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

Thank you, Mr. Chairman. Our outlook has changed very little. As in March, we see the expansion continuing, with growth moving back up to potential—we see potential around 3 percent—later this year. This view rests on the familiar expectations: Housing stabilizes relatively soon without a major drop in prices; investment spending strengthens somewhat as the temporary factors holding it down recede and positive fundamentals reassert themselves; consumption moderates a bit but continues to be supported by strong income growth; the saving rate moves up but only modestly and slowly; and external demand remains strong. We still expect inflation to moderate gradually to a rate just below 2 percent for the core PCE by the end of ’08. We view the recent numbers as somewhat reassuring. Recent data in general have provided a bit more comfort for this scenario. On balance, the downside risks to growth have diminished a bit. The risk that inflation will fail to moderate sufficiently, however, remains significant and material. But in general, the overall outlook, in our view, hasn’t changed that much.

Now, our forecast assumes that we hold the fed funds rate where it is for a while. Our expected path is above the market’s but below the Greenbook’s. We’re below the Greenbook because, although our expected forecast is really similar, we attach somewhat greater weight to alternative scenarios that suggest slower growth. The recent growth numbers have been, on balance, encouraging, and the markets are a bit more confident about the outlook than they were. But I still think the downside risks to growth are significant. Housing could still surprise on the downside, and we could see a deeper, more protracted contraction in activity and, of course, broadly based more-substantial declines in prices. Consumption could be weaker for this reason or because the saving rate rises for other reasons, such as pessimism about long-run income growth. The household sector is substantially more leveraged than it was, and it has less of a cushion to absorb shocks and, therefore, presents some risk of amplifying rather than mitigating broader weakness in the economy. Although a bit better than it was in March, the investment outlook is still a bit tenuous, and it seems unlikely to be a substantial source of strength if broader weakness in demand in the rest of the economy materializes. The most rapidly growing parts of the world are growing well above potential and face rising inflation and substantial asset-price inflation, and I think the authorities there are generally starting tentatively to tighten policy more significantly.

On the inflation front, we still face substantial uncertainty about what is happening to underlying trends and how they will evolve. The broader inflation environment is, if anything, less benign than it has been over the past three quarters, with inflation accelerating a little outside the United States, energy and commodity prices continuing to show signs of rapid demand growth, the dollar potentially weakening further, compensation here firming a bit, and productivity growth probably staying a bit below what we thought was trend. In this context, with inflation still running about 2 percent, inflation expectations could drift up.

Continuing on the risks for a bit, I still think we live with a significant risk of a sharp deterioration in financial markets. Credit spreads, other risk premiums, low levels of implied volatility, and the strength of asset prices in many parts of the world—all imply a level of confidence in ongoing, stable growth and low inflation that seems a bit implausible. In addition, the low level of long forward rates seems hard to reconcile with the strength of demand growth outside the United States, suggesting that much of the world is likely to need to move further toward tighter monetary policy. As financial conditions exert more restraint on demand growth globally, we could see a rapid unwinding of this long period of very benign assessment of fundamental risks. We, of course, face some risk of policy actions here in the form of trade or investment protection. This risk, against the backdrop of some uncertainty about the strength of productivity growth going forward, might make the rest of the world less comfortable financing our still-large external balance on the favorable terms that have prevailed thus far.

On the longer-term outlook for potential in the United States, we are sticking with our forecast of 3 percent, but we have altered the mix a bit, just as the Greenbook has in some sense; however, we feel a little less comfortable with our basic view about potential. We lowered our productivity growth assumption a bit, to 2.25 for the nonfarm business sector, and raised our estimate of trend hours a bit. If potential is lower than we’re assuming, then we are less likely to see the moderation of inflation that we currently expect, but we would expect a lower path for output growth as well. At this stage, however, in view of the strength in income growth that we’ve seen, earning expectations, and other measures, we’re reluctant to embrace a more negative view about growth in potential.

On balance, in view of these risks, I favor staying where we are for a while. I don’t think there is a very strong case for tightening policy or for inducing a significant rise in market expectations about the path of the fed funds rate going forward, nor do I think now that we’re at risk of being too tight. So, in general, I think the best choice for us is to continue to lean against the expectation that we will move to reduce rates soon. Thank you.

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