The president of the Federal Reserve Bank of Philadelphia said Friday that after four years of keeping interest rates low, the central bank may have troubling preventing inflation once a stronger economy signals a shift to a less accommodative monetary policy, which he said could happen in 2014.
Charles I. Plosser told a bankers conference in Somerset he is forecasting that the nation's unemployment rate could decline to near 7 percent by the end of 2013, and that the Fed's target is to keep rates low until the jobless rate falls to 6.5 percent. "We must guard against the medium and longer term risks of inflation" when the Fed begins to unwind the low-rate policies in place since the 2008 financial crisis.
Plosser said, "Business balance sheets are in pretty good shape, and they are actually borrowing a lot because the money is cheap, so they do have cash. But historically business investment is not as sensitive to interest rate movements as a lot of people think it is. Actual business fixed investment doesn't move around that much with interest rates."
Plosser said that while low interest rates provide an incentive for business investment, "something else is holding (business) back—either a lack of demand or uncertainty." He said businesses need households to be healthy to provide the demand for goods and services that drives business investment—but ironically, households are saving more to rebuild the wealth they lost in the housing downturn and the recession, while the current low interest rates are making it difficult for households to rebuild their wealth.
Plosser addressed more than 500 people at the Economic Leadership Forum of the New Jersey Bankers Association at the Palace in Somerset. The association released its 2013 economic survey of New Jersey bankers, which found that two out of three respondents believe both the national and state economy are in "fair shape."
Bankers also reported that loan demand is improving, with two out of three saying current loan demand is fair or good, and predicting increased demand over the next six months for both commercial real estate and commercial lending. But nearly all cited the lack of qualified borrowers and the lack of demand as the largest obstacles to new business lending.
John E. McWeeney Jr., president of NJBankers, said, "New Jersey banks have the capital, the liquidity and the appetite to invest in New Jersey's future."
Plosser, whose bank oversees southern New Jersey, said New Jersey's unemployment rate is 9.6 percent, while the U.S. jobless rate is 7.8 percent. "(Hurricane) Sandy was not an insignificant factor in the unemployment rates, and New Jersey still has some challenges. I think it will gradually come down, but right now New Jersey has higher than national average unemployment."
At some point the Fed will reverse course and begin to gradually increase interest rates, Plosser said. "The Fed has always found it easier to lower rates than to raise them. It is much more politically acceptable: the Fed gets a lot of pushback when it tries to raise rates."
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