Thank you, Mr. Chairman. Recent data on economic activity have been loaded with upside surprises for most spending categories and also for labor markets. Our response, like the Greenbook, has been to boost our estimate of growth last quarter and our forecast for growth this quarter. For 2007 as a whole, we have revised up our projection for real GDP growth about ¼ percentage point, to about 2¾ percent, which is just a bit below our estimate of the trend, which is a bit higher than the Greenbook. This performance continues to reflect the so-called bimodal economy with weakness in housing and autos coupled with strength almost everywhere else.
Looking beyond the first quarter, we interpret recent data as suggesting that the drag from both weak sectors is likely to diminish, providing impetus for an acceleration of activity later this year. Even so, the Greenbook forecasts, and we agree, that other factors will likely offset this acceleration so that GDP will grow slightly below trend in 2007. In particular, the Greenbook hypothesizes that the growth of consumer spending will slow, with the saving rate rising from minus ¾ percent at the end of last year to plus 1 percent at the end of next year. This forecast strikes us as quite reasonable. House-price appreciation has slowed dramatically, and the impetus it has given consumption should diminish over time. In addition, the Greenbook notes, and Larry emphasized, that consumer spending has grown more rapidly than fundamentals can explain, and it’s sensible to predict some unwinding of this pattern. Such an outcome, however, would represent a noticeable change in the trend of the saving rate. So to me the possibility that the saving rate will not, in fact, rebound to the extent anticipated in the Greenbook constitutes a serious upside risk to the outlook. Of course, the staff has emphasized this.
An alternative simulation in the Greenbook illustrates that if spending instead advances in line with income, the unemployment rate would decline noticeably further from a level that is already low. It is precisely because we are starting from a situation in which labor markets are already arguably tight that the upward revisions to growth during the intermeeting period particularly concern me. Some period of below-trend growth may ultimately be necessary to address inflationary pressures emanating from the labor market.
In December, I emphasized the puzzle presented by the combination of an apparently sluggish economy and a robust job market. Upward revisions to estimated growth in the fourth and first quarters resolve a portion of that discrepancy. Even so, Okun’s law still suggests that the excess demand in labor markets as reflected in the low unemployment rate is abnormally large relative to that in goods markets as reflected in estimates of the output gap. The current low unemployment rate may turn out to have benign implications for inflation. For example, labor market tightness may well diminish somewhat over time, given that the lags between output growth and labor market adjustments can be quite variable. Another benign possibility is that the unemployment rate may be overstating the tightness of labor markets. For example, some indicators of labor market conditions, like the Conference Board index for job market perceptions, suggest a bit of softening. Indeed, available indexes of labor compensation do not provide compelling evidence of cost pressures emanating from the labor market. However, compensation data are mixed, and I must admit that the signal from them is somewhat confusing.
While I remain concerned about the risk that labor market pressures could boost inflation over time, I’m still fairly optimistic about the outlook for inflation overall. Core inflation has come down in recent months, which is welcome, although we must be careful not to overreact. Recent favorable data could reflect the dissipation of pressures from energy prices and owners’ equivalent rent; these sources of disinflation are inherently transitory, and once they are fully worked through the system, we will be left with the influence of more-enduring factors, such as the extent of excess demand or supply in labor and product markets. If these markets are, in fact, unduly tight, we could eventually see rising inflation. Inflation expectations also matter for the inflation outlook, and I see the stability of inflation expectations as contributing to a favorable inflation prognosis. As I previously mentioned, my staff and other researchers find some evidence that inflation has become less persistent over the past decade, a period during which inflation and inflation expectations have been low and stable. Both survey and market-based estimates suggest that longer-term inflation expectations remain stable and well anchored.
So to sum up, I continue to view a soft landing with moderating inflation as my best-guess forecast, conditional on maintaining the current stance of policy. We expect core PCE price inflation to edge down from 2¼ percent last year to about 2 percent in 2007. While there are risks on both sides of the outlook for growth, I’m a little more focused on the upside risks after the recent spate of strong data. It’s encouraging that the recent inflation news has been good. However, there’s a great deal of uncertainty about inflation going forward, and to me these risks remain biased to the high side.