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

Thank you, Mr. Chairman. Our forecast hasn’t changed much since the last meeting. We still expect growth to move back to potential in the first half of next year and to stay in the vicinity of potential, which we think is around 3 percent, over the forecast period. We expect inflation, as measured by the core PCE index, to fall to just under 2 percent by the end of ’08.

Our view of the outlook differs from the Greenbook in two respects, as it has over the past few cycles. We have a higher estimate of potential growth, with the difference due to higher estimates of labor force growth, and we expect more moderation in inflation than the Greenbook does, principally because we believe there is less inertia, less persistence in inflation in the United States than does the staff. Both these issues, of course, deserve continued analysis and attention by the Committee. These differences in our forecast relative to the Greenbook don’t extend to the policy assumption. Both outlooks are predicated on a likely path of the fed funds rate that’s nearly flat over the next several quarters. This path, of course, is above the one currently reflected in financial markets. Of course, although some disagreement between our view and the market’s view is not unusual, the size of this gap is significant enough to warrant some attention. It’s hard to know, however, what the source of the difference is and, therefore, what the implications are for what we do in terms of policy.

The risks to the forecast may have shifted somewhat in the direction of less upside risk to inflation and more downside risk to growth. But to us, the current weakness in the economy still seems principally to stem from the direct effects of the slowdown in housing on construction activity and related parts of the manufacturing sector as well as from the reduction in automobile and auto-related production. As things now stand, the softer-than-expected recent numbers don’t argue, in our view, for a substantial reassessment of the risks in the outlook. Surveys of business sentiment outside the manufacturing sector still seem consistent with reasonable growth going forward. A slowdown of investment in equipment and software doesn’t seem to be particularly troubling to us at this point. Consumer spending seems to be growing at a fairly good pace. Employment growth, of course, is still quite solid, and growth outside the United States still looks pretty good.

We think the fundamentals of the expansion going forward still look good, with strong household income growth even after the lagged effects of the recent downward revisions, productivity growth in the range of 2½ percent for the nonfinancial corporate sector, and strong corporate balance sheets in the United States, and prospects for continued expansion outside the United States. Our recent financial market data don’t, in my view, provide a convincing case for a substantial increase in the probability of a much weaker path for growth going forward. Although the yield curve is inverted and long rates continue to drift down, staff research and other indicators suggest that part of that is due to a decline in term premiums, and forward rates seem to be coming down around the world still. This gradual reduction in term premiums and forward real rates globally suggests that what we’re seeing in the long-term interest rates in the United States may not be principally a sign that confidence in the U.S. growth outlook has deteriorated.

It’s not clear even 18 months after the conundrum first emerged whether equilibrium rates globally have really moved substantially lower. The Bluebook estimate suggests we’re still within most estimates of equilibrium real rates in the United States. Equity prices and credit spreads are consistent with the view of sustained expansion going forward. All this seems to reinforce the case for the judgment that we have not yet induced overly restrictive financial conditions.

We still face considerable uncertainty about the outlook for growth and the familiar sources of downside risk, but to us these still seem to rest mainly with the possibility that a more-acute and protracted fall in housing activity and prices will cause a significant deceleration in housing and household spending and ultimately business spending. The nature of these risks, however, hasn’t changed in our view, and the probability that the risks will materialize may have risen a bit but not much. On balance, this situation should reduce the probability that we’ll have to tighten further, but it doesn’t seem to suggest that today we need to induce a further easing in overall financial conditions.

On the inflation front, we confront the familiar mix of underlying inflation still at uncomfortably high levels and considerable uncertainty about whether we’ll see enough moderation soon enough to keep expectations stable at reasonable levels. The remaining inflation risks, in other words, are about whether we get enough moderation. In the absence of a dramatically different outcome for the dollar and energy prices than what’s in the forecast, we don’t see much risk of inflation accelerating from current levels or remaining stuck at current levels. We haven’t had much evidence to justify a significant change in the expected path of inflation or in the risks of that forecast. The news on unit labor costs may be a bit reassuring. Surveys seem to suggest some evidence of diminishing pricing power, which might imply that margins will adjust downward to absorb future rises in labor compensation. The odds of an early return to above-trend growth seem to have receded a bit. Most of the alternative measures of underlying inflation that many of us look at seem to have moderated a bit after the sustained earlier period of acceleration. Inflation expectations derived from TIPS have eased a bit. These pieces of information are somewhat comforting, but they don’t change the fact that our expectation that we’ll achieve the desired moderation in inflation without further tightening of monetary policy remains just that. It is an expectation or a hope; it is not yet reality. Thank you.

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