WASHINGTON (MNI) – The following are the remarks of Federal Reserve
Gov. Kevin Warsh prepared Monday for the Atlanta Rotary Club:
It’s Greek to Me
It is tempting to view the economic events of the last three years
as a series of unrelated, unpredictable, unfortunate financial shocks.1
And it is easy — too easy, really — to bemoan the latest flare-up of
crisis conditions, and chalk it up to the global economy’s continued
string of bad luck.
If what ails us is nothing more than a case of bad fortune, then
the mixed metaphor of the moment has it about right: the black swans are
caught up in the perfect storm. And if what is needed to induce a
durable global economic expansion amounts to more doses of the
now-familiar spending packages and weekend shock therapies, then we
would know that our luck was indeed changing. If only it were so. In my
view, a strong, sustainable U.S. economic expansion is not in the hands
of the fates. It rests in our hands — the hands of fiscal, regulatory,
trade, and monetary policymakers. Equally, it rests with business
leaders like you here at the Atlanta Rotary Club.
We will soon give notice to the third anniversary since the onset
of the global financial crisis. As we mark this occasion — and continue
to witness shocks arising intermittently and unevenly — it might be
worth debunking some popular views that have become part of the crisis
narrative. In their stead, I will begin with what I believe are some
truths, perhaps hiding in plain sight all along.
Subprime mortgages were not at the core of the global crisis; they
were only indicative of the dramatic mispricing of virtually every asset
everywhere in the world. The crisis was not made in the USA, but first
manifested itself here. The volatility in financial markets is not the
source of the problem, but a critical signpost. Too-big-to-fail
exacerbated the global financial crisis, and remains its troubling
legacy. Excessive growth in government spending is not the economy’s
salvation, but a principal foe. Slowing the creep of protectionism is no
small accomplishment, but it is not the equal of meaningful expansion of
trade and investment opportunities to enhance global growth. The
European sovereign debt crisis is not upsetting the stability in
financial markets; it is demonstrating how far we remain from a
sustainable equilibrium. Turning private-sector liabilities into
public-sector obligations may effectively buy time, but it alone buys
neither stability nor prosperity over the horizon.
In the balance of my remarks, I will survey recent economic and
financial market developments. Next, with the benefit and burden of
recent U.S. experience, I will offer some changes for the next edition
of policymakers’ Crisis Response Guide. Finally, even amid greater
uncertainty about economic prospects, I will seek to further the
discussion about a path for policy.
1) The views expressed here are my own and not necessarily those of
my colleagues on the Board of Governors or the Federal Open Market
Committee. Nellie Liang, Daniel Covitz, William English, and Brian
Madigan of the Board’s staff contributed to these remarks.)
Economic and Financial Market Developments
Recent economic data support a moderate recovery in economic
activity. As the Federal Open Market Committee (FOMC) noted last week,
information received in the past couple of months suggests that the
recovery is proceeding and that the labor market is improving, albeit
gradually. Household spending is increasing, but remains constrained by
high unemployment, modest income growth, lower housing wealth, and tight
credit. Business spending on equipment and software has risen
significantly; however, investment in nonresidential structures
continues to be weak. Owing to a less-than-assured economic outlook and
broad uncertainty about public policy, employers appear quite reluctant
to add to payrolls. After sizable increases in March and April, private
nonfarm payroll employment rose by only 41,000 in May. Employers,
however, continue to lengthen workweeks for existing employees. Notably,
the workweek for production and nonsupervisory workers in manufacturing
reached its highest level since July 2000, and overtime hours per worker
now stand at pre-recession levels.
Meanwhile, most broad measures of inflation remain subdued. And
long-term inflation expectations appear stable.
Financial conditions, notably, have become less supportive of
economic growth. In early May, concerns intensified regarding fiscal
difficulties in some European countries. Financial market volatility
resurfaced with a vengeance in U.S. markets. The implied volatility of
equity prices (VIX) jumped to levels not seen in more than a year. In
short-term funding markets, spreads between the Libor (London interbank
offered rate) and the OIS (overnight indexed swap) rate widened and
commercial paper rates for many issuers jumped. Investors became
decidedly less willing to provide funds at longer tenors.
Treasury yields fell to near historic lows, in part as investors
sought refuge in dollar-denominated, highly liquid, safe-haven assets.
Equity prices, reacting to increased risk and prospects for weaker
global growth, also fell. Broad equity price indexes touched lows as
much as 14 percent below their recent peak in April. And retail
investors may have experienced one scare too many; outflows from equity
mutual funds appear to rival the retreat in late 2008. Risk spreads on
U.S. investment-grade and highyield bond prices rose, and corporate bond
issuance fell to about half the run-rate of earlier this year. Broad
measures of industrial commodity prices decreased substantially from
their peaks — mostly on account of weaker expected global demand. There
has been, however, some modest improvement across some markets in the
most recent weeks.
As I noted, a moderate cyclical recovery characterizes the last
several quarters in the United States. But while the recovery is
proceeding, investors remain uncertain about its trajectory. Financial
market participants are still searching — perhaps better characterized
as lurching — for a new equilibrium.
The economy’s path depends in part on whether a new market and
public policy equilibrium is established to keep the financial repair
process on track. If volatility in financial markets persists at
elevated levels, the expected pickup of business fixed investment may
disappoint. Business leaders in the United States may react to the
latest in a long series of shocks by postponing investments in capital
and labor alike. In that way, massive excess cash balances might not be
a source of strength, but a reminder of caution.
If, however, volatility levels across asset markets abate —
indicating that the financial repair process is continuing — the
economic recovery should continue apace. Businesses and consumers would
then be better positioned to convert the recovery into a more durable
expansion.
An Updated Crisis Response Manual
Given recent U.S. experience in responding to the financial crisis,
allow me to offer for consideration some ideas to inform the policy
response going forward. You can judge for yourselves whether
policymakers — at home or abroad — will be receptive to these ideas.
First, don’t blame the mirror. In times of economic weakness or
financial distress, policymakers are often troubled by the messages
embedded in financial market prices or bank lending statistics. Some
supervisors might disagree — even strongly — with the prices markets
assign to a banking system’s financial wherewithal. Some elected
officials may blame commercial banks for the low levels of lending. Some
out-of-favor fiscal authorities may take great umbrage at the prices
assigned to their funding costs. Still, outlawing a class of securities
or upbraiding an industry tends to be counterproductive.
Second, don’t fall in love with the mirror. In benign economic
times, market prices can lull investors and policymakers into a false
sense of security. Financial market prices may appear more sanguine
about prospects than fundamentals suggest. The cost of issuing a 10-year
Treasury bond or German bund might be exceptionally low by historical
standards. Inflation expectations may appear well anchored. But this is
no guarantee of future performance. Market prices adjust slowly and
steadily — until they don’t. Then, market prices can act in a nonlinear
fashion. That’s when policymakers end up with fewer, less desirable
options. And economies are done harm. So, in each of these messages, we
might think of the financial markets as a mirror, a very imperfect but
still telling reflection of reality.
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** Market News International Washington Bureau: 202-371-2121 **
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