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Deleveraging in Today's U.S. Economy

Dennis P. Lockhart
President and Chief Executive Officer
September 7, 2011

The economy is not performing terribly well at the moment. A little over a year ago we saw better growth and we would have expected the continuation of that growth, but the economy began to slow down last summer and has been operating at a pretty slow rate of growth since then. Unemployment has been frustratingly high, at a little over 9 percent, and really we've made relatively little progress from the point of view of the unemployment rate.

It's not an economy where everything is negative, nor is it an economy that has a surfeit of positive elements, it's really a mix. And there are some areas that are pretty strong. For example, in the Southeast we're seeing more activity in the energy sector, particularly oil and gas in the states that are adjacent to the Gulf. Health care remains a relatively strong sector and tourism is relatively strong. It's not a one-sided picture, and that mix of positive and negative makes it all the more difficult to read exactly where the economy is going.

I'm not forecasting a recession. What I'm forecasting at the moment is a continuation of slow growth with some improvement as we go into 2012 and the gradual decline of unemployment. So I do not think that we're going to see an actual contraction of the economy, which is what a recession is. However, I would say that the risks have risen and therefore, it's not a concern that we can dismiss.

Household Deleveraging
One of the drags on the economy is the housing sector. House prices are by one measure at least down about 30 percent from their peak in 2007. That has an effect on consumer attitudes and consumers' willingness to spend, so it's been a drag on consumption.

You know the economy is built on about a 65 to 70 percent consumer component driving the economy. So when Americans decide not to spend or to be cautious about spending you feel it throughout the economy, and that's the case today. I think there are a lot of uncertainties that have affected the attitude of consumers, for example, the uncertainty around the raising of the debt ceiling and the whole political process that led up to that, I think gave the consumer some pause. The high unemployment rate, the weakness of housing, which I've already mentioned, all of these things contribute to a consumer that is a lot more cautious. Also, we're in a probably multiyear process of consumers paying down their debt, the technical word is "deleveraging," and consumers are reducing their debt loads. A lot of that relates to home equity lines, but also some credit card debt as well. So consumers are saving more and spending less.

Deleveraging Across Sectors
Deleveraging is the process of reducing debt whether you are a household, a corporation, or a government. It's the paying down of debt. In order to do that, inevitably you spend less and you accumulate savings. There are a variety of ways in which deleveraging can actually be accomplished, the most obvious one is to save and then pay down one's debt burden, particularly a household would be doing that.

I'm a former banker so I'm going to obviously say that debt is not necessarily a bad thing. It's a question of the ratio of debt to the ability to repay. And debt can be a quite positive thing, it's a lubricant in the economy, it allows households or governments or corporations to smooth their spending and sometimes to accelerate a purchase, which is good for the economy. So it's only a bad thing when it gets excessive relative to the ability to repay.

The overall debt level in the American economy, which accumulates the household sector, the corporate sector or business sector, and the government sector, is about 248 percent of gross domestic product or GDP and really hasn't changed much over the last few years. What has changed is the mix, the household sector has been reducing debt, the government sector has been increasing debt, but looking at the debt level overall, we have not made a great deal of progress. And I would argue that in all probability we are at the early stages, not the later stages, of this deleveraging process.

You have to consider the deleveraging process, particularly of the public sector, the government sector, as a multiyear, relatively long-term, and structural in a sense headwind to growth. And so it's a process that has to play itself out, it's going to take a while, and it requires a pretty substantial adjustment by not only the government itself but by parties that are influenced by government spending. And I think this will be one of the long-term structural requirements to get our economy to a healthy position and it's going to take time.

Monetary Policy
Monetary policy affects the conditions in which some of these longer-term structural adjustments will play out and in which they proceed. We're trying to create favorable conditions for both a cyclical recovery or a recovery that gains momentum and also over the longer term, the necessary structural changes in the economy. Monetary policy works principally through the interest rate, and this Federal Open Market Committee has stated its intention to keep the target policy rate at near zero until the middle of 2013. That's obviously an effort to create the best conditions possible for a recovery to gain momentum and for the deleveraging process to continue.

I do think the situation calls for some patience, I think the process of structural change, structural adjustment, deleveraging being an example of that, simply is going to take some time and my outlook for the economy is an improving picture but a gradually improving picture both from the point of view of economic growth and employment. So that's not a recipe for a quick fix or a quick turnaround, it's really one that's going to take some time to play out.