The Federal Reserve responded to the slowing of the recovery in midyear 2010 by beginning a second round of large-scale asset purchase programs. Those purchases are resulting in a rough tripling of the Federal Reserve’s balance sheet (Chart 42).   U.S. economic conditions are currently quite far away from levels consistent with the Federal Reserve’s dual mandate of the pursuit of the highest level of employment consistent with price stability. I’ve discussed the high unemployment and unused productive capacity in the United States. Let’s turn to inflation.   While trend inflation is quite low at the moment, we see it likely to be near the low point of this cycle. The rate of inflation for nonenergy services is beginning to increase, led by faster increases in apartment rents (Chart 36). A firming of demand along with a decline of the exchange value of the dollar should begin to put upward pressure on nonfood, nonenergy goods prices.   However, underlying inflation fundamentals suggest relatively low trend inflation for some time:      A substantial amount of slack in the economy, reflected in the sharp deceleration of core services prices – and the United States is a services economy (Chart 35).   Relatively wide profit margins, so that firms facing very competitive output markets are able to absorb changes in energy and commodity prices. Moreover, unit labor costs are still falling (Chart 37).   Inflation expectations remain well anchored (Chart 38).
The Bank finds itself in a position rather like that of a church whose congregation attends weddings and burials but ignores the sermons in between. Like the church, we cannot promise that bad things won’t happen to our flock – the prevention of all financial crises is in neither our nor anyone else’s power, as a study of history or human nature would reveal. And experience suggests that attempts to encourage a better life through the power of voice is not enough. Warnings are unlikely to be effective when people are being asked to change behaviour which seems to them highly profitable. So it is not entirely clear how the Bank will be able to discharge its new statutory responsibility if we can do no more than issue sermons or organise burials. Whatever the ultimate shape of the structure and regulation of the banking system – and, as many of you have said, we need to think carefully to get this right – change will be necessary. The costs of this crisis are not to be measured simply in terms of its impact on public finances, the destruction of wealth, and the number of jobs lost. They are also to be seen in the lost trust in the financial sector among other parts of our economy.