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

In the International Division, we, too, were challenged to assess the avalanche of events and information that arrived during the intermeeting period and to make our best judgment as to how these developments would affect the rest of the global economy and the U.S. external sector. One striking feature of the baseline forecast that resulted is the difference between prospects for the industrial countries and those for the emerging-market economies. For the industrial countries, the surprises in the latest data were generally negative, and considerable financial turmoil has been evident in the markets in the euro area, the United Kingdom, and Canada. In contrast, the most recent surprises in economic data for the emerging-market economies have generally been positive, and so far there has been little evidence of financial disruption in those countries. We have revised down total foreign growth a bit less than ½ percentage point for the second half of this year and ¼ percentage point for next year. This downward revision is due entirely to revisions to projected average growth in the industrial countries.

The foreign industrial countries are largely being spared the direct effects of contraction in the residential construction sector so far. But they are vulnerable to negative effects on the pace of overall economic activity from increased volatility and impaired functionality in financial markets. As market participants have demanded higher returns for risky assets and have withdrawn from some exposures, many asset prices in Europe and Canada have fallen sharply. As in the United States, these developments have had implications for bank balance sheets and earnings, as banks have experienced calls on lines of credit or have taken other steps in response to funding difficulties of conduits and other entities sponsored by them. Some markets have experienced severe disruption, particularly European ABCP and a portion of the Canadian ABCP market. Although it is too soon for us to have actual data on the consequences of stresses being put on bank balance sheets, we think it is likely that some constraint on credit extension will result. In addition, business and consumer confidence could well be impaired by the general awareness of heightened risk and uncertainty as strains persist in financial markets. We have very little historical experience on which to base a projection of the magnitude of these effects. Our downward revision of the forecast for real GDP growth in the industrial countries in response to recent financial market events has been small, but we acknowledge that recent financial events have been severe and have lasted long enough that they likely will have some effect on domestic demand in the affected countries.

Other channels of transmission from developments over the intermeeting period are more straightforward. The downward revision to U.S. real output growth causes us to lessen projected export demand growth in our trading partners; for Canada, this channel could be particularly strong. In exchange markets, the intermeeting period has seen upward pressure emerge on the euro, with the dollar-euro rate reaching new highs. This euro appreciation should weaken demand by other countries for exports from the euro area. The downward revision of real growth in the United States and in other industrial countries should, in turn, reduce demand for exports from emerging- market economies.

Economic indicators of activity from months before August have also led us to revise down projected growth in the major foreign industrial countries. In Canada, both retail sales and real manufacturing shipments fell in June. In Japan, second- quarter real GDP growth has been revised to show a decline of more than 1 percent at an annual rate, and industrial production and real household expenditures fell in July. In the euro area, some moderation in expansion is implied by recent data: Real GDP decelerated in the second quarter, and a number of measures of business sentiment, some of which contain responses after August 9, have moved lower. Taking all this together, we revised down our outlook for real GDP growth in the foreign industrial countries, with the change for the second half negative ½ percentage point at an annual rate. Accordingly, we now expect that monetary tightening measures in those countries this year and next, which we and the markets had been projecting in August, will not occur except in Japan.

The upward revision of our figure for average second-quarter real GDP growth in the emerging-market economies from 6 percent at an annual rate to about 7½ percent is indicative of the magnitude of positive surprises we received about activity in these regions. The news was broadly based across Asia, Latin America, and other areas. Importantly, at the time of the August Greenbook, we had already received data on China’s nearly 15 percent real growth in the second quarter, so the developments underlying this upward revision arose outside China. Our forecast calls for real growth in the emerging-market economies to slow to a more sustainable pace of nearly 5 percent over the forecast period from the very rapid second-quarter outcome. We judge that, going forward, the upward boost provided by faster activity earlier this year is about offset by the implications of the weaker outlook for the United States and other industrial country economies, and so our projection for real expansion in the emerging world is about unchanged from August. At this time, we do not see sufficient evidence of financial stress in these countries to warrant incorporating into the forecast restraint from credit channels or from confidence effects.

We do recognize that there are risks to the moderately strong forecast we have for the emerging-market economies. On the upside, with the pace of growth so strong in China, we may once again find that the government is unable to put in place sufficient restraint to cause a discrete step-down in real output growth there. However, Chinese stock prices have continued to rise very sharply, and we see a possible downside risk to growth from a bursting of that bubble with consequent effects on real spending. It is also possible that we are underestimating the spillover of contractionary pressures from the industrial countries onto activity in the rest of the world. For example, one channel by which such forces could weaken activity in Mexico more than we now expect is through reduced remittances. With the U.S. construction sector particularly weak, earnings of immigrant labor and remittances to Mexico could be reduced, and the result could be a slowing of growth in Mexico by more than we have forecast.

Another element of the forecast worth a brief mention is the price of crude oil. The price for spot WTI recently surged above $80 per barrel as recent data on U.S. inventories and some signs of hurricane activity led market participants to bid up prices for very near term oil. However, prices further out on the futures curve have moved down since August, and our overall path for the price of U.S. oil imports is little changed to down slightly by the end of 2008. With the futures curve showing pronounced backwardation, the spot price is very sensitive to unfolding news. Should a serious hurricane or some other factor threaten near-term production, we could see an outsized reaction in the spot price of crude oil.

With the shock to the global economy this time arising largely in the U.S. economy, it is fitting that we might look to the rest of the world to provide some support to overall demand, some contribution to stabilizing global economic activity in general, and some help in damping rather than augmenting fluctuations in U.S. economic activity. As we now read the evidence, such an outcome is likely this time. Strength in the most recent data has led us to revise up projected real export growth in the third quarter. Although foreign GDP growth has been revised down a bit, thereby weakening exports, the dollar is on a path slightly lower than in August; and relative prices should provide a bit more boost to exports than we previously thought. All in all, the contribution to U.S. real GDP growth from exports should be somewhat more positive over the forecast period than we expected in August despite the global financial turmoil. If the Greenbook forecast is realized, net exports should make a positive arithmetic contribution to U.S. real GDP growth of about ⅓ percentage point during the second half of this year and about ¼ percentage point next year. Brian will now continue our remarks.

Keyboard shortcuts

j previous speech k next speech