Bernanke Speaks in Minneapolis

As I’ve said before, Bernanke speaks pretty clearly. Here’s a key part of his talk:

Why has this recovery been so slow and erratic? Historically, recessions have tended to sow the seeds of their own recoveries as reduced spending on investment, housing, and consumer durables generates pent-up demand. As the business cycle bottoms out and confidence returns, this pent-up demand, often augmented by the effects of stimulative monetary and fiscal policies, is met through increased production and hiring. Increased production in turn boosts business revenues and increased hiring raises household incomes–providing further impetus to business and household spending. Improving income prospects and balance sheets also make households and businesses more creditworthy, and financial institutions become more willing to lend. Normally, these developments create a virtuous circle of rising incomes and profits, more-supportive financial and credit conditions, and lower uncertainty, allowing the process of recovery to develop momentum.

These restorative forces are at work today, and they will continue to promote recovery over time. Unfortunately, the recession, besides being extraordinarily severe as well as global in scope, was also unusual in being associated with both a very deep slump in the housing market and a historic financial crisis. These two features of the downturn, individually and in combination, have acted to slow the natural recovery process.

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 peak. Depressed construction also has hurt providers of a wide range of goods and services related to housing and homebuilding, such as the household appliance and home furnishing industries. Moreover, even as tight credit for builders and potential homebuyers has been one of the factors restraining the housing recovery, the weak housing market has in turn adversely affected financial markets and 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.

As I noted, the financial crisis of 2008 and 2009 played a central role in sparking the global recession. A great deal has been and continues to be done to address the causes and effects of the crisis, including extensive financial reforms. However, although banking and financial conditions in the United States have improved significantly since the depths of the crisis, financial stress continues to be a significant drag on the recovery, both here and abroad. This drag has become particularly evident in recent months, as bouts of sharp volatility and risk aversion in markets have reemerged in reaction to concerns about European sovereign debts and related strains as well as developments associated with the U.S. fiscal situation, including last month’s downgrade of the U.S. long-term credit rating by one of the major ratings agencies and the recent controversy surrounding the raising of the U.S. federal debt ceiling. It is difficult to judge how much these events and the associated financial volatility have affected economic activity thus far, but there seems little doubt that they have hurt household and business confidence, and that they pose ongoing risks to growth.

While the weakness of the housing sector and continued financial volatility are two key reasons for the frustratingly slow pace of the recovery, other factors also may restrain growth in coming quarters. For example, state and local governments continue to tighten their belts by cutting spending and reducing payrolls in the face of ongoing budgetary pressures, and federal fiscal stimulus is being withdrawn. There is ample room for debate about the appropriate size and role for the government in the longer term, but–in the absence of adequate demand from the private sector–a substantial fiscal consolidation in the shorter term could add to the headwinds facing economic growth and hiring.

The prospect of an increasing fiscal drag on the economy in the face of an already sluggish recovery highlights one of the many difficult tradeoffs currently faced by fiscal policymakers. As I have emphasized on previous occasions, without significant policy changes to address the increasing fiscal burdens that will be associated with the aging of the population and the ongoing rise in health-care costs, the finances of the federal government will spiral out of control in coming decades, risking severe economic and financial damage. But, while prompt and decisive action to put the federal government’s finances on a sustainable trajectory is urgently needed, fiscal policymakers should not, as a consequence, disregard the fragility of the economic recovery. Fortunately, the two goals–achieving fiscal sustainability, which is the result of responsible policies set in place for the longer term, and avoiding creation of fiscal headwinds for the recovery–are not incompatible. Acting now to put in place a credible plan for reducing future deficits over the long term, while being attentive to the implications of fiscal choices for the recovery in the near term, can help serve both objectives.

Posted by on September 8th, 2011 at 1:52 pm


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