With such heavy trade flows, when the mainland economy does poorly – as during the past year – Puerto Rico’s economy and job growth suffer. Financial regulation also represents an important linkage. Of course, my presence here representing the New York Fed is one example of that particular connection – Puerto Rico is part of the Second District of the Federal Reserve System, along with New York, the U.S. Virgin Islands and parts of New Jersey and Connecticut. I’ll return to the theme of financial regulation shortly. For now, let me just say that we share, along with the rest of the world, a commitment to taking the necessary steps to prevent the type of financial crisis that we just experienced from recurring in the future. The Fed’s role in coping with the crisis and the outlook for the United States The close ties with the mainland means that the broader outlook for the United States is very important for Puerto Rico. The U.S. economy has been through a terrible period, having suffered the worst financial crisis in 70 years. Extensive study of banking crises shows that they tend to be “protracted affairs” with surprisingly similar, if unpleasant, contours. Downturns average four years, during which the unemployment rate rises an average of 7 percentage points. The peak-to-trough decline in output averages 9 percent. Those statistics point out the risks that we faced. Well aware of the threat of a second Great Depression, U.S. policymakers took very aggressive actions to support economic growth in 2008 and 2009.
A healthy banking sector is crucial for economic growth because banks and other parts of the financial system play a key role in determining how savings are allocated among competing projects and users of credit. If households and businesses cannot get credit on reasonable terms, then the economy sputters. To underline this point, the Fed and Treasury did not intervene during the recent crisis to save the financial system (and with it, some big financial firms) for its own sake. We intervened because a collapse of the financial system would have done irreparable harm to Main Street. With the limited tools at hand, we made our choices (often between unattractive options) with the goal of supporting the economy, households and small businesses. A well-functioning financial system is also crucial in fostering economic development. History shows that substantial risks to the economy come from a persistently weak banking sector. Economists have debated whether healthy banks drive real economic growth, or vice-versa, but a wealth of recent evidence suggests that the causality runs at least partly from banks to growth, and not just the other way around. So, from my perspective, getting Puerto Rico’s banking system back onto solid footing is “job one” for supporting growth here. Preparing Puerto Rico to benefit from recovery in the world economy Of course, that isn’t the whole story. Growth may also be impeded by factors that are specific to particular regions or policies.