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

Thank you very much. I, too, as everyone around the table has said, think that there is significant heightening of the downside risks over the last few weeks. As I mentioned at the last FOMC meeting, in talking with a contact at a large credit card company, I saw a very sharp deterioration in consumer behavior. I subsequently spoke with another credit card company that focuses more on the higher-end consumers and found exactly the same issues there of slowing payments—even taking into account the seasonals—more delinquencies, et cetera. So it wasn’t just a middle market phenomenon; it was also happening on the higher end. The quick change between October and December–January, unfortunately, seems to be consistent—or is potentially consistent—with the regime-shift model that we have been talking about. Also, the sharp rise in the unemployment rate could be consistent with that. I just returned from Europe, where concern is growing and there are some especially sharp changes. Spain is seeing some very sharp changes in their housing sector as well as in consumption, and consumption is going down in the United Kingdom. From discussions there, I also had the feeling that they are going to be relatively slow to react to the challenges. So I think we will be getting less support than we have been getting from exports. Also, given that a lot of rate resets are coming, we know that there are going to be more delinquencies and foreclosures. That is kind of baked into the cake. So we know that there are going to be more challenges in the financial system, regardless of everything else, over the next nine months. It does make a lot of sense to think about taking out some insurance against those kinds of risks.

I very much agree with the Chairman’s characterization of the challenges that we will have in the banking and financial system because I think it is not a traditional credit crunch, when there is a sharp contraction, because so much has been brought onto financial institutions’ balance sheets. Not only has a lot been brought on but also there is a really dramatically reduced ability to get things off the balance sheets. Basically, over the last five years or so, the reason that financial institutions could provide so much intermediation and so much support is that things didn’t stay on the balance sheets. Now, because there is an impaired ability to get things off the balance sheets, it requires much more capital to support the same amount of funding that had occurred in the past. Just to try to keep funding at the same old levels is going to require dramatically more capital. They will get more capital, but they are not going to get dramatically more, so that will mean that it will be more and more difficult for them to support funding of operations going forward. So it is very important to think about taking out insurance now.

With respect to inflation, as a number of people have mentioned, there are some disturbing readings recently. But something that is heartening, and for me is really the most important thing, is that I don’t see much evidence so far of a significant change in expectations, because that is really where the long-term costs of our policy moves come in. If there is a temporary slight movement up in inflation, if inflation expectations don’t become unanchored, then the cost is relatively low, particularly given the very large downside cost of a regime-shift to a recessionary scenario. Although I am certainly supportive of a fairly bold move at this point, I do think it would be better to wait a few weeks. I think we achieve some of that by clarifying where we stand through our public discussions. But as a number of people have said, I really think we have done a very good job, despite a lot of pressure with respect to our reaction functions, in how we react to data, forecasts, and such. I think we would lose some of that if we were to move today. That doesn’t mean that we should never move, but I do think it would be a bit of a loss because people could misinterpret what we’ve been doing and, exactly as Governor Kohn said, set up a bad dynamic. After our FOMC meeting at the end of this month, however, we actually have an enormous amount of data that come out because GDP comes out just as we’re finishing up our meeting. Then the details come out after that. We get another GDP report. We’re going to get two employment reports. So I certainly, in some sense, want to keep my powder dry with the possibility of an intermeeting move in the future, but I think that’s a time when we’re going to be getting a lot more data about which we may want to say it’s the time to move. It would be better from our broader communications policy standpoint to say that there have been enough data showing that we really do need to make a move. Thanks.

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