The Federal Reserve’s Open Market Committee released its customary monetary policy statement following its December meeting last Wednesday. While maintaining its accommodative target for the federal funds rate, the committee cited evidence of sustained improvements in economic activity, strengthening of financial markets and an easing of job losses in explaining the sunset timetable of its myriad liquidity interventions. Purchases of agency mortgage-backed securities and agency debt will conclude in the first quarter, as will the various lending and credit facilities. The term asset-backed securities loan facility’s support for new CMBS will run through next June.
The committee is hedging its bets, of course, leaving open the option of timetable adjustments should conditions deteriorate unexpectedly. The decision to leave the cost of Fed borrowing near zero is a further concession to the committee’s view that growth will fall short of inflation-inducing levels.
Just as monetary and fiscal policies remain extraordinarily supportive, the improvements in economic conditions in the second half of the year have actually exceeded policy makers’ expectations. The Fed currently projects that the economy will contract in a range between 0.4 percent and 0.1 percent in 2009. At the upper end of this central tendency, growth in the second half would almost fully offset the contraction in the first half of 2009.
Six months ago, the Fed was markedly more conservative in its expectations for the year, projecting a 2009 contraction between 1.5 percent and 1 percent. The committee’s central tendency outlook for unemployment has remained stable, anticipating a 2009 unemployment rate in a narrow range around 10 percent. Looking forward, the committee’s projections for 2010 GDP growth have been revised up, to a growth rate of between 2.5 and 3.5 percent. The outlook for the unemployment situation has been tempered, however; the unemployment rate is expected to remain above 9.5 through the next year before falling below 9 percent in 2011.
Federal, State, and Local Government
The Fed’s central tendency projections for economic growth are based on expectations for how different sectors will contribute to activity over the next year. In the latter half of this year, federal government spending and consumers have been the principal drivers of growth. In the latter case, most of the gains have resulted from stabilization in residential activity and from a surge in automobile sales relating to the Car Allowance Rebate System program (more commonly, the “CARS” or “Cash for Clunkers” program). With this in mind, it behooves us to ask what 2010 may hold if housing falters under the weight of higher foreclosures and absent an incentive for durable goods expenditures equal to CARS.
The federal government, unique in its ability to borrow at will, has the most direct control over its own spending and investment activities but can only influence other areas indirectly. In the third quarter, total government activity contributed 0.63 percentage points to the headline 2.8 percent growth rate in real G.D.P. growth. Breaking down that contribution, increases in defense spending accounted for the bulk of the increase in government activity. Non-defense activities were less significant. Net declines in state and local governments were drags on the economy.
Notwithstanding constraints on the federal purse and a commitment to unwind some aspects of its direct intervention, Washington’s political machinery is also acutely aware of the relevance of job growth for next November’s midterm elections. Whatever the motivations, the current bias suggests that federal payrolls (apart from the Postal Service) will continue to grow in 2010. The relative distention of federal employment over the past year has benefited the District of Columbia disproportionately. In other parts of the country, increases in federal and federally funded jobs has been offset by declining state and local government payrolls.
