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

Thank you very much. Well, the data have come in so far according to plan, and you can thank Chairman Bernanke for doing that. I think he has some special relations with the BEA and others. [Laughter] Exactly as we had hoped they would and said they would, the data show moderation in growth with a prospect for accelerating growth through 2007 and moderation in inflation—again, according to plan. I think my views are similar to those that President Stern put forward: The economy has shown an enormous amount of resilience.

I want to talk about a few possible puzzles in the way the data have evolved and could perhaps deviate from plan as we go forward. One puzzle is the great strength of the consumer. The consumer has been very, very strong for the past five years, and it seems that no matter what has happened—whether a housing downturn, an equity-market downturn, or a September 11— the consumer has come through rather strongly and continues to be strong. We certainly have had a slowdown in the housing market, and maybe we’re waiting to see its effect on the consumer, as Don Kohn mentioned. But it may just be that some special factors have come in; for example, we have had very strong international economic growth, and perhaps that will persist. When you talk to officials and business people outside the United States, whether in emerging market economies, in the Gulf region, or in industrial economies, they are extremely optimistic, much more so than I have ever before seen, and that may continue. Obviously, there is a risk factor here. The recent strengthening in equity markets perhaps offsets some of the reduction in the asset values of homes. Lower consumer energy prices, of course, have been an offsetting factor, and labor market strength and increases in compensation have been very important. But there’s an upside risk that we will continue to have very, very strong consumption instead of having our error correction go back toward more saving.

Second, with respect to investment, we have had orders above shipments for quite some time, but we have had investment actually declining, or at least not growing as we would expect. Overall in this recovery we have had weaker investment growth, and we have had very high profitability. That raises another puzzle for me: Why have we seen somewhat weak investment over the long run and especially more recently, given that most measures of consumer confidence and business confidence have been positive, equity markets seem to be positive, spreads seem to be low, and so forth. Why are we not seeing more investment? Investment may turn around in the next quarter or so, and then we’ll be out of the woods. But I think the conditions that we predict will lead to an investment turnaround have been there for quite some time, and we haven’t seen the investment turnaround; and that is a puzzle to me.

Third, with respect to inflation, obviously we are all pleased that the numbers have been coming out with greater moderation. But I have a discomfort about exactly what is driving that moderation. We have good short-term stories about how the slowdown in energy prices in the second and third quarters and some other temporary factors with respect to owners’ equivalent rent could be bringing down inflation. But when we consider a longer period and try to look at the systematic data, we don’t see those kinds of relationships. Are we just in some sort of regime shift? Are those correlations not very good because we just haven’t had a lot of variation in the data over the past ten to twenty years, and so those forces are actually there, but we just find it very difficult to pull them out econometrically? For me that is a puzzle, to be able to tell a short- term story with each of these pieces, but when I go to the staff and ask, “Well, what is the systematic evidence on it?” they say, “Well, it really isn’t there.” That is a bit disturbing for me in trying to figure out where things are likely to go.

Things have moved in a benign way. I don’t think there’s a strong expectation that they would move in a nonbenign way. But I don’t have a lot of confidence that I understand why they have moved as they have. So my concern is that various shocks or other factors could come in to move them in a way that is not nearly so benign. Broadly, however, I share the views that most people have expressed around the table that we have good growth prospects going forward and so far reasonable moderation of inflation. But precisely because we have those good growth prospects and because we may have had some temporary factors that have kept down inflation, we have to be ever mindful of the upside risk to inflation.

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