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

It’s not fair. [Laughter] Well, to the extent that this sounds like North Dakota, let me just proceed. Despite data from the housing markets that suggest that New England is suffering the real estate slowdown perhaps more than the rest of the nation—at least in terms of falling house prices—the overall regional economy appears to be doing fairly well. This is the bimodal model that a couple of people have talked about. Moderate employment growth continues. Layoffs are down, and electronic job postings, as opposed to newspaper want ads, are rising. Retailers are cautious about the fallout from the housing market, but except for those in the hardware or furniture businesses, sales were reportedly buoyed by the drop in gasoline prices. Indeed, October saw the first year-over-year decline in gas prices in the Boston area in four years. Manufacturing overall has been running ahead of last year, with aircraft, energy, and scientific equipment particularly robust. Growth in high-tech and biotech service companies remains strong; and while wage growth overall is slightly below national levels, salaries for higher-skilled staff with professional degrees are being bid up, reflecting strong demand. Consumer confidence is solid, especially regarding future conditions, and I’ve seen the same thing that President Moskow commented on—the optimism of business contacts. Business confidence as measured by local organizations has been on a steady upward trend since June, with employers significantly more positive about national economic conditions, the rising stock market, falling energy prices, and favorable interest rates. The mild fall weather, although a major problem for the early ski season, boosted tourism, which is reportedly going gangbusters—that’s a technical term—in Boston and other areas. Convention sites are booked ahead, and hotel rates are rising.

The regional housing market continues on the downside. Sales of existing homes declined 20 percent from their year-earlier peaks, and inventories and time on the market continue to rise. Prices of existing homes were down in New England overall for the first six months of the year and down again from Q2 to Q3 for three of the six states, according to the OFHEO index. Moreover, new housing permits were down 13 percent, and the dollar value of construction contracts was off sharply. However, New England’s market for new construction is small, and as near as we can see, not much speculative building occurred during the boom. Thus, homebuilder finances remain in relatively reasonable shape. There will likely be write-offs for suppliers this winter and perhaps some consolidation in the local industry, but we don’t see many major local economic effects from this. On the positive side, price-level declines have the welcome effect of making regional housing stock, particularly housing in the Boston area, more affordable. Suppliers and bankers noted that they saw signs of a modest pickup in sales in September and October, and they look forward to a brighter spring season if mortgage rates stay at their current lows.

Commercial real estate remains a very different world, however. In fact, comments regarding commercial real estate investment in a number of cities around New England have served to highlight the liquidity that continues to characterize debt and asset markets, driving the yields lower, keeping spreads tight, and moving prices of even unlikely assets higher. In the notes from our Beige Book contacts was a very interesting conversation with a commercial real estate firm in Hartford, Connecticut, which has long been a depressed area. The contact reported that Hartford was attracting institutional investment interest for the first time since the 1980s and that commercial real estate deals were being done with cap rates of 7 to 8 percent. Providence reported similar commercial real estate strength; and in Boston, cap rates were said to be a bit below 6 percent. Pricing action in Boston remained above replacement cost with inflows of funds for deals reportedly from Middle Eastern and Irish sources. Vacancy rates in Boston are down. Rental rates are up, and pressure to serve the growth of new biotech firms is reportedly creating hot commercial real estate markets in Cambridge and in suburban areas just west of the city. While hot commercial real estate markets in eastern Massachusetts and even Providence are not particularly new news, such interest in Hartford really is. On the one hand, investor interest in places like Hartford may be a sign of real overheating. On the other hand, if the lid stays on, areas like Hartford stand to benefit from a rise in investment and, one hopes, related job growth.

Turning to the nation, the recent tone of the incoming data, especially on the manufacturing side, has been subdued, as declines in the housing market and in motor vehicle spending and production have taken their toll. But I think this tone may well result from the ebb and flow of high-frequency observations. At the time of our last meeting, incoming data seemed more positive overall, and many of the factors present then—including solid employment growth, low unemployment, healthy debt and equity markets, solid corporate profits, good foreign growth, and a less negative or even a neutral-to-positive effect of net exports—remain. Fourth-quarter GDP data may well be disappointing to the markets, but given both what the staff believes is a calculation error on the part of the BEA and the fact that so many supportive factors remain, I am hopeful about prospects for ’07 and ’08.

Our forecast in Boston retains the same trajectory as the Greenbook’s—a slow fourth quarter and a growing rebound over the next couple of years as residential investment recovers combined with a gradual small uptick in unemployment and an ebb in core inflation to the low 2s. Thus, despite the sense in markets that momentum has shifted downward, I don’t think that the baseline outlook has changed much since our last meeting, and the Greenbook forecast reflects that pretty well. Similarly, although risks exist both that growth will be slower and that inflation will be faster, I believe those risks to be fairly balanced at this point, though they are certainly not minor. Of concern, however, is the cost of being wrong on the inflation side. This is certainly not the time to let down our guard on this front with labor markets fairly tight, the unemployment rate at 4½ percent, and most of the downward effect of declining energy prices behind us. We could see inflation move sideways rather than down, and that could well be an issue. Markets see us beginning to ease as soon as the late first quarter, early second. Perhaps they’re right, but I remain to be convinced by the incoming data. Thank you.

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