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

Thank you, Mr. Chairman. Business activity in the Seventh District appears to be expanding at a slightly slower pace than the last time we met. But most of my contacts were still positive about the outlook, and when we put together our forecast for the national economy, we did not make any large changes to the projections of either growth or inflation. We see output recovering as we move into ’07 and core PCE staying near its current rate through the forecast period.

As Janet discussed, we’ve talked about the bimodal nature of the national economy. Housing is weak, and the auto sector is struggling, but the rest of the economy is performing well. We see these sectoral differences, particularly with regard to autos, in our District economy. Michigan’s unemployment rate is about 7 percent, and it was the only state to show a year-over- year decline in the OFHEO house price measure. In contrast, Illinois and Wisconsin have a more diversified manufacturing base, and they’re doing well. Furthermore, we continue to hear reports of growth in demand for manufactured goods outside of autos and residential construction. One example of this is Caterpillar. They expect revenues from highway construction and mining equipment to remain strong with some easing in the U.S. market being offset by increased demand from abroad. Manufacturers of machine tools continue to report solid orders. Of course, such reports contrast sharply with our conversations with the Big Three automobile makers. General Motors indicates that they expect ’07 to be another challenging year. Incentives are one issue. GM thinks that their own incentives are now about the right level, including the Classic, [laughter] whereas others are still high. Another issue is that the UAW contract will be coming up for renewal next year in September, and the negotiations are expected to be difficult.

Turning to labor markets more generally, Kelly and Manpower said that the overall nationwide placements of temporary workers were unchanged year over year, but placements of light industrial production workers continue to increase, and conversions from temporary to permanent remain strong. Moreover, their clients, while cautious, generally do not expect any prolonged period of weakness. These temp firms said that wage pressures were steady to down a bit, but a major national specialty retailer indicated that he was having difficulty hiring holiday workers and permanent workers and that he was planning for an increase of 10 to 12 percent in wages for entry-level full-time hires. Retailers also told us that they believed strong labor markets were supporting spending, and they were looking forward to good results for the holiday season.

With regard to inflation, even though energy prices have moved off their peaks, there were few signs of rollbacks in fuel surcharges. Indeed, we even heard of further cost pass-throughs from petroleum-based inputs. However, we did not get the sense that general cost pressures were intensifying.

Finally, we held our annual economic outlook symposium ten days ago in the midst of the first major snowstorm of the year. The three dozen hardy forecasters predicted real GDP growth of 2.8 percent in ’07 and the employment rate to drift up to 4.9 percent by the second half of the year. They also forecast that total CPI would increase 2½ percent and that sales of light vehicles would be 16.4 million units.

Turning to the national outlook, the data have come in somewhat softer than I expected at our last meeting. Our uncertainty about the outlook has increased somewhat, but I still think that there are significant forces supporting activity and that the economy will return to a better growth path as we move into next year. To be sure, residential construction is quite weak, auto sales are softer, and the businesses supplying these industries are experiencing some sizable reductions in demand. However, I do not get the sense of a secondary spillover to other sectors of the economy. Importantly, the labor market has remained robust, supporting household spending—as we’ve talked about. Business confidence appears to be holding up fairly well. Indeed, I’m impressed by the lack of pessimism among my contacts, even those who are experiencing flattening sales or sluggish sales. Finally, real interest rates are low across the maturity spectrum, and risk spreads remain narrow. Given the liquidity in the system, it’s still hard to see current financial conditions as being that restrictive.

In the end, we did not make any large changes to the overall contours of our GDP forecast. We still see the economy growing moderately below potential in ’07 and increasing at a pace moderately above potential in 2008. Now, we condition our baseline forecast on market expectations for interest rates. Accordingly, this outlook is boosted by the expected decline in the funds rate that’s in the market. If, like the Greenbook, we had assumed a flat federal funds rate path, we would project a recovery only to potential in ’08.

Turning to inflation, the recent data have not clarified the trends. The six-month change in the core PCE price index is down, but the three-month numbers have moved up. In Chicago, we like to use indicator models, like the ones that Stock and Watson developed, as a way to assess the implications of incoming data for future inflation. These are time series models, and they forecast inflation based on more than 80 economic indicators linked to inflationary pressures. The projections of these models have changed little since our last meeting. Our forecasts continue to show inflation running too high for my taste. Even our most optimistic models, which are estimated using data only since 1984, have core PCE inflation flat at 2.4 percent through 2008. In sum, I am still concerned that inflation will be too high for too long; and even though the downside risks to growth have increased, I continue to see inflation as the predominant risk.

Keyboard shortcuts

j previous speech k next speech