Speech by Governor Jefferson on the US economic outlook and monetary policy considerations

Good morning everyone. Thank you for inviting me to speak. It’s a pleasure to be here. I would like to take this opportunity to share with you my perspective on the US economy, credit conditions and monetary policy.

Before I begin, I want to remind you that the views I will express today are my own and not necessarily those of my colleagues in the Federal Reserve System.

Aggregated economic activity

Despite heightened uncertainty due to banking sector stress, geopolitical instability and the aftermath of the pandemic, I expect the economy to grow in the second quarter. However, the pace of growth will be slower than what we observed in the first quarter, when real GDP increased by 1.1 percent year-on-year. My expectation is based primarily on data showing weakening spending in recent months, and other data pointing to spending moderation, including a significant fall in consumer confidence in April, as measured by the first estimate of the University of Michigan Surveys of Consumers. While my base case scenario for the US economy is not a recession, I expect spending and GDP growth to remain fairly sluggish for the remainder of 2023, reflecting continued tight financial conditions, low consumer confidence and a fall in savings from households built up after the outbreak of the pandemic. I further acknowledge that there are downside risks, including the possibility that the level of bank lending restraint and uncertainty could weigh on economic activity more than I expect.

The labor market

Even as GDP growth has slowed, employment has continued to increase and the current job market is one of the strongest U.S. workers have seen in decades. The economy created 253,000 jobs in April and the unemployment rate was 3.4 percent, the lowest since 1969. Job creation has proved remarkably resilient amid tighter financial conditions. Employers added an average of 280,000 jobs per month this year. That’s less than the 350,000 per month created in the second half of 2022, but still robust. The tight labor market has pushed up wages and other benefits for workers. Wage growth continued to be ahead of the pace consistent with inflation at 2 percent and current trends in productivity growth. Wage gains are welcome as long as they are consistent with price stability. For the 12 months ending March 2023, the employment cost index (ECI) for total hourly compensation for private sector workers increased by 4.8 percent, only a small decrease from the peak of 5.5 percent in June last year .

My expectation is that the slowing economy will soon begin to curb job growth, resulting in a better balance between labor supply and demand. The unemployment rate may gradually rise to levels still consistent with a growing economy. Data on job openings and voluntary layoffs by employees indicate that demand for labor has declined somewhat, and this is also reflected in a modest decline in median hourly earnings growth, from a 12-month rate of 5 percent in November to 4, 4 percent in April.

Inflation

Now I come to the outlook for inflation. While inflation has fallen significantly since last summer, it is still too high, and progress has slowed by some measures. After a 12-month peak of 7 percent last June, personal consumption expenditure (PCE) inflation fell to 4.2 percent in March, also down from 5.1 percent in February. This reflects substantial declines in energy prices and a sharp slowdown in food inflation. Cheaper energy and a slowdown in food price increases are good news for lower- and middle-income households who spend a higher proportion of their income on these products.

But beyond energy and food, progress on inflation remains a challenge. Excluding these prices, which tend to be more volatile than the prices of other goods and services, you are left with what we call “core inflation,” and this measure is a useful guide to distinguishing long-term inflationary movements. Core PCE inflation was 4.6 percent in March, down from a peak of 5.4 percent in February 2022. While we don’t yet have a report on PCE inflation for April, another measure of inflation, the core component of the consumer price index (CPI) showed little further improvement in April. Taking a closer look at core inflation, I like to divide it into three parts: commodity inflation; housing, which is classified as a service; and non-housing services. Inflation for core goods fell sharply in the second half of 2022 as supply chain bottlenecks eased, but has recently stabilized at around 2.6 percent. Inflation of housing services, including rent and owner-occupied housing equivalents, is 8.2 percent on a 12-month basis. Housing is a big part of inflation, and while rent increases for new leases have fallen significantly over the past year, it will take some time for this weakening in rents to show up in 12-month changes. And, finally, inflation in non-housing services, the largest component of services, has remained stubbornly high at around 4.5 percent and has yet to show signs of a significant decline.

Recent stress in the banking sector

Overall, the US banking system is sound and resilient, and I am confident that it will be able to continue to play its important role in providing credit to households and businesses. Nevertheless, it is reasonable to expect that recent stress events will lead some banks to further tighten credit standards. The evidence is that there has been only a modest incremental tightening of credit conditions so far, which had already tightened significantly over the past year since the Federal Reserve began raising interest rates. In a survey conducted by the Federal Reserve in April, credit officials reported that 46 percent of banks had tightened credit standards for commercial and industrial lending to larger companies in the past three months, up from 44.8 percent in the January survey. was tightened. The increase in the share of banks reporting in the April survey was similar, albeit slightly larger, for commercial and industrial lending to smaller businesses. At this point, it’s hard to say how much of this tightening was already underway, following continued interest rate hikes, and it’s also hard to say to what extent medium-sized bank stress will ultimately limit lending in the coming year. In addition, there is great uncertainty about the magnitude of the impact on household spending and business investment, and this uncertainty complicates the economic outlook.

The resilience of the insurance sector

In view of your meeting here today, I would be remiss if I did not say a few words about the insurance industry before closing time. The insurance sector has performed well due to the recent tensions. While the profitability of non-life insurance companies was reduced in 2022 by natural disasters and inflation, the sector’s capital appears strong when we factor in a range of plausible stress events. For life insurers, the recent rise in interest rates has been a mostly welcome development that has supported higher investment returns, but also carries risks, such as early retirements by some policyholders. While the capitalization of the life insurance industry remains strong, the use of reinsurance deserves continued monitoring. That said, I want to talk about monetary policy.

Monetary Policy Considerations

So what factors will I consider in the coming weeks as I think about the right course of monetary policy going forward? In the coming weeks, we will receive a significant amount of data on economic activity for April and May, including the May employment report and a report on CPI inflation in May. Monetary policy must be forward-looking. It should be executed in such a way that longer-term inflation expectations are well anchored around our inflation target of 2%. Monetary policy must also rely on data to continuously learn about the underlying structure of the economy as new data comes in. These principles of monetary policy-making are always valuable, especially when the level of uncertainty is high, as it is today.

I am guided by the double mandate given to the Federal Reserve by the US Congress: price stability and maximum employment. On the one hand, inflation is too high and we have not yet made sufficient progress in reducing it. On the other hand, GDP has slowed significantly this year, and while the effect on the labor market has been limited so far, demand is clearly starting to feel the effects of interest rates rising 5 percentage points from slightly more than they were a year ago . History shows that monetary policy operates with long and variable lags and that a year is not long enough for demand to feel the full effect of higher interest rates. Another factor weighing on my mind is the uncertainty about stricter lending standards I mentioned earlier. I intend to consider all of these factors over the coming weeks as I ponder the appropriate course of monetary policy going forward.

Thank you.