Maryland for years benefited from its close proximity to the nation's capital, but the mandatory federal spending cuts called sequestration will be a drag on the state's economy for the next couple of years, said the president of the Federal Reserve Bank of Richmond.
"This retrenchment at the federal government level ... is tough this year. We are still finding out what the dimensions of this are," said Jeffrey Lacker, the Fed president.
Despite the pain, the spending cuts are needed for the long-term fiscal health of the country, he added.
"While it wasn't deliberative and didn't seem strategic in the sense that it reflected a nuanced choice of priorities, the silver lining to it is that it takes a step toward the fiscal adjustment we needed," he said.
Lacker was in Baltimore Wednesday as part of a two-day fact-finding mission to learn about the economy here and talk to area business leaders. The Fed's fifth district, which Lacker oversees, covers Maryland, the District of Columbia, Virginia, North Carolina, South Carolina and most of West Virginia.
Lacker had good news for the new crop of college graduates, saying their job prospects are better than they were a year or two ago.
His advice to new grads: "It's all about skills, and it's all about acquiring new skills over time. I urge people to look for places where they are going to learn a lot because you are going to be depending 20 years from now on skills you don't have now."
The economy is recovering at an annual rate of 2 percent, compared with the typical 3.5 percent growth rate in decades before the 2007 recession. Lacker predicts that the 2 percent rate will persist for the next three years.
One reason the growth rate isn't more robust, he said, is that consumers are more cautious after losing jobs and seeing their incomes shrink along with the equity in their home.
"People appreciate this is a riskier economy than they thought, and so they are managing their affairs more cautiously, paying down debt, building up liquid savings and being more cautious about spending," he said.
Businesses, too, are reluctant to make hiring or investment commitments because of uncertainty over possible tax increases and regulatory changes, he said.
Since the recession, lawmakers in Washington have been at loggerheads, stirring up crises on taxes, the debt ceiling and other financial issues. Asked whether the political gridlock in Washington is slowing economic growth, Lacker said the uncertainty over how politicians will settle issues has dampened growth, but he can't say by how much.
"At least to some noticeable extent, it is slowing down growth," he said. "But we have had these periods before in our history. There have been times in which there have been a lot of issues on the table and a lot of struggle over how to resolve those issues."
Usually, a political consensus emerges, then consumers gain more confidence about making commitments for the future, he said.
"I'm confident we are resilient enough that we will get through this," he said.
Lacker said economists continue to study the reasons behind the 2008 financial crisis and what can be done to prevent another.
"I'm not sure we have gotten it right, and I suspect we haven't done enough to prevent it from happening again," he said.
Lacker wants to eliminate the notion that a financial institution is too big to fail.
He supports so-called living wills, in which large financial institutions draw up plans for how they would wind down their business in a bankruptcy without a government bailout. This would force companies to act more prudently, knowing the government won't be there to save them if they're reckless, he said.
Lacker said he believes this could have prevented the last crisis.
The Richmond Fed president is an inflation hawk and last year suggested interest rates might have to be raised in 2013 to tamp down inflation. But inflation has remained mild.
Lacker said he doesn't expect an uptick for the rest of this year, but he's not about to become complacent.
"We became complacent in the late '60s, and we let it creep up on us and get out of control," he said. "Inflation doesn't take care of itself. You have to be watchful."