—I would say that I’d be surprised by that outcome.
There are several looming financial problems that are likely to affect financial markets. Bill Dudley highlighted the one that I think is the biggest for me, which is that the NAV (net asset value) triggers for hedge funds will be a significant problem in the fourth quarter. Without comprehensive information on hedge funds, it’s difficult to know the extent of the problems they are facing. However, since the stock market remains one of the few markets available for the disposing of assets in bulk without a significant liquidity haircut, I’d expect significant selling in the fourth quarter. My second big concern is that rollover financing will become more problematic as financial problems persist. Particularly exposed are real estate developers and highly leveraged private equity firms. My third worry is that neither insurance companies nor commercial banks have reserved for the economic outcome in our baseline forecast. Under-reserving and high payout ratios are likely to limit the amount of additional lending that banks are willing to take on. These financial problems place additional downside risk to our forecast.
Our forecast, like the Greenbook forecast, expects the rate of inflation to slow as a result of falling food and energy prices and significant excess capacity emerging in the economy. In fact, our equations indicate there is a non-negligible risk that deflation will be a problem in the outyears of our forecast. Unlike President Lacker, I was surprised that it stayed as high as 1 rather than as low as 1. The outlook for a weak real economy and falling inflation highlights the need for both monetary and fiscal policy to offset some of the financial and economic problems that we are likely to experience. Thank you.