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

Thank you, Mr. Chairman. The near-term outlook for the Third District is moderate growth going forward. The major source of the strength in the District continues to be employment growth, and nonresidential construction is fairly stable and modestly healthy. However, manufacturing continues to be sluggish and residential construction weak.

Job growth has picked up considerably in our District, having grown at 0.9 percent at an annual rate in the past few months. Unemployment rates have fallen in the region, and the labor market in Pennsylvania in particular has been especially strong. To get a better handle on labor market conditions, in our last business outlook survey we asked a panel of firms whether they had experienced problems filling jobs in the past three months because applicants didn’t have sufficient qualifications. Remarkably, more than two-thirds of our firms said that they had trouble with this and that the percentage has been growing since we first started asking the question three years ago.

The strength in the regional labor markets is reflected in the rebound in our staff’s indexes of leading indicators of economic activity in the three states in our District, especially in Pennsylvania, where the index is predicting stronger growth over the remaining three quarters of the year. An area of stability in our region’s economy has been the ongoing modest strength in nonresidential construction. The growth in this sector has recently been largely in noncommercial construction—hospitals, education buildings, and so forth. However, general commercial vacancy rates in Philadelphia have been falling steadily, and the absorption rate in Center City is nearly at a record high. With regard to manufacturing, growth is stalled. According to our April manufacturing survey, our general activity index is close to zero, or just mildly positive, as it has been since late last year. Both new orders and shipments are close to zero, as they were. Further, in April the index of future capital expenditures was down somewhat and below the averages that we have been seeing in most expansions. The only bright spot was the significant bump-up in our future activity index, which signaled that more-robust activity is anticipated by our survey participants. It also comes as no surprise that residential construction remains weak in the District, and housing permits have continued to decline as the value of residential construction contracts has as well. Also, there seems to be little or no appreciation in house prices. On the inflation front in the District, prices paid and prices received by manufacturers have moderated a bit. Further, retailers are reporting very little change in prices over the past few months. In summary, the Third District is growing slowly, and our staff projection is for modest growth going forward. Labor market fundamentals appear strong, but we have yet to see any sign of the pickup in manufacturing that some of the national numbers indicate.

On the national level, since the last meeting I have actually become a bit more comfortable with the economic situation. While I say that I am more comfortable, that’s a relative not an absolute statement. The most recent month’s readings on core inflation were welcome, but I think that caution and vigilance are still the order of the day. Indeed, the Greenbook authors, as we’ve noted, seem to have been revising their forecast of core inflation upward slightly over the past several months rather than downward, and that to me is a bit disturbing, even if the numbers don’t change a whole lot.

News that has made me more comfortable with the projection of a somewhat quicker return to something closer to trend growth in the second half of the year is the recent strength in durable goods orders and the ISM numbers, which are indicating that manufacturing has picked up. Further, recent strength in manufacturing was broadly based, and the output of business equipment was strong. Along this dimension, I am in agreement with the latest forecast of the Board staff. However, these reports represent only one month of data, as people have said, and although they are consistent with a modest bounceback in the second quarter, there is still substantial uncertainty. I hope that, in the coming months, those data will be reinforced as new data come in; but, again, at this point that is only wishful thinking. I would add, though, that my business contacts, particularly in the financial sector, continue to report to me that business loans are strong, C&I loans are strong, demand is strong for loans, and balance sheets and firms still look good. So they see things as looking good from their perspective, but that positive news is not really showing up in some of these other numbers, at least as yet. So I’m a bit puzzled by that. Furthermore, job growth and personal income growth appear to be on solid footing, and I find myself increasingly puzzled by the weakness in the labor market as portrayed by the Greenbook forecast. The strength in personal income, along with a rebound in asset markets, leads me to view consumption as somewhat healthier going forward than the Greenbook sees it. Those circumstances, coupled with the more positive news on investment to which I just alluded, lead me to view closer-to-trend growth as the best forecast and, therefore, to have a little more optimism in my outlook for the second half of the year and into ’08. That is reflected in the forecast that I submitted.

That said, I realize there are significant risks to this return to trend growth. The biggest risk remains housing. The extreme fluctuations in weather over the past four to five months have made discerning trends a lot more difficult, and I’m not sure exactly how much seasonal adjustment factors are bouncing the numbers around and making it harder to disentangle effects. Inventories of housing, as we have talked about, remain extremely high, and there is very little signal of a pickup in demand, at least as yet. However, I’m a little skeptical that this sector will continue to subtract a full percentage point of real growth from the forecast, as the Greenbook suggests. I’m a little more optimistic than that. I remain optimistic in part because I think real mortgage rates remain relatively low. I see strong income growth continuing, and I am increasingly less concerned, actually, about the spillover from subprime markets. So I can envision housing demand strengthening a bit more than is implied in the Greenbook, and that leads to less of a subtraction going forward.

On the inflation front, I’m a bit less worried than last time but far from sanguine. The last core PCE inflation number was obviously very encouraging at something close to zero, but, again, we have to be very careful in extrapolating out one month’s data. As I said before, the Greenbook authors seem to be inching up their forecast of core inflation or at least pushing the decline out further into the future, and that concerns me a bit. I believe inflation is still too high. Inflation expectations are stable, but they are too high as well, and we need to bring that rate down. Thus, we need to be vigilant here and continue with a somewhat restrictive policy.

In regard to my forecast, I’m not going to say much. I just assure you that, without collusion, President Lacker’s view of the forecast and how it evolves is very similar to mine. So rather than repeat what he said, I will just let his comments largely speak for mine. I have a slightly faster return to trend growth, partly because my productivity estimates are somewhat higher. I thought Janet Yellen’s comments about her productivity analysis were quite thoughtful, and I appreciate them. The optimal monetary policy, or at least my preferred path for monetary policy, might include some tightening if trend growth returns more quickly than we had indicated. But, indeed, my forecast for core PCE was actually down to 1.7 percent by 2009. I’ll stop there. Thank you.

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