Transcripts of the monetary policymaking body of the Federal Reserve from 2002–2008.

I’m referring to the next exhibits that are attached to the material you are already looking at. Since the September FOMC meeting, financial market distress has intensified and has spread around the world, threatening many emerging market economies that previously had been less affected by the U.S. and European credit crisis. As shown in the top left panel, equity prices have fallen sharply in Europe, Japan, and the United Kingdom. Indeed, the Nikkei is at a 26-year low today. The carnage has been just as pronounced in emerging markets, shown on the right. Credit spreads between industrial countries’ risky corporates and government bonds (plotted in the middle left panel) soared, especially in the euro area; and as shown in the right panel, credit default swap premiums on sovereign debt in many emerging market economies have skyrocketed. The widespread pullback from risk led to safe-haven flows into dollar assets; as shown in the bottom left panel, the dollar appreciated nearly 11 percent against the major currencies (the black line) despite a 9 percent depreciation against the yen (the red line) as carry trades were unwound. The dollar strengthened 9 percent against the currencies of our other important trading partners. As shown on the right, effective exchange values of the currencies of Brazil, Mexico, and Korea were particularly hard hit.

In your next exhibit, the top left panel shows the extent to which investors fleeing risk have been liquidating emerging market equity funds. Several foreign governments, notably Russia’s, have fought related currency pressures by drawing down their reserves (the top right panel). For instance, since the peso fell sharply against the dollar in early October, the Bank of Mexico has deployed 15 percent of its reserves to shore up its value. China and Russia have even intervened to stem the fall in their equity prices. Following the collapse of Lehman Brothers, credit markets seized up, and dollar funding needs intensified. Since then, governments around the world have taken several steps to support their banking systems (the middle panel). Some central banks have injected massive amounts of liquidity, and many have cut policy rates or reserve requirements or both. In addition to the countries joining the Fed in a coordinated 50 basis point rate cut on October 8, a wide range of other economies have eased policy lately. Note that there have been a few exceptions: Hungary, Iceland, and Denmark increased rates to counter currency pressures. Governments have also expanded bank deposit insurance and guaranteed new bank lending in order to improve confidence and liquidity. Following a similar initiative in the United Kingdom, euro-area governments announced plans to guarantee the issuance of new medium-term senior debt by banks and to directly assist their recapitalization if necessary. In recent weeks, authorities have announced capital injections into a number of banks whose financial soundness was in question. The swap lines extended by the Federal Reserve to foreign central banks have been expanded. The ECB approved a €5 billion swap line for Hungary and a €12 billion one for Denmark, and several Asian countries are currently negotiating swap lines with each other as well. Private firms in several emerging market economies have confronted pressures in rolling over foreign currency funding, and authorities there have also raised deposit guarantees, guaranteed bank lending, and injected capital into vulnerable banks. Finally, several countries have applied to the IMF for assistance.

The bottom left panel shows median credit default swap premiums for banks in Europe, the United Kingdom, and the United States. The declines since the beginning of this month suggest that the announcement of these plans has improved confidence in banks’ safety, even if they have not restored confidence in broader economic prospects. As shown by the implied OIS forward rates in the bottom middle panel, market participants expect considerably more monetary policy easing in Europe than they did at the time of the last FOMC meeting. We assume that further cuts in official rates (shown on the right) will be forthcoming as output falls short of potential and inflation recedes.

As can be seen in exhibit 3, highly stressed global financial conditions and the weaker U.S. outlook have led us to take a whack out of our outlook for foreign growth. Comparing lines 1 and 2, we have marked down our estimate of total foreign growth for the third quarter more than 1 percentage point, and we have slashed our forecast even more for Q4 and 2009. We project outright recessions in the advanced foreign economies (lines 3 through 7) and in Mexico (line 12). In other emerging economies, we foresee growth rates well below potential. Chinese real GDP growth (line 10) is estimated to have slowed considerably in the third quarter. We expect some payback in Q4, but beyond that we have revised down our outlook. As can be seen in the middle left panel, exports fell in August in many of our largest trading partners, though they still chugged along in China through September. The black line in the middle panel shows that the volume of exports from Canada has been falling for some time, but exports had held up in Japan and Germany until the third quarter, when they fell. Industrial production in Japan (the red line in the middle right panel) has fallen nearly 5 percent below its year-ago level, and IP has also fallen over the past year in the United Kingdom and the euro area. As global demand has slumped, oil prices (the black line in the bottom left panel) have plummeted, and nonfuel commodity prices have fallen as well. The decline in commodity prices along with slackening economic activity is projected to help bring down inflation in all of the regions shown (on the right).

