William C Dudley: The economic outlook and the Fed's balance sheet – the issue of "how" versus "when" Remarks by Mr William C Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York, at the Association for a Better New York Breakfast Meeting, New York, 29 July 2009. *  *  *  It is a pleasure to have the opportunity to speak here at the Association for a Better New York. This group has obviously been very successful. New York today is a far different and vastly superior place from what I found when I first arrived as a freshman at Columbia University in 1970. Today, I’d like to accomplish two tasks. First, I’ll comment briefly on the economy and the economic outlook – where we have been and where we may be going. I’m going to suggest that the balance of risks is still tilted toward weakness in growth and employment and not toward higher inflation. I will also argue that it is premature to talk about “when” we are going to exit from this period of unusual policy accommodation. Second, I will talk about the impact of the Federal Reserve’s lending facilities and purchase programs on the size of the Fed’s balance sheet. I’ll explain why an expanded balance sheet does not constrain our ability to exit from the current degree of policy accommodation. In other words, contrary to what is sometimes argued, it is not the case that our expanded balance sheet will inevitably prove inflationary.
It is important that this critical issue be well understood. The public must be absolutely confident that the Fed can meet its monetary policy objectives of low and stable inflation and sustainable economic growth. Before I begin to get into these issues in earnest, let me note that, as always, the views I put forward today are my own and do not necessarily reflect the position of the Federal Open Market Committee (FOMC) or the Federal Reserve System. Turning first to the outlook, the economic contraction appears to be waning and it seems likely that we will see moderate growth in the second half of the year. The economy should be boosted by three factors: 1) a modest recovery in housing activity and motor vehicle sales; 2) the impact of the fiscal stimulus on domestic demand; and 3) a sharp swing in the pace of inventory investment. In fact, if the inventory swing were concentrated in a particular quarter, we could see fairly rapid growth for a brief period. Regardless of the precise timing, there are a number of factors which suggest that the pace of recovery will be considerably slower than usual. In particular, I expect that consumption – which accounts for about 70 percent of gross domestic product – is likely to grow slowly for three reasons. First, real income growth will probably be weak by historical standards.