Thank you, Mr. Chairman. I’m not going to say much about the District conditions. In the Third District, as many of you have noted, they’ve weakened considerably. I will make just a couple of observations that I think might be pertinent. Our last Business Outlook Survey, the one that was released a week ago, had actually gone into positive territory in September to 3.8, which was the first positive reading we had had since January—since, I guess, last December, actually. And it dropped from that plus 3.8 to minus 37.5 in one month. Now, it’s relevant to know the timing of this a bit. Our survey is done during the first 2 weeks or the first 10 or 12 days of each month—which meant that the September survey was closed on September 12, 4 days before that weekend. So what we see is a very precipitous, dramatic change in the tone that had as much to do with events and perhaps policy actions as with what was actually going on in the economy.
I share a bit of President Lacker’s concern to try to disentangle a little the tone and feel of the economy, which really did feel as though it fell off a cliff in September, unlike any other month that I’ve seen during this episode. We have to think carefully about disentangling that effect not just because something fundamental happened to the economy but also to see to what extent policies, whether our policies or Treasury’s policies, have contributed to a change in tone and increased uncertainty and aggravated what might be the real fundamentals going on. I don’t know the answer to that question, but it suggests something that many of us have argued over time—that more- consistent and more-predictable policies can help us avoid some of that.
One special question that was asked in this survey in October was whether firms had trouble getting credit. Interestingly enough, only 14 percent of the respondents reported that they had trouble obtaining credit, but twice that number, almost 30 percent, reported that they believed that their customers were having trouble getting credit, which was an interesting dynamic going on that leads to a bit of uncertainty. I guess the best thing I can say about the Third District right now is “Go Phillies!” [Laughter] Maybe that will turn things around in the Third District.
Anyway, let me turn briefly to the national outlook. It has deteriorated, certainly more than I expected, from what I thought in June. In our conference call on October 7, I indicated that I was revising my forecast downward. I expect the economy to contract during the second half of this year and perhaps in the first quarter of next year—but that’s less clear to me—and then gradually approach what I would consider trend growth over 2009, so that by the end of 2009 we’re getting back toward what might be considered trend growth, which I consider to be about 2.5 to 2.7 percent. In essence, for 2010-11, I pushed out my recovery of the economy by somewhere between six and nine months because of the current turmoil. I expect the unemployment rate to peak around mid- ’09 at about 7¼ and then to decline gradually to its long-run rate of about 5 percent by the end of 2010. Inflation pressures have subsided somewhat since June, and inflation expectations have remained contained. I expect core inflation to decline gradually from the current levels to my goal of about 1.7 percent by 2010.
Now, my overall forecast is considerably better than the Greenbook baseline forecast. In fact, it’s similar to what we talked about as the “more rapid financial recovery” scenario, which makes some of the adjustment for the financial turmoil somewhat quicker and somewhat less dramatic than in the baseline. The fed funds rate path underlying my forecast is less accommodative than the Greenbook. I assume that the fed funds rate remains at 1½ percent through the spring of next year and then gradually begins to rise, reaching 4¼ percent by the end of 2010. Now, there are certainly risks around that forecast. Somebody at this table has to be a little more optimistic after all, and we have risks around all forecasts in this environment. Certainly mine is no exception. In particular, the effect of the financial markets, as we’ve all been talking about, remains highly uncertain and highly risky, and I am not trying to disregard that. Every day it seems as though there’s a new development, usually negative, although I guess 900 points on the Dow today should be considered good news.
But in fact, I believe that the risks around the Greenbook baseline forecast are to the upside, as I have alluded to. First, the baseline entails a sizable downward adjustment based at least partly on the volatile financial data, especially spreads. Spreads can fall dramatically, although they don’t always do so. But they can rise and fall very quickly, and I think it’s very risky to base monetary policy, which ought to be taking a longer-term perspective, on week-to-week movements in such volatile variables. If spreads do continue to fall over the next quarter or two as they have in recent days and if the financial market tools we’ve put in place have the desired effect, we could see the economy becoming much stronger than the Greenbook’s baseline. Second, in the Greenbook, inflation falls and remains low despite a very low fed funds rate path. In fact, it’s reminiscent of the funds rate path in 2003-04. This apparently is due to the sizable output gaps that open up in the forecast period. Now, these output gaps arise in the forecast because the effects of the financial turmoil show up mainly in aggregate demand. However, as I’ve suggested in previous meetings and as President Lacker alluded to, I think a plausible alternative view is that the financial market disturbances we’ve experienced—resulting in a restructuring of the financial system and a lowering of the efficiency of financial intermediation—act on the supply side as well, much like a somewhat persistent productivity shock with an associated damping effect on measures of potential GDP for some period of time. If so, we’ll see much smaller output gaps opening up, and that means the risk of higher inflation than in the Greenbook, especially if the baseline funds rate path is followed as they lay out.
In thinking about the appropriate monetary policy going forward, it’s important that we not let our policy be whipsawed by volatile market data. We have been lowering the funds rate since January, largely in anticipation of a recession or to mitigate the chances of one occurring. Now, it may finally have arrived. Does that mean we have to lower more? A difficult question. The level of the funds rate is always a difficult question. Clearly, if we experience a sustained slowdown in real economic activity, which suggests a lower equilibrium in the real rate of interest, policy needs to allow the funds rate to fall with the equilibrium rate, and I based my recommendations throughout the year on such a forecast. But I think it’s a mistake to overreact to volatile data, especially when it’s the stock market. Although there has always been the desire and much pressure from markets to do something when we see such swings in the market, in my view, the economy is better served if monetary policy is a steadying hand, taking appropriate action when the intermediate-term view dictates, but not overreacting to fluctuations in the market with an inappropriate tool. Thank you, Mr. Chairman.