Exhibit 4 focuses on the outlook for Europe. Banks remain leery of lending to each other, as evidenced by the growing amount of funds parked at the ECB’s deposit facility. The latest BoE bank lending survey (the top right panel) pointed to further tightening of U.K. lending standards in the third quarter and suggested that banks expected to tighten them somewhat further in the fourth quarter (the striped bars). Notably, this survey was taken before Lehman failed. A confidential conversation with a contact at the BoE who had talked with a few bankers more recently suggested that the latest survey considerably underestimated the recent tightening of standards. The quarterly growth of U.K. loans to nonfinancial corporations (the red line in the middle left panel) fell from double-digit paces for the past two years to 5 percent in the third quarter. Credit expansion to households (the dashed line) declined as well. Loan growth in the euro area (the middle panel) also slowed. Europe has clearly moved into recession. The middle right panel shows that house prices have fallen over the past year in the United Kingdom and Ireland and have also slowed in other European locales. But it is not just the property sector that has slumped. Business confidence (the bottom left) has disintegrated. Total economy purchasing managers’ indexes (the middle panel) are in the downturn range in both the United Kingdom and the euro area. Unemployment rates have increased, especially in France and Spain, where construction activity has slowed sharply.

Your next exhibit takes a quick tour through the rest of the world. In Japan, business confidence (the red line) has plunged, partly because lending terms faced by firms, particularly small and medium-sized enterprises, have become more restrictive. Investment intentions (not shown) have deteriorated as shipments (the black line) and exports have declined. The labor market has deteriorated, with the ratio of job offers to applicants (in blue) falling to its lowest level in the past four years. The Bank of Japan recently downgraded its outlook and stepped up measures to deal with financial market stresses. In China, investment spending (the black dashed line in the top right panel) continued to be strong through September, and retail sales accelerated. However, industrial production (middle left panel) slowed this summer partly because of efforts to reduce pollution in Beijing during the August Olympics but also because of declining steel production, suggesting further slowing. Industrial production has also slowed in Korea and Taiwan, and export orders (shown on the right) are falling in China, Brazil, and Singapore. As shown in the bottom left panel, Mexico has suffered a steep fall in remittances, flattening industrial production, and declining auto exports. Oil revenues (not shown) are down as well. Finally, global PMI and new orders indexes, which aggregate data for 26 major countries, are both in contractionary territory but have not yet reached their depths at the trough of the 2001 recession.

Exhibit 6 reviews the main elements of the U.S. external outlook. As shown in line 1 of the top panel, net exports contributed 1.8 percentage points to growth in the first half of this year, but we expect this contribution to drop off considerably in coming quarters as exports (line 3) slow with foreign growth and imports (line 5) remain flat. Total foreign growth (the black line in the middle left panel) is now projected to dip down about as much as U.S. growth, while the dollar (shown on the right) is well above the level we projected in the September Greenbook. As shown in line 3 of the table, we now expect export growth to move down sharply starting in the current quarter and to remain well below what we’d written down in our last forecast. Although lower U.S. demand caused us to lower import growth (line 5), the projected contribution of net exports to GDP growth has, on net, been revised down a bit over the forecast period. The bottom panel gives a longer perspective on U.S. external deficits. The non-oil trade deficit (the dashed orange line) and current account deficit (the red line) have continued to narrow over the past year and a half although oil imports have remained large. The current account deficit to GDP ratio is forecast to fall below 3 percent in 2010, a level last reached in 1998. Brian Madigan will continue with our presentation.

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