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

Thank you, Mr. Chairman. I would not have thought to call an intermeeting videoconference. I tend to think of the in-person meetings as those where we make the decisions and do the analysis. But since you made us think about it, I agree with your assessment of the economy. I think that things are noticeably softer. I don’t think there is much accommodation in place at a funds rate of 4¼ percent. To influence aggregate demand noticeably we probably need accommodation on the order of what you are talking about, which is about 100 basis points from a neutral federal funds rate. That range is probably on the order of 4½ to 4¾, so that would put such accommodation at 3½ percent. We have to recognize that monetary policy, if it is going to have any influence on aggregate demand, is going to do so with a lag. That is what all our analysis assumes and suggests, and so if we want to influence aggregate demand to limit midyear weakness, I think we need to take action sooner rather than later.

In terms of the data developments that you talked about, one thing that is taking place right now is that uncertainty is being resolved. The weakness that we are seeing I am currently interpreting tentatively as sort of an unraveling of things that we haven’t seen so far, not necessarily a deeper weakness. The December data have been weaker. The employment data were poor, and the unemployment rate was a lot higher. In constructing my outlook for the economy in 2008 and beyond, I had been more optimistic than many that consumer spending would hold up in part because of the positive labor market situation. Taken at face value, the December employment report puts a crack in that supporting foundation. It is now likely, it seems to me, that consumer spending will soften with these labor developments.

Dave Stockton went through a bit of analysis of the indicators that might lead to a recession. President Lacker and you, Mr. Chairman, mentioned regime-switching as well. I just want to mention that in Chicago we have been publishing our Chicago Fed National Activity Index for a number of years. We started out right at the onset of the 2001 recession, as it turns out. As you know, Mr. Chairman, this index is very closely related to your data-rich environment analysis with Jean Boivin and Stock and Watson. If you do an analysis where you try to assess these regime-switching events, this indicator has done a fairly good job of picking that out when it goes below a threshold of, say, minus 0.7. That is some of the probabilistic analysis that I did with this back then. If you take some of the developments in the employment report at face value, I think that this is headed for a probability of recession this year that is higher than 50 percent. So we have to be a little concerned about that. Anyway, that is the economic situation that I worry about a good bit.

What about inflation? Clearly there are risks, and the risks are evident. Core inflation rates are projected to be higher in the near term. Headline inflation has been significantly above core for long enough to make people wonder about underlying inflation, but inflation expectations have remained contained. With energy prices traversing high levels over a short time, the possibility of pass-through during a period of economic weakness cannot be dismissed. We also have to be concerned about the reputational cost of inflation going up. But, again, I agree with you, Mr. Chairman, that if we do end up with significantly weaker economic activity, it would limit the inflation risk.

What is hard in this period is balancing the risks of going slowly on monetary policy if we really think that the risk of a recession is higher. I agree with what you said and Governor Mishkin’s thinking about being aggressive in the near term to respond to weakening aggregate demand and then making sure that we take back any excessive accommodation at the appropriate time. I know that’s hard, but I think that’s what we should do. I would actually favor action today on the order of 50 basis points because I think that’s about the only way to get to 3½ in a quick enough period of time by our next meeting. That’s what I would prefer. Anyway, those are my comments.

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