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

Thank you, Mr. Chairman. Economic conditions in the Eighth District have deteriorated since the September Beige Book. Citing weak demand and higher input costs, a variety of manufacturing firms throughout the District reported job cuts and plant closings. The decline in manufacturing activity has been concentrated in firms producing durable goods. Service sector activity also continues to decline. In particular, recent layoffs have been reported in business, medical, and financial services. Two large auto dealers have closed and filed for bankruptcy. Retail sales are steady, but contacts have noticed that consumers are trading down to lower-priced products. The residential real estate sector continues to decline across the District. As lending standards have tightened for commercial building projects, industrial construction has slowed.

Payroll employment numbers continue to vary across the Bank’s Branch cities. The most recent figures suggest that Memphis and St. Louis continue to lose jobs at a pace faster than at the national level. Louisville has moved from two consecutive months of positive year-over-year employment growth to negative growth in the most recent month. Little Rock continues to experience positive year-over-year employment growth. Unemployment rates in St. Louis and Memphis remain above 7 percent—that’s 7.2 percent and 7.1 percent, respectively. Louisville’s unemployment rate is 6.6 percent. In opposition to the national trend, Little Rock’s unemployment rate has fallen to just 4 percent.

The national outlook is clouded by dramatically increased uncertainty fueled by the financial market turmoil. The explosion of uncertainty is driven in part by speculation about the nature of the government response to the turmoil, both in the United States and abroad. We know from past experience that, when economic actors—investors, businesses, and consumers—are faced with new and substantial uncertainty, they tend to adopt a “wait and see” approach, during which they make as few commitments as possible. This seems to be a reasonable expectation in the current environment, so we should expect to see many types of important economic decisions being deferred. Anecdotal evidence seems to support this idea. Most likely, this means we will experience an important deterioration in economic activity during the second half of 2008 and into 2009.

In times of increased uncertainty, it can be useful to consider distinct alternative scenarios instead of considering a baseline scenario with many possible offshoots. The financial sector crisis that we are experiencing has some admittedly inexact parallels with the banking crises that occurred in Japan since 1990 and in the Nordic countries in the early 1990s. The general tenor of the literature on these events is that the Nordic countries dealt forthrightly with their financial sector problems, suffered through recessions, but were well positioned to grow once the crisis had been addressed. For Japan, real economic performance was subpar for a long time, and it is the Japanese outcome that is a looming risk for the U.S. economy. Part of the Japanese experience was the lowering of nominal interest rates to zero. This was done, no doubt, in the name of doing everything possible to help the economy recover. It was not very successful and, in fact, may have been counterproductive.

Recent academic work—I’m thinking of Jess Benhabib here—has emphasized the possibility of a low nominal interest rate, low inflation rate, steady state equilibrium, and a trap at very low or zero nominal interest rates. This steady state coexists with the targeted steady state, the one we know and love, which has inflation at our specified target and relatively high nominal interest rates. So there are two possible focal points for the economy. Markets clear at both of these focal points. My main concern is that if we choose to continue to flirt with the trap steady state, we should think clearly about the possible implications given the current environment. The trap steady state is associated with very low inflation expectations, actually deflation. This is, in fact, what happened to Japan. They experienced deflation of about 1 percent for a number of years. Since our core problems are in the housing market, which is dominated by nominal contracting, deflation could sharply exacerbate our problems and lead to further difficulties. I am, frankly, not sure that this is a wise route for the Committee or for the nation. My preferred approach would be to maintain rates at the current low level and to use alternative fiscal policy actions to address the particular concerns in financial markets. Thank you.

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