On the state and local side, a rising economy should boost sales and income tax revenue, and help narrow near-term fiscal shortfalls. We also need to remain watchful for signs that low interest rates could foster a buildup of financial excesses or bubbles that might pose a medium-term risk to both full employment and price stability. Fortunately, current risk spreads on U.S. financial assets are not unduly compressed. This suggests that people are still being relatively cautious about taking on a lot of financial asset risk. On the inflation side of the ledger, there are some signs that core inflation is now stabilizing after falling for several years. At the Fed, we track core inflation (which excludes the volatile food and energy prices) because experience and research tell us that core inflation provides the best measure of whether overall inflationary pressures are building up or subsiding. Core inflation has proven quite reliable in predicting future total, or “headline” inflation rates. At the moment, both headline and core inflation remain below levels consistent with our dual mandate objectives – which most members of the FOMC consider to be 2 percent or a bit less on the personal consumption expenditures (PCE) measure. Recent evidence shows that the large amount of slack in the economy has contributed to declining inflation over the past couple of years. I expect this slack to continue to dampen price pressures in the near term. Inflation expectations are well-anchored today and we intend to keep it that way.
For example, the share of household after-tax income that families owe for servicing debts and paying for housing (including property taxes, homeowners insurance and rents) has declined sharply over the past two years and is now back to levels last seen in the late 1990s. Households have cut the total amount of debt they owe. They are also refinancing outstanding debt to take advantage of the lowest mortgage interest rates since the mid 1950s. We expect the increased rate of mortgage refinancing now in place to continue over the near term. This represents another means by which households can free up income for other uses. Now, let’s consider the slow housing recovery. Housing market activity – both new construction and sales – remains depressed. On the construction side, total housing starts are running at just 600,000 units per year (seasonally-adjusted) in recent months. This is up from 530,000 units at the trough in the first quarter of 2009 but it is still extremely low by the standards of the last 50 years. In fact, the rate of new construction is so low that there is barely any net growth in the U.S. housing stock these days. One reason why so little housing is being built is that many existing homes stand vacant. We estimate that there are roughly 3 million vacant housing units more than usual. And more vacancies are added daily as the foreclosure process moves homes from families to mortgage lenders.