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

Thank you, Mr. Chairman. The economic picture in our region has changed little since our last meeting. The coincident indicators in our Business Outlook Survey suggested that economic activity continues to expand at a moderate pace in each of our three states, and the business contacts expect that pace to continue. I’m beginning to feel as though I’m reading the same chapter of the book again. It’s like Yogi Berra—it’s déjà vu all over again.

The weakest sector in our region, as in the nation, is of course housing, which continues to decline. Sales and permits continue on a downward trend, and cancellations rose significantly in November; but builders have been able to resell, albeit at lower prices, homes whose initial purchasers have reneged. However, our survey of smaller homebuilders suggests that conditions on average in the housing market in our District seem somewhat better than in the nation as a whole. None of the builders we polled reported low inventories of unsold homes. Interestingly enough, 86 percent of them said their inventories were about right; only 14 percent said inventories were high; and no one reported that they were extremely high. In comparison, across the nation, 51 percent of builders reported that inventories were either low or about right, and 49 percent reported either high or extremely high inventories. Certainly some areas in our District have had a sharp drop in housing activity. The most notable is the Jersey Shore. But generally, based on what I’m hearing from firms in our District, I would continue to characterize the decline in housing in our region as an orderly one.

Commercial real estate continues to perform very well. We’ve had some downturn in the value of nonresidential building contracts in the last month, but these data are very volatile, and the revisions tend to be upward as new contracts are reported over time. Our contacts in that sector continue to be among the most optimistic in our region. Office vacancy rates continued to decline in the past few months both in Center City Philadelphia and in the suburbs, and the net absorption of office space continues to be positive. Rents have risen, and the increase in occupancy has led to a scarcity of large blocks of available space, which bodes well for construction.

Manufacturing activity in our region has been softening this fall, and we haven’t seen much of an increase since then. After two negative readings in September and October, the general index of economic activity in our business outlook survey turned positive in November, but its level of slightly above 5 suggests that that’s really not much change in the outlook. New orders and shipments were modestly weak. Shipments were actually strong. Orders were a little weaker, but the recent weakness is consistent with softness in national manufacturing and, as we’ve seen, in the purchasing managers’ index. Optimism for future capital spending actually rebounded last month— so the picture there is very mixed. Consumer spending continues to hold up well. Auto dealers and retailers reported strong sales in November and are optimistic about the holiday season.

Labor market conditions in the District have changed little. Payroll employment growth in our three states is up at an annual rate of about 0.7 percent, which is slower than the national rate, but that’s just a fact of the population growth in our District. Unemployment rates remain low, near or below the national rates. Business contacts continue to cite difficulty in finding qualified workers, especially for skilled and professional positions. Area employers indicate that, over the past few months, wages have been steadily rising at a pace higher than earlier this year.

I also want to mention some anecdotal information that I find interesting. Last week I met with a number of mostly manufacturing CEOs from my District. An observation that one of them made, which many agreed with, was that from their perspective money was almost free. This observation is consistent with what some others have been saying around the table. They thought that there was plenty of liquidity and that interest rates were not limiting them particularly in any way. This observation is also consistent with the views that mortgages rates are still relatively low and that credit spreads show less stress on businesses at this point. I take these observations to indicate that monetary policy is not particularly restrictive at this point.

Also on the anecdotal side, the several manufacturers who participate as suppliers to both homebuilding and commercial real estate lamented their housing-related business, whether plumbing, cabinetry, or flooring, which were the three industries represented. On the residential side, the markets were terrible. Business was very bad. However, they all said that the commercial side was booming so much that it more than made up for their weakness on the residential side so that business tended to still be pretty good.

In contrast to President Poole’s comment about trucking, I had one trucking CEO who said actually that business was good. It was weak in the Northeast—shipments were down there—but in the South and West their business was picking up and doing pretty well. He also made an interesting comment that I had not really thought about. He said that part of the change in trucking is that, while volumes may be down and they are having trouble finding drivers, there has also been a revolution in packaging. In fact, even though trucking volumes are down, the value of products and goods being shipped is actually up. As an example, they used to ship the big boom boxes that people listened to music on; now they’re shipping iPods. So as packaging has become more efficient and more protective, the truck volume is less, but the value is actually higher. He said that this was an ongoing trend in the trucking industry and that one had to be careful about interpreting volumes.

