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

Thank you, Mr. Chairman. Conditions in New England seem broadly supportive of the continued expansion of the region at about the pace of the nation as a whole, perhaps because the pace of national activity has slowed somewhat and so the region seems to be lagging less, though I do think there is a bit of a brighter tone to economic activity. I certainly do not want to overemphasize that, however, as concerns do linger about the strength of job growth and the housing market, among other things.

Two matters came up in our rounds of gathering data and anecdotes around the region. First, although growth in overall labor costs in the region is moderate relative to that of the nation, concerns continue about the cost and availability of skilled labor. Respondents are also increasingly concerned about other input costs—oil, copper, zinc, other metals, and chemicals—and report that they are attempting to pass on higher costs within the supply chain or directly to consumers and are succeeding in many cases. We have not heard much locally yet about the effect of three dollars a gallon for gasoline, and I am hoping the refinery outages that apparently caused this uptick prove temporary enough not to dent regional demand or to increase price pressures. However, the general rise in primary energy costs is not particularly reassuring. Second, while the residential real estate data for the region continue to be downbeat in terms of permits, starts, year-over-year sales, and price trends, anecdotes—particularly as they regard high-end markets, as I noted before—offer some hope that the spring picture for sales of existing homes will be brighter when all the data are in. I had a comment in here about spring weather; but that turned yesterday, so I won’t make that comment. [Laughter]

The incoming data since the last Committee meeting contained some pluses and minuses that, by and large, offset one another. Thus our forecast in Boston, which is quite close to the Greenbook and similar to other forecasts around the table, has not changed an awful lot. In short, the economy appears to have made what one hopes is the final step-down in overall growth from its unsustainable momentum of only a year or so ago and is in the process of settling in at a pace that will gradually accelerate over this year to slightly below potential in ’08 and ’09. This forecast assumes that the effect of the housing bust begins to subside by midyear and that business and consumer confidence remains strong enough to support continued hiring, consumption, and business investment. It also assumes that strength in the rest of the world buoys corporate profits and foreign consumption of our exports and, combined with a slowly declining dollar, adds at least marginally to U.S. growth. All of this occurs with a continuation of very accommodative financial markets that both sustain household wealth and ease borrowing costs and provide a haven for foreign investment flows. Finally, the current boost in energy costs proves temporary, and inflation subsides gradually as unemployment moves up slightly, reflecting the output gap created by a year or more of slightly sub-potential performance. Looking at the data we received on other projections through ’09, our forecast fell within the central tendency in all the areas, but I think that we see inflation as somewhat more persistent than others do—along the lines of the Greenbook. In fact, this forecast sounds pretty good to me as an outcome if it works out this way, and I have even begun to think, versus where I was at the last meeting, that the risks around both sides of this forecast may be a little smaller.

On the growth side, the big question involves spillovers from the housing bust and possibly the problems with subprime adjustable-rate mortgages, but we have been expecting to see spillovers for some time, and they are yet to emerge in any real way. They still might, and we, like the Greenbook authors, have marked down our forecast for residential investment in ’07 based on incoming data. But I am inclined to think that broader market and economic spillovers get less likely over time. In fact, as I noted before, maybe there is some leveling-off in sales of existing homes if we smooth through the month-to-month variation in the data. Credit restraints could well damp the participation of subprime borrowers in home purchases, but low mortgage rates ought to support prime borrowers, and we see evidence for this in discussions with local banks and certainly all the advertisements in newspapers and on television that are focusing on the theme that now is the time to borrow because mortgage rates are low and maybe they will not stay that way for long. So we think—I think anyway—that we have some reason to believe that, through this year, home buying may help keep home prices and equity positive or perhaps neutral contributors to household wealth. Indeed, assuming that gasoline prices edge off their current high levels and that equity markets continue on an upward pace, there is at least some possibility on the upside for consumer spending.

Another aspect to the growth forecast that concerned me at our last meeting was the unusually slow pace of business investment in equipment and software. Given the underlying fundamentals of robust corporate profits, cash reserves, and a declining user cost, especially for high-tech goods, we would have expected faster growth. I am still concerned here, especially as such spending patterns could augur poorly for continued hiring, but I find the most-recent data on orders and shipments and the ISM survey encouraging, although as President Moskow mentioned, one should not take a lot of confidence from a single month’s data. So all in all, it seems, to me anyway, that the downside risks around growth in our forecast are a bit less.

On the inflation front, I remain concerned that the forecast is just a bit too perfect. Without too extended a growth slump, unemployment rises slightly, and inflation falls slowly. We have not done the work that San Francisco has on slicing and dicing productivity, and I found Janet’s comments very interesting. I also am very much in agreement with her and others’ perspective that the level of underlying structural productivity growth may not be declining to the degree that the Greenbook authors seem to think it might. However, if what seems to be a cyclical low continues, unemployment could well be sticky. Both the recent increase in energy and raw material costs and the burgeoning growth in the rest of the world could increase resource pressures at the same time that the dollar continues its slow decline. All of this taken together could be a recipe for accelerating rather than decelerating inflation. As I’ve noted before, I really have no problem with stable inflation around its current low level. What does concern me, however, is the potential for acceleration. In that regard, the recent small moderation in core data was welcome, though certainly not sufficient to ease this concern entirely.

In sum, I remain ready to bet on the baseline forecast. I think it is about as good as we can hope for. There continue to be risks on both sides, but at this point I would not weigh them equally. Being wrong on the inflation side could be a more difficult place to be. That is, if growth falters, it is clear what to do; but if inflation should accelerate, it might take a while and be quite costly to remedy. Thus, I would continue to favor policy that incorporates a bit of insurance. But we will get to that later. Thank you.

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