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

Thank you, Mr. Chairman. I certainly share your concern that the current federal funds rate is too high. You said that you thought we had about offset the effects of tighter credit and declining house prices on demand. I’m not so sure that we have actually done enough to make that offset. Certainly, if you look at the staff forecast, we haven’t. They have the unemployment rate rising to 5¼ percent, half a point over the NAIRU, at the current funds rate, which suggests to me that the current funds rate is substantially above neutral, not at neutral. If you look at the market—and, President Fisher, I assure you I am not going to get pushed around by the market—I do think the market is telling you that there are a lot of people out there who think that the funds rate has to drop 100-plus basis points more, and they don’t think that will be consistent with a pick up in inflation. Now, they could be wrong. I’m sure they probably are and often are. But I think there is some signal there about the degree of pessimism out there about underlying demand that we shouldn’t throw away entirely just because it is coming from the market.

So in my view, policy is probably still restrictive rather than neutral. I don’t think we fully adjusted to the deteriorating condition we saw in December. What we saw then was that the credit constriction had spread and would be bigger and more prolonged than we had thought previously. We saw a steeper, more intense housing decline, with multiplier–accelerator effects, and wealth effects on the decline in house prices. We saw the beginning of spillovers to other sectors, and I don’t think our 25 basis points really adjusted to all that new information. Moreover, the incoming information, although it hasn’t lowered the near-term GDP, does imply weaker growth going forward. With regard to the labor market, it is true that it is one month, but it is three different sources of data—the household survey, the establishment survey, and the initial claims—all telling us the same thing. Now, we will get more information over the next couple of weeks on at least the initial claims part of that and the continuing claims. I think we should treat the labor market information as more than just one series for one month. It’s three series for one month, and there is probably a little more weight there. In addition, the new orders and the ISM survey, housing, and stock market wealth have declined substantially since the meeting. So I would say, obviously, we have no insurance. I’m not even sure we’re at neutral, and I see the downside risks that you, Mr. Chairman, Dave Stockton, and many others have talked about, particularly from the credit markets and credit conditions.

I agree that the inflation situation is somewhat concerning. Now, some people have cited the increase in the staff’s inflation forecast for 2008 of 0.4 percentage point; but of course that’s the energy price situation. I think so far through this cycle the feed-through of energy prices into core inflation has been pretty darn low. The staff has built in a little here. Inflation expectations do remain anchored. To be sure, the core inflation numbers came in a little higher, so they’re a little worrisome, too. I think there is going to be less pressure on resources than we thought. The unemployment rate is higher, capacity utilization will be lower, and I think the competitive pressures are going to constrain compensation and prices. As somebody pointed out, the fact that even at a 4½ percent unemployment rate we really have seen very little, if any, pickup in labor costs suggests that my concern about that occurring at a 5 and a 5¼ percent unemployment rate would be very, very low. If the staff is right—and, of course I just heard the Romers lecture me about how the staff was right and the Committee wasn’t—[laughter] then a 50 basis point decline would just about put interest rates at neutral. It wouldn’t be accommodative, and therefore, I don’t think would be particularly inflationary.

I agree with everyone else. If I thought that a decline in rates would increase the most likely forecast for inflation—put it on an upward track—that would be unacceptable. Or if I thought a decrease in rates would increase inflation expectations, which would then give legs to an increase in inflation, that would not be acceptable either. But I think a decrease in rates at this time under these circumstances doesn’t really have that risk. It does shift the balance of risks a bit. If you take a little of the downside risk out of growth, you are presumably taking some of the downside risk out of inflation, maybe shifting that risk on inflation at the same time. But I think a substantial decrease in interest rates at this time would not shift those risks on inflation so that they would deviate from the general path over the next couple of years that most of us saw in our projections in October. So I’m not as concerned as President Lacker about that.

In sum, I agree that we need to reduce rates substantially just to get close to buying insurance. I would do it sooner rather than later. I would have been prepared to support an intermeeting move today. I think the data are weak enough; we are far enough behind the curve. To me, looking at the equity market declines, what we have seen since the middle of December is a bit of a loss in confidence in the financial markets that we will do enough soon enough to keep the economy on an even keel. So I think there has been a palpable deterioration in confidence in the Federal Reserve out in the financial markets. I am concerned that we are going to get three weeks of bad news and that the erosion of confidence will just gather steam. But I see the issues and the negatives also. An orderly FOMC process is to be protected. We are at risk of scaring the markets or looking as though we are lurching. I think we are at risk, if we move, of creating market dynamics such that they would constantly be in volatility and on alert as to when the next intermeeting move is. So there are a bunch of negatives here; and I guess on balance the case for moving—especially if it’s not supported generally by the Committee because I think it has to be supported generally by the Committee—is not overwhelming.

Obviously, I am prepared to wait and make a substantial move at the meeting, but I agree that you should signal something in your speech tomorrow that we are likely to move against the emerging economic weakness. I don’t think, President Fisher, that a speech that the Chairman makes after consulting with the whole FOMC is comparable to the speeches we make as individuals. He doesn’t have the risk of misleading the market when he has heard from all of us at the same time. This is a very different situation from the situation that many of us were in during the previous intermeeting period. Thank you, Mr. Chairman.

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