NEW YORK (MNI) – The following are excerpts from New York Federal
Reserve Bank President William Dudley’s remarks prepared for the
Brooklyn Chamber of Commerce Friday, titled “The Road to Recovery:
Brooklyn”:

Economic growth so far this year has been disappointing.
Real GDP in the first quarter of 2011 grew at a tepid 1.8 percent annual
rate, and the available data suggest that growth in the current quarter
will not be much better.

A major factor behind this slowdown is that real consumption growth
(that is, spending on goods and services adjusted for price increases)
has been slower than in the last quarter of 2010. This occurred, in
part, because higher gasoline and food prices reduced the income that
households could spend on other purchases. High energy prices also
contributed to lower consumer confidence, which may have had an
independent negative effect on consumer spending.

As noted, a number of economic indicators suggest that economic
growth in the second quarter will also be subpar. Manufacturing
production fell in April. Most business survey indicators, including the
New York Fed’s own Empire State Manufacturing Survey, also have declined
recently, although most continue to signal some growth. The housing
market remains very weak and home prices fell in early 2011. After a
notable improvement earlier in the year, the labor market showed more
softness recently: more workers filed for unemployment insurance in the
past few weeks, firms added fewer jobs on net in May, and unemployment
inched up in April and May.

In part, this softness is related to factors that I expect will
prove transitory. These factors include the rapid rise in gas and food
prices that I noted earlier, supply disruptions associated with the
earthquake in Japan, and severe weather and flooding in parts of the
United States. All three suggest that the soft patch may not persist.
However, we continue to monitor the data for signs of more persistent
weakness, whether related to the interaction of housing and consumption
or some other factor.

Another reason to expect the economy to recover from this soft
patch is that many fundamentals have improved since last year. In
particular: Financial conditions have improved, albeit gradually, which
makes it easier for larger, well-established firms to borrow and invest.
However, new startups and smaller businesses continue to find credit
difficult to access. With stock market prices higher than a year ago and
household debt lower, household balance sheets are in better shape,
which should support household spending. Demand abroad — particularly
in Asia — still appears robust, supporting our exports. Most
importantly, and notwithstanding the May jobs report, the labor market
appears more solid than it was a year ago. Private firms added jobs at a
faster pace over the last five months than they did last year. This
growth has been strong enough to more than offset government layoffs.
Unemployment is also noticeably lower than it was in November, after a
decline that was rapid by historical standards.

Consequently, I anticipate that economic growth will pick up enough
in the second half of 2011 to sustain a moderate economic recovery.
Still, the pace of recovery probably will be painfully slow for the many
unemployed and underemployed workers. Even if the economy added 300,000
jobs per month over the next year and a half, we would likely still have
considerable labor market slack at the end of 2012.

Even though I expect a moderate economic recovery to be sustained,
the recent disappointing data suggest that downside risks to the outlook
have increased. Let me list some of them for you: As I mentioned
earlier, high oil and commodity prices have further strained many
families that already had tight budgets. The renewed decline in home
prices could dampen consumer spending and housing activity more than I
expect. The recent slowing of consumer spending growth could prompt
businesses to limit hiring and investment. Finally, aggressive near-term
government spending cuts or tax increases could slow economic growth at
least in the short- to medium-term. I would emphasize, however, that a
credible plan for long-term fiscal consolidation is sorely required and
would have many economic benefits.

Although these issues bear watching, I still believe that they
remain risks rather than the most likely outcomes.

With respect to inflation, after a period when inflation was lower
than the Fed would like to see, headline inflation (on a yearly basis)
has risen somewhat above desired levels. The recent rise in commodity
prices is likely to push up headline inflation further in coming months.
It is noteworthy, however, that the spike in oil and food prices over
the past year has not spilled over much to the prices of other goods and
services. Furthermore, commodity prices have dipped in the recent weeks.
Thus, most measures of underlying inflation trends-including core
inflation (which excludes volatile food and energy prices)-remain below
levels consistent with our mandate for price stability.

Going forward, futures markets do not signal that investors expect
commodity prices to rise rapidly from current levels. Provided these
prices stop rising rapidly (or indeed retreat further), I would expect
headline inflation to decline to a level closer to our longer-run
objectives. While this process plays out, however, it is critical that
we ensure that inflation expectations do not become unmoored. It is much
harder to keep inflation in check if people begin to raise their
expectations of inflation. At this point, measures of inflation
expectations overall remain well within the range of recent years-and
some measures have moved down significantly in recent weeks.

Economists at the New York Fed have examined inflation expectations
using a unique survey that we sponsor. As reported in a recent post on
our new Liberty Street Economics blog, they find no evidence to suggest
that a wage-price inflation spiral is getting underway. However, we
continue to monitor expectations for medium-term inflation very closely.

To sum up, despite the recent soft patch, economic conditions have
improved in the past year. I expect a moderate recovery to continue.
However, we still have a considerable way to go to meet the Fed’s dual
mandate of full employment and price stability.

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