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

Thank you, Mr. Chairman. I would characterize where we are compared with the last meeting as that we have gone through a soft patch, which was more extensive than we expected. But the basic longer-term outlook is really the same as the one that we had the last time around. That is what is really relevant to our policy decisions because our policy decisions now do not affect the economy until a year or two down the road.

Looking at the issue of the risks, I was most worried at the last meeting about what was happening in business fixed investment, particularly because I did not really understand what was going on; and it is always the case that, when you have Knightian uncertainty, you get much more nervous. The numbers have come in a bit better on those grounds, so I am a little less worried about business fixed investment. But then we have had a downshift in housing, which again was unexpected. So when I put those things together, I think that we are in a situation of a fair amount of uncertainty. Maybe I am a little less worried about the uncertainty and the downside risk, although I think they are still there, only because in the housing case, from the point of view of the longer-run fundamentals, I do not see a big problem. It really is an inventory-correction issue, which we are trying to sort out. That is creating uncertainty, but it creates more uncertainty in the shorter term rather than in the longer term. Even though there is still uncertainty with the issue of business fixed investment, it may be a little bit less. So perhaps there is a slight skew on the downside in terms of my confidence intervals, but a little less than last time, if that gives me any comfort.

About the inflation issue, I am more optimistic than the Greenbook. I see inflation coming down to 2.1 percent by the end of 2007 and then to 2 percent and staying there thereafter. My reasoning here, I think, is familiar to you. I consider long-run inflation expectations to be a key driver of the inflation process. I see those numbers as around 2 percent, and unless we make a concerted effort to change inflation expectations, I think that is where they will stay. Also, I am confident that we will do the right thing to make sure that inflation expectations do not go up from there, and I think the markets have similar confidence in that regard.

When I look at the risks in terms of inflation, of most concern to me is the issue of what has happened to structural productivity. We have numbers coming in that we really cannot fully explain. Maybe there is just something a bit wrong with Okun’s law, and productivity will revert back to it, and then we’re okay. But maybe there is actually something more, that we have had such tight labor markets when, in fact, the economy has been growing at quite a slow pace. There is a real question about what this may mean. If structural productivity is actually downshifting more than we expect, that does create a serious inflation risk that we have to be very concerned about. On the other side is the issue about whether we really are in tight labor markets. You look at the numbers in terms of compensation and so forth, and they don’t look too bad. This might tell us is that the NAIRU may be somewhat lower—again, if we even know exactly what the NAIRU concept means—which is the issue of Knightian uncertainty, not normal uncertainty. So in this context, the basic forecast outline that we have is actually a fairly benign one. I am willing to bet that it is probably the most reasonable forecast to have. I am pretty comfortable with it. But we will have to wait to see what kind of data come in. Thank you, Mr. Chairman.

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