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

Thank you, Mr. Chairman. Economic activity continued to expand moderately in our District in November. Manufacturing shipments and new orders bucked the national trend and rebounded last month following an October dip. Revenues and hiring slowed a bit in the service sector but continued to expand moderately. Retail was a bright spot: Stores reported an uptick in sales and customer traffic for November, including the Thanksgiving weekend. Our store contacts were generally optimistic about sales prospects for the coming holiday season. Fifth District housing activity continues to soften on the whole, although there are areas that have seen much less, if any, of a slowdown. We’re not hearing any reports of cutbacks in capital expenditures, and commercial real estate markets appear to remain fairly strong in our District. Reports on price pressures were mixed in November but remained at elevated levels.

At the national level, an essential question seems to be how long the current weakness will persist. To a large extent this question centers on the housing market, and it’s still hard to pin down the outlook with much certainty. The special survey on homebuilders paints a picture that varies widely across the country. Construction activity is falling at a rapid clip in many regions, but many housing markets are still fairly stable. Nationally, there are some indicators suggesting that housing demand has stabilized at a low level. Sales of new homes have been fluctuating around an annual rate of 1 million since July, and purchase mortgage applications have been fairly flat since then as well. But the national data also show a sizable overhang of housing inventory that will continue to depress new building activity going forward. If—and, like David, I recognize this is a big “if”—the demand for housing holds up at current levels—and favorable fundamentals such as moderate mortgage rates and continued real income gains should help—then the adjustment process is simply a matter of working inventories down. This is consistent with the Greenbook’s estimate that residential investment will no longer subtract from real GDP growth after the first half of next year.

The strength in nonresidential construction has until recently offset the decline in residential. Most recent reports show nonresidential construction spending and employment falling in recent months, although I’m struck by the fact that there are hardly any references in the Beige Book to deterioration in commercial construction and we aren’t hearing such reports from our contacts either. So I’m not sure how much to mark down the nonresidential outlook just now.

As David said, consumer spending keeps chugging along at about 3 percent despite weakening auto sales. This is notable because one way the housing downturn could spread to the remainder of the economy is through a wealth effect. So far I’m not persuaded by this gloomy view, and I think there are good reasons to doubt it. Household net worth looks pretty strong, and equities continue to advance. The other leading candidate for a spillover channel is the labor market, but so far the weakness in construction and real-estate-related employment has not been large enough to offset the broader strength in employment. I remain skeptical of a housing-induced step-down in consumption growth. Business investment continues to be a source of strength. The Greenbook notes the possibility of negative accelerator effects, but the other fundamentals still look good. Profitability is high, and cost of capital is low. Moreover, financial markets are not showing signs of impending business weakness or investment slowdown. In sum, it looks as though the current weakness is likely to be relatively transitory, and after the housing market correction plays out, we should return to near-trend growth. There are risks to this outlook, to be sure, but this is what looks most likely to me right now.

The recent news on inflation has been disappointing yet again. It is now quite difficult to discern any moderating trend in core PCE inflation over the past several months. You have to be really careful in selecting how many periods you average over, and I have serious doubts about the forces that are described as slowing inflation over the forecast period. First, the recent fall in energy prices is now behind us by a couple of months, and prices are beginning to rise again. If the Greenbook forecast is correct and in 2007 crude oil prices rise somewhat above their current level of $62 per barrel, then we have seen all we are going to see of the abatement of the effects of higher energy prices on core inflation, speaking to President Plosser’s point. Second, since the odds seem to favor a further depreciation of the dollar, I think import prices are unlikely to help ease inflation much. Third, as we’ve discussed at previous meetings, the projected increase in unemployment is not likely to have much of an effect on inflation, over the forecast period at least. On top of all this, inflation expectations appear to be anchored between 2 and 2¼ percent right now, and they’re likely to exert a gravitational pull counteracting any moderation of inflation. Thank you.

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