Regional President Speech

MID-STATES CORPORATE FEDERAL CREDIT UNION ANNUAL ECONOMIC FORUM Indianapolis, Indiana October 17, 2002 ..................................................................... A Perspective on the Current Economy Thank you, Mike. It’s a real pleasure to be here this morning at Mid-State’s annual economic forum. Not only isIndiana a beautiful place to be in the fall, but I’m pleased to have a chance to connect with those of you in the audience who make use of our Indiana Office for processing payments. It’s always nice to visit with good customers. I also had the pleasure to meet briefly with Governor O’Bannon and several members of the state legislature earlier this morning. As Mike mentioned, I’m a central banker focused on monetary policy — and an economist by training. As such, I’m often asked to make predictions about the course of the economy...which is why you invited me here today. But I have to tell you, in all honesty, that this is not easy to do. As they say, economic forecasting is the only profession where you can be wrong all the time...yet right on average...and still keep your job. We economists have to evaluate conflicting data from a variety of sources that mostly are looking backwards. The economy responds to a myriad of factors that are hard to quantify...not the least being the psychology of businesses and consumers. This is particularly challenging in a year such as this one, where we’re confront- ed with so many mixed signals... So you can see why I try to live by the three rules of forecasting: • Never forecast unless you have to… • If you do forecast, do it often… • Give a number or a date, but never both… 80 Michael Moskow Speeches 2002 Seriously, I’m much better at explaining how the economy works than making predictions. But I’ll do my best today to give you my perspective on the economy — both here in the Midwest and nationally — and how I arrived at my conclusions. I’ll also touch briefly on the role of productivity in the economy and how drivers of productivity growth impact the payments system. Background on Federal Reserve Before I discuss the economy in detail, I’d like to give a little background on the Federal Reserve and its role in the economy. The Federal Reserve System comprises 12 regional reserve banks that, together with the Board of Governors in Washington, D.C., serve as the nation’s central bank. The Chicago District covers a five-state area that includes most of Indiana, Illinois, Michigan, Wisconsin and all of Iowa. As president of the Federal Reserve Bank of Chicago, I serve on the Fed’s key policymaking group, the Federal Open Market Committee, or FOMC. This is the group chaired by Alan Greenspan that is responsible for determining monetary policy. At each meeting, we report on regional economic conditions and share our outlook and policy recommenda- tion for the national economy. After our discussion of the outlook, the FOMC makes a decision on where to set its target for the federal funds rate. Our goal is to foster the monetary conditions that are most conducive to the economy achieving maximum sustainable growth and price stability. Clearly, this is a tough job. With regard to our current situation, while overall output has recovered from the recession we suffered last year, the economy is still experiencing uncertain times. At our September FOMC meeting, the Committee left the federal funds rate target at 13⁄ percent, the accom- 4 modative level it has maintained since last December. The Committee also kept the accompanying “balance of risks” statement unchanged. From March until August, that statement had said that risks were balanced between economic weakness and inflation. But during the August meeting, we changed the statement to say that we see the risks as being “weighted mainly toward conditions that may generate economic weakness.” And we reiterated that statement the September FOMC meeting. The Committee noted that, “considerable uncertainty persists about the extent and timing of the expected pickup in production and employment owing in part to the emergence of heightened geopolitical risks.” But it also indicated that, “over time, the current accommodative stance of monetary policy, coupled with still robust underlying growth in productivity, should be sufficient to foster an improving business climate.” I will return to the economic outlook in a little while. Michael Moskow Speeches 2002 81 The Midwest economy First, though, I’d like to take a look at conditions here in the Midwest. Economic activity in the region slowed earlier than it did in the rest of the nation. For example, employment growth began to fall off in the region in late 2000, about six months before the nation as a whole. It is interesting to note that, over the latter half of the 1990s, the rate of net job creation in the Midwest was only about half that of the nation. This was not due to a lack of economic vitality. Rather, we were running short of qualified workers to fill job openings. By contrast, when job growth began to slow in the latter half of 2000, there was little doubt that it was due to a softening economy. Indeed, the Midwest’s unemployment rate rose quickly, and for much of last year it stood above the national average. This was after spending the better part of the previous decade well below the national rate. Subsequently though, as softness spread throughout the economy, labor market trends here have more or less mirrored those in the rest of the nation. Much of the softness in our labor markets can be traced back to our manufacturing industries. Manufacturing was one of the first segments of the economy to feel the effects of the slowdown, as the imbal- ances that developed toward the end of the last expansion reduced the demand for capital equipment and inventories. Earlier this year, it appeared that the contraction in the manufacturing sector had come to an end. Industrial production experienced a relatively steady and widespread recovery. Admittedly, though, the improvements were modest. And in recent months the signals we have been getting from our manufacturing sector suggest that growth has been uneven and sporadic. The latest release of our Chicago Fed Midwest Manufacturing index, which estimates actual output in the District, shows that output fell in August in the auto, steel and resource sectors, and that production in the machinery sector was unchanged. Ofcourse, the health of the manufacturing sector remains vital to the Midwest economy since we are still the most heavily industrialized region