Last time several of us noted that there would be an avalanche of data between the last meeting and this one [laughter]—two employment reports, two rounds of ISM, GDP, ECI, compensation revisions, all of that. But it seems from the discussion here that we’ve actually gotten very little new information, with one exception, and that relates to Dave Stockton. We heard that not long ago he was on the psychiatrist’s couch dealing with a schizophrenia issue of whether the economy is going up or going down. But now we know that he is on his death bed. [Laughter] I hope this does not bode ill for the economy going forward, but I did want to note that one very important change, Mr. Chairman.
We’ve had the same discussion of a two-tiered economy, with housing and autos being slower and the rest of the economy moving forward, and continuing concerns about the risk of spillovers; but the central tendency seems to be that we’ll be moving ahead perhaps a little below potential, with some reasonable chance of getting back to something closer to potential by the end of next year. Continuing the discussions of labor market tightness and some concerns about shortages in certain areas, I think that we certainly have seen some softness in construction, but that’s an area for which we’ve probably underestimated employment growth and perhaps employment falloff because, as I think many of us know, many of the subcontractors in residential as well as nonresidential housing have a lot of undocumented workers, and they tend to be undercounted both on the upside and on the downside. So there may be a little more softness in the labor market than we’re seeing, at least in the construction sector; however, in the higher-skilled sectors, we’re seeing continued tightness.
Consumer spending continues to be strong. There has been just an amazing persistence of consumer spending, no matter what has happened over the past five years. Whether the stock market has crashed, whether the housing market has boomed, whether we’ve had September 11, or whether we’ve had concerns about spillover effects, the consumer seems to have been very, very persistent, and it seems as though that’s the case now. We’ve talked about challenges in the energy markets, and we did see a little slowing. Energy prices were higher, and energy prices are lower, but these aspects of the macroeconomy seem still to have little effect on consumer spending.
We continue to have concerns about some upside risks to inflation. So I’ll just mention quickly a few issues and then talk about some international issues that Dino and Tim touched on earlier. Regarding housing, we know we have terrible price data, but it seems as though there’s a little more flexibility and nimbleness in the housing market than there was in the past. So the past data on housing may not be too useful. Although we know we don’t get good data on effective prices, we do seem to be seeing more evidence that people, rather than just holding things on the market longer, are providing the marble bathroom, the Lexus, the Hyundai, the Kia, the Yugo, or whatever they’re providing. In New Jersey, where I grew up, it would be a Yugo. [Laughter] So I think there’s more flexibility on that side. Also, because of the way the housing market has developed, a lot of residential construction is no longer at just the local level. The large national builders are better diversified and, as has been discussed, have options on land, and then, if they see the market turning down, they give up those options. So they have a much greater ability to shift both down and up in production much more quickly. Prices, too, are a little more flexible, which is one reason that we’ve seen a sharper correction in the housing market. But that flexibility, with the recent data indicating that certain things may be flattening out, may mean that, though the correction may have been sharper, it won’t necessarily persist— that the correction has occurred in a shorter time, rather than being dragged out longer and having more potential for negative spillover, confidence effects, and so forth.
Well, what has changed? As Governor Kohn mentioned, inventory accumulation is a bit of concern: It seems to be ticking up. It always seems a bit odd when a positive effect on GDP results from businesses being unable to sell the things that they’ve purchased. That doesn’t strike me as necessarily a positive thing for a GDP report. We’ve gotten some more, probably confusing, numbers on productivity. Is productivity slowing or not? We are getting some data that may be suggesting that it is, although I would agree with Dave and the staff that it’s much too early to say. I think the evidence both anecdotally, as a number of people have mentioned, and more broadly is that productivity is likely to continue to go forward. Another thing that changed, as Dino and others discussed, was the yield curve. But this phenomenon is very much an international one. Long rates have come down more—since the last meeting, they have fallen a fair amount and not just in the United States. The three-month versus the ten-year in Europe has fallen about 40 basis points, so the spread is about 7 basis points now. On average, since the euro has been around, it has been about 40 to 50 basis points. In the United Kingdom, which tends on average to have very flat yield curves, the inversion has steepened about 25 basis points to 65 basis points. Japan is little changed, but Japan is sui generis. Emerging markets have also seen this. In Mexico, for example, the ten-year versus the three-month has dropped about 60 basis points. Clearly, this is not just a U.S. phenomenon, and I think it’s telling us not just about U.S. growth, unless you think that U.S. growth is driving world growth and so it’s really all about the United States. I think that’s a bit extreme, even though, as was mentioned, some correlations suggest that when the United States goes down, there is a lagged effect and the rest of the world tends to go down. But I think it’s suggesting that some other factor is occurring and that we shouldn’t read too much into it. Also, interestingly, if you look at the real short and long rates around the world—at least for the industrial countries—real rates tend to be about 1½ to 2½ percent, which is very much where we are. Thus there has been a convergence of real rates around the world. So I would be wary of taking too much information from the bond market as referring to something that’s specific to the United States rather than to some factors that are common worldwide.
Just quickly on inflation—we’ve talked about how energy prices have gone up and down but core inflation hasn’t been affected that much. Labor market tightness doesn’t seem to have had much of an effect. As for output gaps—if you like output gaps—when you look at the data, it’s hard to find much evidence of an effect of output gaps on core inflation. Also, given the discussion that we’ve had, it doesn’t seem that the gap will be too wide or, even if you believe it will be wide, that you’d be getting much effect from it in the near term. We talked about some temporary factors like owners’ equivalent rent that may have boosted measured inflation for a while and is now coming down. I don’t think there will be much effect on inflation from the dollar. The United States still is just not that open an economy. Even to the extent that it is open, the pass-through of exchange rate changes to domestic prices is very slow and very partial—typically, over a three-year to five-year period, barely 50 percent. The evidence suggests that the pass-through is decreasing. Even if the dollar went down further, I don’t see much of an effect there. That said, it’s hard to see exactly what forces are moving inflation in one way or another right now. A reasonable scenario is that it could drift down slowly, but it’s hard to point to clear evidence of where it’s going to go. To the extent that there is information in the yield curve, the markets clearly do not expect inflation to take off, and it’s likely that inflation will be moving lower or at least staying contained where it is. So we have much data and relatively little information. I see risks on both the upside and the downside to growth and have continuing concern about upside risks to inflation precisely because I don’t see an easy path to lower core inflation going forward. I think that lower core inflation in the future is reasonable but uncertain, particularly given that it’s hard to see a lot of systematic evidence of factors that are occurring now that would be correlated with that result. Thanks.