Bernanke: Recovery from Crisis Less Robust than Hoped


Chairman of the Federal Reserve Ben Bernanke today gave a speech outlining near-term and long-term prospects and policy considerations concerning the nation’s economy. While Bernanke noted some positive developments have occurred in the two years since NBER’s end-date for the Great Recession, he also detailed economic disappointments that are a source of ongoing concern for any small business owner or stakeholder in the housing market.

And while some on Wall Street may have been hoping for an explicit mention of an additional round of quantitative easing, Bernanke provided no specifics on future policy.

On specific issues, Chairman Bernanke had the following to say —

On housing, the chairman’s comments match NAHB’s concerns and analysis regarding housing’s traditional role of lifting the U.S economy out of recession, In particular, Bernanke noted tight credit conditions for buyers and builders, the impact of possible future housing price declines on macroeconomic growth, and a vicious cycle of lower household net worth, leading to more cautious lending to households, which in turn reduces housing demand, lowers prices and reduces household net worth.

Notably, the housing sector has been a significant driver of recovery from most recessions in the United States since World War II, but this time–with an overhang of distressed and foreclosed properties, tight credit conditions for builders and potential homebuyers, and ongoing concerns by both potential borrowers and lenders about continued house price declines–the rate of new home construction has remained at less than one-third of its pre-crisis level. The low level of construction has implications not only for builders but for providers of a wide range of goods and services related to housing and homebuilding. Moreover, even as tight credit for some borrowers has been one of the factors restraining housing recovery, the weakness of the housing sector has in turn had adverse effects on financial markets and on the flow of credit. For example, the sharp declines in house prices in some areas have left many homeowners “underwater” on their mortgages, creating financial hardship for households and, through their effects on rates of mortgage delinquency and default, stress for financial institutions as well. Financial pressures on financial institutions and households have contributed, in turn, to greater caution in the extension of credit and to slower growth in consumer spending.

On future housing policy, Bernanke alluded to what we have refered to as shadow housing demand (we estimate nearly 2.1 million potential households have not formed that would have been expected to due to population growth but did not due to economic conditions), but shied away from many of the specific housing policy issues that hold downside risk for the sector, including expiring GSE/FHA loan limits, QRM downpayment requirements, inaccurate appraisals, and the fate of the mortgage interest deduction and other housing tax rules.

Notwithstanding the severe difficulties we currently face, I do not expect the long-run growth potential of the U.S. economy to be materially affected by the crisis and the recession if–and I stress if–our country takes the necessary steps to secure that outcome. Over the medium term, housing activity will stabilize and begin to grow again, if for no other reason than that ongoing population growth and household formation will ultimately demand it. Good, proactive housing policies could help speed that process. Financial markets and institutions have already made considerable progress toward normalization, and I anticipate that the financial sector will continue to adapt to ongoing reforms while still performing its vital intermediation functions. Households will continue to strengthen their balance sheets, a process that will be sped up considerably if the recovery accelerates but that will move forward in any case

On future monetary policy, the chairman repeated the FOMC’s decision to hold the federal funds rate at a near-zero rate through at least mid-2013. While Bernanke did not endorse another round of quantitative easing, he did note that the September meeting of the FOMC would be extended to two days to allow a more lengthy discussion of other monetary policy tools the Fed might deploy.

In light of its current outlook, the Committee recently decided to provide more specific forward guidance about its expectations for the future path of the federal funds rate. In particular, in the statement following our meeting earlier this month, we indicated that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. That is, in what the Committee judges to be the most likely scenarios for resource utilization and inflation in the medium term, the target for the federal funds rate would be held at its current low levels for at least two more years.

In addition to refining our forward guidance, the Federal Reserve has a range of tools that could be used to provide additional monetary stimulus. We discussed the relative merits and costs of such tools at our August meeting. We will continue to consider those and other pertinent issues, including of course economic and financial developments, at our meeting in September, which has been scheduled for two days (the 20th and the 21st) instead of one to allow a fuller discussion. The Committee will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate to promote a stronger economic recovery in a context of price stability.

On the unusual alignment of short-term and long-term monetary policy goals:

Normally, monetary or fiscal policies aimed primarily at promoting a faster pace of economic recovery in the near term would not be expected to significantly affect the longer-term performance of the economy. However, current circumstances may be an exception to that standard view–the exception to which I alluded earlier. Our economy is suffering today from an extraordinarily high level of long-term unemployment, with nearly half of the unemployed having been out of work for more than six months. Under these unusual circumstances, policies that promote a stronger recovery in the near term may serve longer-term objectives as well. In the short term, putting people back to work reduces the hardships inflicted by difficult economic times and helps ensure that our economy is producing at its full potential rather than leaving productive resources fallow. In the longer term, minimizing the duration of unemployment supports a healthy economy by avoiding some of the erosion of skills and loss of attachment to the labor force that is often associated with long-term unemployment.

This linkage of short-term monetary policy goals with long-term objectives, which are usually at odds, is a reminder that today’s primary economic challenge is weak economic growth and high unemployment.

On fiscal policy, the Fed chairman all but endorsed short-term fiscal stimulus, while also noting long-term fiscal challenges associated with government-related health care spending.

To achieve economic and financial stability, U.S. fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is at least stable or, preferably, declining over time. As I have emphasized on previous occasions, without significant policy changes, the finances of the federal government will inevitably spiral out of control, risking severe economic and financial damage. The increasing fiscal burden that will be associated with the aging of the population and the ongoing rise in the costs of health care make prompt and decisive action in this area all the more critical.

Although the issue of fiscal sustainability must urgently be addressed, fiscal policymakers should not, as a consequence, disregard the fragility of the current economic recovery. Fortunately, the two goals of achieving fiscal sustainability–which is the result of responsible policies set in place for the longer term–and avoiding the creation of fiscal headwinds for the current recovery are not incompatible. Acting now to put in place a credible plan for reducing future deficits over the longer term, while being attentive to the implications of fiscal choices for the recovery in the near term, can help serve both objectives.

Fiscal policymakers can also promote stronger economic performance through the design of tax policies and spending programs. To the fullest extent possible, our nation’s tax and spending policies should increase incentives to work and to save, encourage investments in the skills of our workforce, stimulate private capital formation, promote research and development, and provide necessary public infrastructure. We cannot expect our economy to grow its way out of our fiscal imbalances, but a more productive economy will ease the tradeoffs that we face.

Overall, Bernanke’s assessment of the economy and the government’s policy options is a sobering one. Weak economic growth threatens short-term objectives such as job creation and housing market stability while also weakening long-term government deficit prospects. We suggest that Bernanke’s overview is once again a reminder to policymakers that there can be no robust, sustainable economic recovery without stability and growth in the housing sector. And given the number of policy debates that are underway that would further weaken housing, such a reminder is well-timed.

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