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

Thank you, Mr. Chairman. My outlook, like most of the rest of yours, was basically the same as the one in the Greenbook, and it hasn’t changed all that much over the past few weeks. Like the rest of you, I see income growing at less than the growth rate of potential for several quarters, the pace held down by housing and the slower growth of consumption that has become evident in recent data and confirmed by President Poole’s reports. This is offset over time by a strengthening of business spending, the end to the inventory correction that we see in IP and ISM statements, and a pickup in capital expenditures as businesses feel more comfortable that the expansion will continue and that any overbuilding they did when income growth was higher in those three or four years that President Stern was talking about has been absorbed. Like the rest of you, I see a pickup in demand to something like the growth rate of potential some time next year as housing activity adjusts to the lower level of demand and as inventory is worked off. Several favorable factors support this eventual return to potential: supportive financial conditions, especially for businesses; credit availability, which we’ve just been talking about; narrow credit spreads; low long-term rates; and good foreign demand— another upward adjustment in this Greenbook to rest-of-the-world economic growth; and the decline in the dollar—which will support exports. I used the staff structural growth of 2½ percent. It seemed to me that the adjustments the staff made were small, offsetting in participation and productivity, and looked reasonable given the recent data. There is still a tension between the labor data and having potential growth as high as it is, and it leaves the staff in a position in which labor force participation is slightly above the trend, which strikes me as where it ought to be when the unemployment rate is slightly below the NAIRU. Also, productivity is slightly below the trend, so they need faster-than-trend productivity growth just to get back to their now lower trend, which strikes me as where it ought to be after three or four quarters of below-trend growth and presumably some labor hoarding, but not that much below trend. So that looked like a reasonable assumption to me, and that’s what I used in my projection.

I differ from the Greenbook in a couple of respects. One is that I had softer equity and house prices than the staff did. On the equity front—I think I said this last time—I expected equity prices to be soft, and they’re up 6 percent. [Laughter] Fortunately, I don’t back my predictions with my personal wealth. But—I’m going to hold to that prediction—[laughter] the market still seems to be building in a more rapid increase in profits than seems consistent with moderate nominal GDP growth and some rebalancing of the labor-capital share, which we may be beginning to see. Certainly, there is practically no growth at all in domestic profits in the Greenbook for ’08. Now, the market may get more from the foreign profits, as people have been saying, but I think there is potential for disappointment there. On house prices, inventories are large, and the price-to-rent ratio is still extremely high. On the demand side, I think demand is being damped by tightening in subprime and alt-A markets. On the supply side, there will be some more foreclosures, particularly as rates adjust up this year. So I presume that prices will need to drop somewhat, rather than just stay level as in the staff forecast, even to get the housing stabilization and eventual slight rebound that the staff and I included in our real GDP forecast. Now, to offset the effects of weakness in wealth from these prices, I had a slight easing of monetary policy this year, next year, and the following year—¼ percentage point each year—to get that same output. This was only a slight easing in real rates given that inflation is edging down and inflation expectations aren’t presumed to change very much. I did this in the context of what I would have as an interim inflation target of 2 percent. I think 2 percent is achievable without significant output loss: It is low by historical standards and broadly consistent with price stability and minimal welfare distortions relative to 1½ percent. I agree that a little lower might be nice eventually, but I would get there opportunistically by leaning against any increases and accepting decreases rather than deliberately going to 1½ percent. I’m skeptical about the expectations effect that might accrue from the announcement of a 1½ percent commitment.

A second difference with the Greenbook is that I assumed a slightly lower NAIRU— 4¾ percent. Any point estimate is silly—we really have only the vaguest idea—but it seemed to me that the compensation data, the price data, of the past few years were more consistent with a NAIRU that was a bit below 5—and so I assumed 4¾ percent. As a consequence, I had slightly less inflation than the staff forecast—0.1 in ’07 and in ’08. So I had 2.2 in ’07 and 2.0 in ’08 and had it staying there in ’09. In some sense I thought the more interesting part of the forecast was thinking about the second moments—the skews and the probabilities around the central tendencies. I confess that for ’07 I committed the sin of thinking things were more uncertain than usual, Mr. Chairman. [Laughter] I hate it when I hear people say that.

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