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

Thank you, Mr. Chairman. In looking at the latest Blue Chip forecasts for GDP growth, I noted that the range between the highest and lowest is among the largest on record. The 10 most optimistic forecasters are predicting over 2½ percentage points faster Q4-over-Q4 growth than the 10 most pessimistic ones. Such forecast dispersion is indicative of the unusually high degree of uncertainty that we are facing.

The Greenbook presents one of the most pessimistic economic forecasts; yet I find its recessionary projection quite plausible and see downside risks that could take the economy well below that forecast. Although I found it especially difficult this time to decide on the most likely outcome for the economy, I ended up submitting a forecast that shows somewhat more growth in 2008 than the Greenbook, even though we shared the same assumption concerning monetary policy this year. My forecast projects 2008 growth of ¾ percent. This averages no growth in the first half and 1½ percent growth in the second. The unemployment rate increases to just over 5½ percent by the end of this year, a bit lower than the Greenbook. In one critical area—namely, the adverse effects of financial sector developments on the real economy—I remain just as pessimistic as the Greenbook. Although the likelihood of a severe financial panic has diminished, the risks are by no means behind us. Moreover, credit conditions have turned quite restrictive. This credit crunch reflects the drying up of financing both for markets that were important sources of business and consumer credit and from banks that are contending with capital-depleting losses and illiquid assets.

Among banks, the latest Senior Loan Officer Opinion Survey noted a clear tightening of lending standards, and my own discussions with bankers confirmed this point. They say they are carefully reassessing and significantly curtailing existing home equity lines of credit as well as unsecured consumer loans of all sorts. Banks are also clamping down on the provision of revolving business credit, even to very creditworthy customers. For example, the treasurer of Chevron, a highly rated oil company that, as you can guess given energy prices, has a very strong profit outlook, recently complained to me that banks were reluctant to extend even its credit line. Such reluctance is also evident for lending to students, consumers, and other businesses. The risk of a deepening credit crunch remains as a weak economy—especially with further sharp declines in housing prices—escalates credit losses, harms financial institution balance sheets, and causes them to scale back lending even further. My sense from our business contacts is that their perception of reduced access to credit is causing them to manage their firm’s liquidity more carefully and is leading to some deferrals in capital spending projects as a precautionary measure. Certainly the mood is decidedly more pessimistic and cautious.

Amid the gloom of the credit crunch, I do see a possible silver lining in that it may amplify the effects of the fiscal stimulus package, and this is part of the reason that my forecasted downturn is a little milder than the Greenbook’s. In particular, because of the credit and liquidity considerations, the latest fiscal package could well provide a bigger bang for the buck than the tax rebates in 2001. First, the current tax rebates are more directly targeted at lower-income households, which are more likely to be credit constrained and to spend the cash once it’s in hand. Second, given the current tightening of credit availability, households will likely spend an even greater fraction of the tax rebates than they did in 2001. Of course, there is considerable uncertainty about assessing the potential size of these effects. But over the next few months as the checks go out and the retail sales reports come in, we should get a pretty quick preliminary read on how things are shaping up.

Regarding inflation, the most worrying developments since we met in March have been the price surges for a wide variety of raw materials and commodities, especially the jump in the price of crude oil. From the U.S. perspective, this run-up in prices represents mainly a classic supply shock, which could threaten both parts of our dual mandate, although the decline in the dollar has slightly exacerbated the severity of the impact. Like the Greenbook, my forecast for inflation does take commodity price futures at face value and foresees a leveling-out of prices going forward. Although I must say, after four years of being wrong, I am beginning to feel like Charlie Brown trying to kick that football. The most recent core consumer price data have shown some improvement, and like the Greenbook, I’m optimistic that core inflation will subside to around 1¾ percent over the forecast period, assuming that the commodity prices do finally level off and compensation remains well behaved.

An interesting analysis by Bart Hobijn of the New York Fed as well as my own staff implies that, in an accounting sense, pass-through from the run-up in oil and crop prices may have boosted core inflation as much as 0.3 percentage point over the past two years. So a leveling-off of these prices could lower not only headline but also core inflation. My core PCE inflation forecast is a tenth or two lower than the Greenbook this year and next also because we assume lower pass- through of the dollar depreciation to non-oil import prices. We have been reexamining the data on this issue and find the evidence quite convincing that pass-through has been quite low recently— lower, for example, than embodied in the FRB/US model.

With respect to inflation expectations, market-based measures have now edged down. We took little comfort from this fact, however, because we had viewed the uptick in inflation compensation in recent months mainly as a reflection of a higher inflation risk premium and not a reflection of higher inflation expectations. I am also somewhat concerned that the median expectation for inflation over the next five to ten years in the Michigan survey has ticked up.

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