On the inflation front, manufacturers continue to report higher production costs, but these cost increases have been less widespread than recent surveys indicated. Indexes of prices paid and prices received have continued to climb, and they’re still above where we’d like to see them.

On the national side, my outlook has changed very little since our last meeting. Compared with earlier this year, growth has weakened, as we all know and have discussed. Housing slowed a little faster than perhaps we anticipated but—I agree with President Lacker—the prospects of spillovers remain relatively low. Again, as Bill applauded Janet’s wonderful one-handed/two- handed presentation, the labor markets are sending a completely different signal. As I said earlier, manufacturers and employers in our region continue to find scarcity in the labor market, both skilled and unskilled. If we thought that the economy were weakening and we expected growth to remain appreciably below potential and weak for a number of additional quarters, it might be important to allow short-term interest rates to move down—but not because I think the Fed can do much to prop up growth in those circumstances, that is, to ride some kind of Phillips curve. After all, businesses say there’s ample liquidity, and mortgage rates remain relatively low. But because equilibrium market rates may be lower over a sustained period, we might want to see a fed funds rate that’s consistent with that. This would be particularly relevant if we were sanguine about inflation. However, in my view, we’re not in that situation yet.

As has been alluded to, many market commentators have pointed to the inversion of the yield curve as an indicator that recession is probable, but as suggested by the Chairman and the research that has been done, some of it by the Board staff, the predictive power of changes in the slope of the yield curve depends on why the slope of the yield curve changes. The change in the slope of the yield curve suggested by the research that was alluded to earlier has been about 100 basis points, but about half of that has been in the risk premium associated with long-term rates. At the same time, the predictive content of that risk premium change for recession or GDP growth is much less than absolute changes in real rates. So I take that research to say that the inversion of the yield curve may be forecasting slower growth but not a recession to date.

Thus, inflation remains a significant concern to me. Recent readings on headline inflation have shown some encouraging downward movement, and inflation expectations have remained stable. But the level of core inflation continues to be higher than what I consider to be consistent with price stability. Moreover, the forecast does not show us reestablishing price stability in the near future. That’s a reasonable, although unwelcome, forecast to the extent that very accommodative monetary policy over the past five years helped fuel the acceleration of inflation and that monetary policy and financial markets have not tightened much and aren’t expected to tighten much over the coming period. The Bluebook indicates that the current real fed funds rate is within the range of model-based estimates of the equilibrium rate—that is, policy is not terribly tight—and, as I suggested earlier, long rates including mortgage rates are at relatively low levels, suggesting ample liquidity in the market.

I’m not convinced that price stability will be achieved without further action on the part of the Fed, and I’d feel more comfortable after seeing a few more months or even another quarter or two of deceleration. The slight deceleration in core inflation that we have seen, coupled with the slower economic growth, has meant that implicit firming of policy even without a change in the nominal funds rate might be in the cards, and that would be a welcome change. I’m not convinced that the recent decline in energy prices will provide the relief we would like to see in core inflation. As suggested by Jeff and my question earlier, I’m concerned that, if oil prices stabilize around $60 a barrel, we will see core inflation begin to creep back up once the temporary benefits of the decline have disappeared. Indeed, gasoline prices have already risen somewhat in the past few weeks from the lows that we saw in late September and early October. As has been mentioned, the sharpest increases in the components of inflation that we’ve looked at over the past few months seem to be in those elements that are least likely to be influenced by energy prices. In addition, as Jeff said, I’m very dubious that the gap measures that we allude to periodically are going to act as much of a constraint on price increases going forward. The bottom line is that I’m not hopeful that energy prices or the output gap will provide us with much of the inflationary relief that we’re looking for. Thank you, Mr. Chairman.

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