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

Thank you, Mr. Chairman. Economic activity in our District lost a bit of momentum in January. Retail sales contracted in recent weeks as automobile dealers noted waning interest and buyers of big-ticket electronic goods stayed home, perhaps to watch the big screens they purchased during the holidays. [Laughter] Another source of slowing was a further pullback in the factory sector. I should mention new orders in our District slipped in recent weeks, on top of December’s modest contraction, and factory hiring edged lower for the second straight month. On the plus side, services firms continued to report moderate growth in revenues and employment. Despite this mixed picture, however, a wide variety of firms remained optimistic about their prospects six months out. District labor market conditions remained tight, and skilled workers continued to be in strong demand in large metropolitan areas. Businesses tell us that they are pushing up wages as a result.

Real estate activity is, on balance, hanging in there. Anecdotal reports indicate fairly firm home sales across many areas in December, and we’re hearing more reports of pockets of strength in some suburban housing markets around D.C., though assessments from other areas continue to be somewhat downbeat. We have also heard that homebuilding activity rose somewhat in a number of District metropolitan areas in recent weeks. Commercial real estate prospects remained relatively bright, with leasing activity firm and a solid number of projects on the books for ’07. Price pressures at District firms seem to have moderated somewhat, confirming the national trends.

The national data flow since our last meeting has been encouraging. The Greenbook now predicts a higher trajectory for real GDP. I agree with the Greenbook’s short-term outlook. Declining housing construction is still depressing the real growth rate now, but demand has stabilized, I think, and inventories may be topping out. Each batch of housing data has bolstered my confidence in the trajectory we sketched out last fall—namely, that the drag from housing will mostly disappear by midyear with spillover having been relatively limited.

Consumer spending has been quite resilient. Evidently, favorable income prospects have trumped weakening housing prices. The fundamentals for business investment remain favorable with the cost of capital low and profitability high; and the latest news—that unfilled orders for capital goods are continuing to increase—fits in well with the view that equipment investment is likely to be a source of strength going forward. The Greenbook has real growth later this year and into next year returning to trend, driven by strength in business investment and solid consumer spending. I agree with that outlook with the caveat that my estimate of trend growth is higher than the Greenbook’s.

The inflation news since the last meeting has been encouraging as well. Core CPI inflation was 1.8 in the fourth quarter, and core PCE inflation was estimated to have been 2.1 percent. It’s tempting to extrapolate this favorable news forward as the Greenbook does and forecast a gradual downward drift without further overt action by the Committee. That outcome is certainly plausible, especially if oil prices cooperate and remain contained within recent trading ranges. But I remain apprehensive. First, core inflation has exhibited fairly substantial high-frequency swings over the past couple of years. So it will take many more months for me to be very confident that inflation is trending down. Second, and related, over the past three years large swings in energy prices have been followed by swings in core inflation with a short lag. Indeed, the cross-correlation between core and energy components of the PCE price index seems to have increased in the past few years. The recent dip in core inflation may therefore be the transitory effect of last summer’s decline in energy prices, and the December uptick in core CPI may signal that it’s behind us now. A downward drift in inflation thus is likely to depend critically on the absence of upward movements in energy prices. Note that the staff follows the futures market in assuming, as I calculated it, a 13 percent rise in oil prices by the end of 2008, which suggests continuing upward pressure on core inflation. Third, expectations could well exert a gravitational pull in an upward direction rather than the downward direction as claimed recently in a popular newsletter and also as the staff indicated underlies their forecast. Personally, I place the center of gravity a little higher, above 2 percent. The twelve-month change in core PCE inflation has been above 2 percent, as we all know, since March 2004, and none of the usual measures of expectations either from surveys or TIPS markets are much below 2½ percent for the CPI. So even though the recent inflation news has been comforting, I think there’s a good reason to continue to worry about it.

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