in the nation. While it is true that our economy has diversified from the rust belt days of the 1980s, we are still more heavily concentrated in manufacturing than the nation as a whole. In fact, three Midwest states — Indiana, Wisconsin and Michigan — rank first, second and third in the nation in terms of the percentage of total employment engaged in manufacturing industries. Given its heavy concentration in manufacturing, Indiana was quick to feel the effects of the recession. Total employment here fell faster than the national average, and unemployment rates rose more. Manufacturers in the state have shed nearly 75,000 workers since the beginning of 2000. This represents nearly 11 percent of the state’s manufacturing employment base. The good news is that here in Indiana, as well as the rest of the Midwest, labor markets seem to be recover- ing more quickly than in the rest of the nation. For much of this year the region’s unemployment rate has been somewhat below the national average. In Indiana, the unemployment rate continues to be below the nation- al average, as it has been for the last decade. 82 Michael Moskow Speeches 2002 Even manufacturing employment, which continues to fall in the U.S., has remained fairly steady since the beginning of the year. In part, this reflects the strength of the automobile industry, which, as you know, is very important to the Midwest as well as the overall U.S. economy. The auto sector worked-off its excesses early in the recession, and with demand remaining strong has had high production rates. In some respects, it appears that the region’s economy has been doing somewhat better than the nation in recent months. In addition to autos, appliance sales have been strong. And sales of both new and existing homes have been robust, in line with the rest of the nation, thanks in part to the lowest fixed mortgage rates since the 1960s. The national economy Now let’s take a closer look at the national economy. Following the declines earlier in 2001, real GDP began to rise again in the fourth quarter of last year. Although we won’t see the first estimate for this past quarter until the end of the month, overall, real GDP growth looks to have averaged somewhere around the 3 percent mark over the last four quarters. Much of the support has come from the household sector. In addition, businesses are in the process of moving from liq- uidating inventories to restocking them. But even though a recovery in overall output has already occurred, the path of GDP growth has been — and could well continue to be — somewhat uneven. Indeed, the consensus outlook, made early this month by pri- vate sector forecasters, suggests that the economy is currently experiencing a soft spot. But that consensus forecast still sees output increasing, and growth returning to rates somewhere near the economy’s longer-run potential in 2003. Challenges to economy Clearly, though, the economy is facing many challenges. Businesses purchased a great deal of capital equipment during the late 1990s, greatly boosting their produc- tive capacity. However, in some cases the increases exceeded what, in retrospect, was needed to meet demand. The resulting reductions in capital spending were a major factor in the recent downturn. Much of the over- hang that led to the decline has been worked off. But even now in some sectors, such as telecommunications, substantial idle capacity remains. Thus it may be some time before the level of capital spending returns to where it was prior to the recession. And ofcourse, weare living in a different world than we did before 9-11. Even without another terrorist inci- dent,theemphasis on heightened security has impacted, and will continue to impact, the economy. The cost of doing business is now higher, both through increased insurance premiums and the costs of providing heightened security and back-up contingencies. The economy is facing another important challenge — How do we deal with accounting improprieties and failures in corporate governance? Michael Moskow Speeches 2002 83 These revelations have added to an already uncertain business climate. They also undoubtedly have raised the cost of financing new investment. This is evident from the increased risk spreads on corporate borrow- ing, particularly for lower-grade issues. And, to the extent that the scandals affected the stock market, it is evident through the lower prices coming to any new equity issues. Indeed, if lower stock prices are main- tained, the dent in households’ balance sheets would also be a negative factor for future household spending. To be sure, to the extent that markets had been mis-evaluating risks and returns, then investors should be demanding higher premiums. The concern, however, is that they may go overboard. Capitalism cannot thrive without entrepreneurial risk taking. If we are too risk-averse, we will stifle innovation and, with it, our abil- ity to generate continual increases in our standard of living. That said, capitalism also requires a transparent system of laws and regulations that are enforced in a fair manner. So if we find evidence of criminal behavior or fraud in the executive suite, we must root it out and prosecute. Those found guilty must be punished...which in some cases should include jail time. The other main challenge facing the economy today is that we are operating in a world of increased geopo- litical risk, with heightened concerns about developments in the Middle East. No one knows how these events will play out. But adding the geopolitical situation to the shock of the accounting and corporate governance failures, both so soon after last year’s downturn and 9-11, we come up with an economy that is dealing with a substantial amount of uncertainty. And such uncertainty can inhibit activity. For example, firms may become hesitant to take on capital spend- ing projects or hire permanent workers when the downside risks are more apparent — or if the consequences of such risks appear to have become more serious. Firms may simply decide to hold off doing anything until they feel more certain that the projects would soon start showing positive cash flow. Factors supporting economic recovery Despite these challenges, as I noted earlier, the consensus forecast is that the economy will work its way through the soft spots. We at the Chicago Fed agree that — on balance — a moderate economic expansion will continue. Here’s why. Aggressive inventory control means that stock levels are now very lean. Thus, some further lift from inven- tory investment can be expected. This would give a temporary boost to growth. But to solidify the expansion, final demand needs to gain a firmer footing. Important to this will be the degree to which business fixed investment turns around and household spending keeps moving forward. While many things influence business and household spending, particularly over the near term, several fac- tors should support growth. Inflation remains low and well contained. This has allowed monetary policy to maintain an accommodative stance for an extended period of time. This accommodative stance bolsters demand throughout the economy. 