released at the end of this month.

With demand growth barely keeping pace with firms’ ability to
increase productivity, job creation has been too weak to significantly
reduce unemployment, which stands today at 9.6 percent. And, as is
typical in such circumstances of considerable slack, the rate of
inflation has declined.

Viewed through the lens of the Federal Reserve’s dual mandate-the
pursuit of the highest level of employment consistent with price
stability, the current situation is wholly unsatisfactory. Given the
outlook that the upturn appears likely to strengthen only gradually, it
will likely be several years before employment and inflation return to
levels consistent with the Federal Reserve’s dual mandate.

Why are we experiencing this soft patch now? There are several
reasons:

1.) As is typical for the early stages of a recovery, the economy
over the past four quarters has benefited from a strong inventory cycle.
The swing in inventories from liquidation back to restocking contributed
about 1.75 percentage points of the 3 percent growth of real GDP over
that period. But this effect is now petering out.

2.) The growth impulse from the 2009 fiscal stimulus package is
beginning to wane.

3.) The usual hand-off from inventory-led growth to private final
demand is not yet fully established.

Instead, we have ongoing sluggishness in two key sectors that have
led past recoveries: consumer spending and housing.

The slow recovery of consumer spending and housing in the face of
very substantial monetary and fiscal stimulus reflects the painful
unwinding of the dynamics at work during the expansion that preceded it.
Beginning around 2003, underwriting standards for residential mortgages
were significantly relaxed, leading to a sharp rise in household
borrowing and in home prices. The rise in home prices helped to support
additional demand for credit as households used the collateral
represented by their homes to borrow large sums of money via home equity
lines of credit and second mortgages. This also fueled a strong boom in
home construction. But house price increases could not be sustained
without limit. When home prices peaked and started to turn down, the
dynamic linking house prices, credit and consumption went into reverse,
forcing substantial adjustments on the part of the household sector and
in the housing market itself.

I’ve discussed in recent speeches the role monetary and regulatory
policy can play in helping to support economic activity and in improving
economic outcomes relative to what would otherwise be experienced in the
absence of this support. These steps include critical reforms that make
the financial system safer and accommodative monetary policy that make
mortgages more affordable and make the investments that create jobs are
more attractive. Today I will focus on the economic trends themselves.

Let’s consider first the consequences of this dynamic for consumer
spending-that is, households’ purchases of goods and services. Families’
expenditures rose at a slow 2 percent annual rate over the first half of
2010 and (so far) this sluggishness appears to have continued in the
third quarter of 2010. Families have not yet boosted their spending
above the levels preceding the severe cuts they made during the
recession. This frugality stands in stark contrast to the first year of
recovery from previous deep recessions. Several factors are inhibiting
families from spending.

Many people have lost their jobs and are still unemployed, or have
had their hours or pay reduced. Confidence in the economy remains quite
low. And households’ net worth, which fell substantially as real estate
and stock prices dipped, remains well below its previous peak compared
with disposable income. So, households have been saving more. The
personal saving rate, which rose to 5.5 percent by the end of 2009 from
a recent low of 1.2 percent in the third quarter of 2005, seems headed
even higher in the third quarter. Households are “deleveraging”; they
are paying down their debts. Of course, lenders have also reinforced
this tendency as they have tightened underwriting standards for consumer
credit, relative to their pre-recession standards.

Have households completed their deleveraging, so they will soon
spend more? Although we believe that substantial progress has been made,
it is hard to tell how much further this process has to run. For
example, the share of household after-tax income that families owe for
servicing debts and paying for housing (including property taxes,
homeowners insurance and rents) has declined sharply over the past two
years and is now back to levels last seen in the late 1990s. Households
have cut the total amount of debt they owe. They are also refinancing
outstanding debt to take advantage of the lowest mortgage interest rates
since the mid 1950s. We expect the increased rate of mortgage
refinancing now in place to continue over the near term. This represents
another means by which households can free up income for other uses.

Now, let’s consider the slow housing recovery. Housing market
activity-both new construction and sales-remains depressed. On the
construction side, total housing starts are running at just 600,000
units per year (seasonally-adjusted) in recent months. This is up from
530,000 units at the trough in the first quarter of 2009 but it is still
extremely low by the standards of the last 50 years. In fact, the rate
of new construction is so low that there is barely any net growth in the
U.S. housing stock these days.

One reason why so little housing is being built is that many
existing homes stand vacant. We estimate that there are roughly 3
million vacant housing units more than usual. And more vacancies are
added daily as the foreclosure process moves homes from families to
mortgage lenders. This stock of vacant homes will shrink when fewer are
foreclosed upon and more of these homes are sold or rented out.

On the sales side, even though low mortgage interest rates and
falling home prices have together boosted housing affordability to its
highest level in 40 years, the current pace of sales is quite sluggish.
Impediments to home sales include tight lending standards, a weak job
market and continued uncertainty regarding the future path of home
prices. The large decline in home prices that occurred between 2006 and
2008 is also important. This decline reduced the amount of equity that
owners have in their homes, making it difficult for people to come up
with the funds needed to “trade-up” and move into better homes.

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