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

The financial market turmoil over the intermeeting period has not been confined to U.S. markets. In today’s financially globalized world, events in one asset market frequently have consequences in other markets and other countries; both the level and the volatility of asset prices abroad have moved with U.S. asset market developments. Equity prices are generally down, although not in China. Yields on long-term sovereign fixed-income securities are also generally down. CDS spreads, corporate bond spreads, EMBI+ spreads, and similar measures are generally up. With so much action happening in global financial markets, you might have expected some major revisions to our outlook for foreign real growth and inflation. Yet with the exception of revisions to some second-quarter numbers because of surprises from incoming data, the baseline forecast this time is little changed from that in June.

Two reasons for the lack of significant macroeconomic consequences in the rest of the global economy from these financial events seem particularly noteworthy. One is that there is no sector abroad in any of the major regions that corresponds to the U.S. housing sector and its direct ties to credit problems related to subprime mortgages. The second reason is that we do not observe any telltale signs, such as overexpansion by one or more industries or fragile household balance sheets, that would suggest that some repricing of risky assets and perhaps some restraint in credit creation would trigger significant changes in real economic behavior of firms or households. The global economy expanded strongly in the first half of this year with the underlying strength broadly distributed across regions and sectors. As a result, it is in robust condition and is likely able to withstand the adjustment proceeding in financial markets without substantial risk to continued real expansion or creation of inflationary pressures. Of course, we cannot be certain that continued or more- intense disorderly conditions in financial markets will not trigger a negative macroeconomic reaction, nor do we know for sure that problems are not already present but are not yet visible to us. So we see the events of the past several weeks as giving rise to an abundance of downside risk to our forecast of real activity rather than to changes in the baseline.

Despite a basically unchanged outlook for the rest of the global economy, two elements of the international forecast merit some further discussion: global oil market developments over the intermeeting period and the staff’s judgment that U.S. real imports of goods and services will expand at a rate about 1 percentage point lower than we projected in June. On July 31, the spot price for WTI rose above $78 per barrel and attracted attention for having reached a new peak value. Although that price subsequently moved back down somewhat, the spot WTI price was about $7 per barrel higher on the day we finalized the Greenbook forecast than it was on the comparable day in June. In part, the upward shift in the spot WTI price reflected an unwinding of most of the unusual discount for WTI relative to Brent and other grades of oil that persisted from mid-March until recently as a result of large inventories of WTI at certain locations. By comparison, the spot price for Brent crude oil rose nearly $4 per barrel over the same interval. The upward pressure on spot prices appeared to arise from the supply side, with production restraint by OPEC a factor. However, although prices moved up noticeably at the front of the curve, futures prices for oil dated later this year and early next year moved up much less; and futures prices for crude oil in late 2008 and beyond actually moved down. As a consequence, the oil futures curve returned to what is called “backwardation,” meaning that the spot price is above futures prices, which tend to flatten out at more- distant dates. Putting all this together, our forecast for the U.S. oil import price is more than $4 per barrel higher for the very near term than it was in June, but it is little changed over 2008. So the impact of higher oil prices on our trade deficit is limited. Whereas some upward push to consumer prices abroad might result from the recent increases in crude oil prices, our expectation, based on futures markets, that they will prove transitory means that few sustained pressures on inflation should result.

Our forecast for the growth of total U.S. imports of goods and services has been revised down about 1 percentage point for the second half of this year and nearly that much for next. The resulting annual growth rates of 2¾ percent in the near term and 3 percent next year are about 3 percentage points below the growth we are projecting for real exports of goods and services. Although in the near term slightly weaker projected imports for oil and natural gas are part of the story, further out weaker growth in imported core goods and services largely account for the revision. For these two categories, the downward revision reflects the changes in this forecast to the projected level of the dollar and to the path for U.S. real GDP.

We have made some small adjustments to our outlook for the constituent currencies in our broad dollar index that by chance are offsetting, leaving the staff forecast for the rate of depreciation of our real broad dollar index going forward about the same as in June. However, the depreciation of the dollar that has already occurred since your June meeting resulted in a downward shift in the current-quarter starting value for our forecast path of about 1¼ percent. That real depreciation works to restrain imports of core goods and of services somewhat, especially in the near term. Parenthetically, it also has a stimulative effect on our exports of core goods and services.

The lower path for U.S. GDP growth going forward is the primary explanation of our downward revision to projected import growth. With U.S. GDP now expected to grow at an annual rate of 2 percent, rather than 2½ percent, imports of both core goods and services decelerate more than in proportion, as our best estimate of the income elasticities for each of these categories is above 1. Of course, the baseline path for U.S. real GDP takes into account the lower imports and the simultaneous nature of the determination of GDP and its components. But the information contained in the annual revision to past U.S. GDP growth and the prospect of lower potential GDP going forward was “news” to our import model and led us to make the downward revisions I have just described. With growth of real exports of goods and services revised up only slightly, their positive contribution to real GDP growth is just a bit more positive. In contrast, the negative contribution from real imports is now significantly smaller in absolute value. As a result, the overall arithmetic contribution from real net exports to real GDP growth over the forecast period is positive at an annual rate of about ¼ percentage point. Such an outcome would mean that real net exports have contributed or will contribute positively to real GDP growth in each of 2006, 2007, and 2008. From the perspective of real GDP, a positive contribution from real net exports is one very reasonable criterion for external adjustment, should it be sustained. Brian will now continue our presentation.

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