84 Michael Moskow Speeches 2002 Furthermore, fiscal policy moves, including last year’s tax legislation and bills signed into law after 9-11 and early this year, also have been stimulative. Importantly, incomes continue to grow. Despite the recession and the modest pace of the early recovery, real disposable personal income currently stands about 51⁄ percent higher than it was at the time the recession 2 began. In contrast, if we look back over the past 30 years, real disposable incomes a year and half after the onset of a recession were at best up only modestly. Ofcourse, part of the difference is that output fell less this time than during those earlier downturns. In addi- tion, the inflation picture and tax legislation have helped. Real income also has been supported by strong gains in productivity, or output per unit of input. Improvements in technology and the skills of workers, as well as more flexible labor markets, led to an acceleration of productivity. Beginning in the mid-1990s, the rate of productivity growth was more than double the pace of the previous 25 years. Furthermore, productivity was unusually well maintained during last year’s downturn. And, on average, it has increased at a remarkably robust pace in recent quarters. The rapid gains we’ve seen in productivity sup- port the growth in incomes and profits needed to maintain the economy’s forward momentum. And this is a positive sign for the U.S. economy for more than just the near term. Productivity is the key to the longer-run prospects for both the household and business sectors. Ultimately, it is productivity growth that determines our standard of living. Evolution of the payments system One of the key drivers of productivity growth — namely technological advancement — continues to directly impact your business through improvements in the payments system. This system includes cash, checks, credit cards, debit cards and automated clearing house payments, known as ACH payments, and large-value transfer systems. Just to give you a sense of scale, in the U.S. alone, $3.9 trillion of payments are made daily via the wholesale funds and securities systems, operating through proprietary networks. This translates into nearly $1 quadrillion annually — that’s one followed by 15 zeros. Clearly this scale is possible because of continuing advances in computing and telecommunications technology over the past 20 years or so. The talk of a “check-less society” began more than 30 years ago, based on the promise of emerging payments technology. But the number of paper checks continued to increase each year through 1995. Now, however, a decline in check volume is real. The U.S. love affair with paper checks peaked in the mid-1990s, with an esti- mated annual volume of 49.5 billion. By 2000, the Fed estimates that the volume of checks fell to 42.5 billion. At the same time, electronic payments continue to grow. In addition to credit card transactions, which have increased dramatically over the past decade, debit transactions through ACH are growing at 15-20 percent per year. And debit card use is rising at 30-35 percent per year. This evolution is spurred in part by the Internet. Initially developed to facilitate faster information transfer, the Internet has had tremendous impact on commerce and banking in general. And new ways to buy things require new ways to pay for things. Michael Moskow Speeches 2002 85 Growth of electronic commerce is critically dependent on the electronification of existing retail payment instruments or the creation of new ones. We at the Fed recognize the need for a payment system that is more compatible with Internet commerce than are cash and checks. Where appropriate, we are partnering with private-sector institutions to promote a more efficient payment system. The challenge, of course, is to make payments safe, secure and reliable. Within the financial services industry there is a critical need to address issues of privacy, security, interoperability and law. The industry must work: • To protect the confidential nature of transactions in an electronic world. • To prevent hackers from getting in, clearly assign liability in the case of fraud, and prosecute offenders. • To encourage better integration of electronic networks. • And to foster increased efficiencies, which is why the Federal Reserve supports the Check Clearing for the 21st Century Act that will increase processing speed by allowing images to substitute for a paper checks. I wish we had time to discuss these issues in greater depth today. But let me simply say that we at the Fed are working closely with industry trade groups, financial institutions and service providers to promote indus- try standards in all these areas. Looking ahead, continuing advancements in computers, telecommunications and electronics — and corre- sponding improvements in the payment system — will enable people to pay anyone, anytime anywhere...and this will only further strengthen the resiliency of the free enterprise system. Conclusion Let me conclude with some final thoughts on the U.S. economy. Lookingahead, while we are faced with some uncertainties in the near term, the long-term prospects for the U.S. economy, and that of the Midwest, are good. During the last 20 years or so, we’ve deregulated financial markets, developed more flexible labor markets and made major advances in technology, including the payments system. These efforts help foster solid non- inflationary economic growth at home and contribute to greater openness and prosperity abroad. 86 Michael Moskow Speeches 2002

Michael Moskow (2002, October 16). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_20021017_michael_moskow

@misc{wtfs_regional_speeche_20021017_michael_moskow,
  author = {Michael Moskow},
  title = {Regional President Speech},
  year = {2002},
  month = {Oct},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_20021017_michael_moskow},
  note = {Retrieved via When the Fed Speaks corpus}
}