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

Thank you, Mr. Chairman. In spite of the fact that I am going to validate what President Fisher said in terms of content, I am reminded of what candidate Ronald Reagan said in 1980 against George Bush. To paraphrase, “I paid for the plane ticket down here. I’m going to tell you what I learned.” [Laughter]

Pessimism is running deep, and no one I spoke with this round was immune to the current economic and financial turmoil. Even contacts who have sworn for months that their prudent financial management had insulated them from funding difficulties now report being stressed. The speed of the turnaround in sentiment has been breathtaking. Some of these new reports about changes in financing conditions came from large manufacturing firms that had been doing well this cycle. For example, John Deere noted that its financing subsidiary was having difficulty rolling medium-term notes that fund their customer leases. This seems symptomatic of financial stress because the subsidiary has a large capital cushion with high-value collateral backing the leases. Caterpillar did have better luck getting such funding but only because it went to the market during a very brief window when lenders were actively seeking customers with high credit quality. I also heard numerous reports of businesses having difficulty renewing long- standing lending arrangements with their banks; and for those who were able to get new loans, the terms were typically viewed as unattractive—at least they felt so.

Several Chicago directors indicated that businesses were successfully tapping existing loan commitments and revolving credit, much along the lines that President Yellen just mentioned. However, this was not greeted enthusiastically by their bankers. In fact, I heard a very interesting story about a major New York bank CEO who spent some time in Chicago a couple of years ago. He was calling a large customer to assure him that their credit lines were good and that they didn’t need to be taken down preemptively. The customer, who is our chairman, listened politely and then tapped the line anyway. [Laughter] No wonder banks are worried about their liquidity position.

With regard to nonfinancial developments, reports on both current and expected real activity have turned uniformly more negative. An abrupt change occurred in September. People are spooked—sorry—[laughter] and it is showing through to spending. Retail sales are weak. I have grown accustomed to the inherent pessimism of one of my retail contacts. He has often said that business has never been weaker in 40 years, but this time he said never in 46 years. I also heard many reports about how the slowing in demand is worldwide.

In my District, the sharp slowdown is evident in the Chicago purchasing managers’ index. In October, it plunged nearly 20 points, to 37.8, the lowest level since the last recession in May 2001. This index will be publicly released on Friday. Businesses appear to be responding to the drop in demand by doing anything and everything they can to cut back spending. Labor demand is way off. My Manpower contact indicated that even companies that are doing well had turned cautious about hiring and are trying to squeeze out more productivity. He thought that the drop in sentiment could have some extra impact, given that it was occurring during the annual planning cycle for corporations. The idea was that a lot of harder-to-sell structural adjustments were being implemented anyway and that CEOs wanted to get these moves done quickly and have them behind them by early 2009. This is consistent with a range of reports we have heard that new capital spending is dead in the water or that planned expansions are being canceled. On a positive note, I think we are seeing the benefits of the structural improvement and inventory management that has occurred over the last 25 years. My contacts are reporting some increases in inventories, but they think that so far they have kept stocks under relatively good control. With prompt production cuts, we may not get the additional downside of a big inventory swing later in the cycle, perhaps when it is more painful.

Turning to the national outlook, our forecast envisions a full-blown recession, roughly on the scale of the Greenbook. But like everyone else, I have a great deal of uncertainty about this projection. Things could turn out a lot worse. In contemplating the transmission from recent financial events to the real economy, there seem to be at least two channels to note. First, there is the dramatically reduced availability and higher cost of credit. Second, a recessionary psychology has emerged strongly in households and businesses. With regard to the psychology, I haven’t spoken with anyone this round who thought there was a good reason to undertake any kind of discretionary expenditure. Clearly, the self-reinforcing dynamics implied by these and other reports could generate a deeper downturn than I have written down in my forecast. That’s a big risk. With regard to the credit channel, the hit to the nonfinancial sector has intensified a good bit. We clearly are sailing in uncharted waters when it comes to quantifying these effects. The factors identified in the Greenbook highlight the unprecedented nature of the financial impulses to the economy.

Looking ahead, I expect that the improvement in financial conditions will be somewhat faster than in the Greenbook. That is my cautious optimism. Still, in our forecast, financial headwinds weigh substantially on growth throughout 2009 and continue, to a degree, into 2010. Accordingly, substantial resource gaps remain open throughout the projection period. Also, I expect inflation expectations to decline in this depressed environment. With greater slack, lower inflation expectations, the reduction in energy and other commodity prices, and the higher value of the dollar, we are projecting core inflation to move under 2 percent by 2010. And I won’t be shocked if the Greenbook projection for this to happen in 2009 actually happens. So, on balance, I think that inflationary risks are low but the downside risks to the economy are very high. Much as President Fisher indicated, it is much in line with the reports so far. Thank you, Mr. Chairman.

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