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

Thank you. Let me just summarize and add a few comments. As Governor Kroszner mentioned, we had an avalanche of data, and the snowman is still standing in the same place as before. [Laughter]

Most people still see a two-track or bimodal economy. In the first part of the economy— the goods economy, housing and manufacturing—there seems to be some softening since the last meeting but not a large change. Housing remains the center of the weakness. There are some indications that demand for housing may be stabilizing, but a few people noted that there are probably still some downside risks in that sector. Manufacturing is also becoming a bit softer, partly but not entirely linked to housing. Automobiles, too, have softened, and a few other areas as well, as I’ll discuss later. One interesting point was that, where the aggregate data show some decline in growth in commercial real estate and the Greenbook seconds that conclusion, the anecdotes do not seem all that consistent with it. The second part of the economy, which is focused primarily on services, remains quite strong, particularly in sustaining a robust labor market with good income growth. Together with lower energy prices, those factors are leading to well-sustained consumption, which is continuing to drive the economy forward. A few people mentioned balance sheet issues for the consumer, but the references to balance sheets were both negative and positive.

Looking forward, again to compliment the staff, I think most people around the table accepted the general contour of the Greenbook forecast—that is, moderate growth perhaps below potential for the next few quarters but returning to potential growth later next year, with risks to the upside as well as to the downside. So far there is little evidence of spillover into consumption in particular, although obviously we have to keep an eye on that. There are a number of strong underlying conditions, including supportive financial conditions, strong profits, and a strong international economy, which are providing a cushion to the economy.

On inflation, I have to say there wasn’t much change in view. Most of you still expect a gradual decline in inflation. Others are concerned that we might get stuck at current levels. Even those who expect a gradual decline remain somewhat concerned about the pace of the decline. Some of the factors that may return inflation to lower levels are a slowing economy, well-contained inflation expectations, and the downward revisions to the wage data. Those who are more concerned about inflation cited the weakening dollar, accommodative financial conditions, and the expectation that growth will not be below potential for very long. So I think that some of these concerns and risk assessments do not seem markedly different from those at our last meeting.

Let me add just a few comments. These are all marginal because I think the broad outlines of the story and the risks are quite reasonable. First, I think I took a bit more weakness from the data in the first part of the economy than some people around the table. The Greenbook has single-family housing starts leveling out at current levels. They did fall 16 percent in October. We’re not entirely sure that they will, in fact, stabilize. Multifamily construction permits have been dropping: They’re off about 30 percent since the first quarter. That had been a source of stability so far this year. There might be a bit less strength there. Then, nonresidential construction is an issue. The data, in terms of employment and construction put in place, suggest some slowing, and I do think that some slowing from the very strong pace of earlier this year is pretty much inevitable. But the sense of the Committee must be that we will have to wait a bit longer to judge how much that is going to slow. In manufacturing, obviously the strongest slowdowns are related to autos and housing. But if you look at employment and the ISM data, for example, you also see weakness in areas like machinery and electrical machinery, which suggests some possible weakness in equipment and software spending going forward. This remark does not represent a major difference with the Committee; I just saw a bit more weakness in the first area than some did.

At the same time, like many members of the Committee, I see a very strong labor market and a very strong services sector plus a very strong nonmanufacturing ISM, which, though it includes construction, was nevertheless still very strong. One begins to wonder a bit about the measurement of the services sector—whether or not we are understating growth and productivity in that sector. That’s a question we’ll need to continue to consider. So like most people around the table, I think that a soft landing with growth a bit below potential in the short run looks like the most likely scenario. I expect the unemployment rate to increase gradually but income growth and other factors to be sufficient to keep consumption above 2 percent, which is essentially what we need to keep the economy growing. Again, I see the risks going in both directions.

Let me add a couple of extra comments about risks in the housing market. I talked last time about the dynamics of starts. Even if final demand stabilizes, starts may take a time to fully work out the inventories. A couple of other factors are like that, which I just would like to bring to your attention. One has to do with the very strong presumption we seem to have now that demand for housing has stabilized. That may be the case, but I would point out that we have seen a very sharp decline in mortgage rates. People may have a sort of mean-reverting model of mortgage rates in their minds. It could be they are looking at this as an opportunity to jump in and buy while the financial conditions are favorable. So even if rates stay low, we face some risk of a decline in demand. The counter argument to that, which I should bring up, is that if people thought that prices were going to fall much more, then they would be very reluctant to buy. That’s evidence for stabilization of demand. Another point to make about housing is that, even when starts stabilize, there are going to be ongoing effects on GDP and employment. On the GDP side, it takes about six months on average to complete residential structures. Therefore, even when starts stabilize, we’re going to continue to see declines in the contribution of residential construction to GDP.

On the employment side, I asked Bruce Fallick of the staff to run a regression of residential construction employment on residential single-family starts and to project forward what the employment results are going to be. According to this regression, if starts stabilize at the October level, as projected by the Greenbook, the job losses in that sector will actually continue to rise for the next two or three months and return to the November level of about 15,000 per month only by the middle of next year. There will be lagged employment effects from the housing sector and presumably from the associated manufacturing sectors, like appliances and furniture, which also tend to lag. So there will be some employment drag coming forward, and I think it’s reasonable to think that unemployment rates will start to rise. But, again, this is about 15 percent of the economy as compared with 85 percent of the economy.

On inflation, I agree that the latest core PCE number was disappointing. I think perhaps it overstates the trend a bit, just as the core CPI number understates the trend a bit. I think there are still indications of a mild deceleration in prices, and most of the factors supporting that are coming into place, including the slowing of rents, the improved energy situation, some increase in slack, and expectations, which include a five-by-five-year expectation which has come down about 20 basis points since we stopped raising rates in August. So I think there are some bases to expect a gradual decline in inflation. I would note also that outside forecasters are a bit more optimistic about this than the Greenbook is. For example, the Blue Chip median forecast of core PCE inflation for next year is 0.2 percentage point lower than the Greenbook on a comparable basis.

I’ve talked before about owners’ equivalent rent, which is a somewhat special category, and I’ve indicated that I think its slowing will contribute to slower inflation. In the interest of being even-handed, let me talk about a category that might go in the other direction, which is medical costs. Medical costs in the short run depend a great deal on government policy, Medicare reimbursement decisions, and the like. Therefore, only in the medium term will they respond to monetary policy. I think that’s a source of risk. The twelve-month change in medical costs has been declining: It was 4.3 percent in 2003, 3.5 percent in 2004, 3.3 percent in 2005, and 2.9 percent so far this year. So that gradual decline in medical costs has been a positive in terms of inflation. But in the latest month, the number was 0.6 percent on a one-month basis, or more than 7 percent on an annualized basis. To the extent that we see some bounceback of medical costs, that’s going to be another factor of concern in terms of inflation going forward. Again, however, I think that we have some reason to think that inflation will slow, but I don’t disagree with the very wide sentiment I hear around the table that the slowing is far from certain and that the risks are still to the upside on inflation.

Are there any comments on or questions about my summary? If not, let’s go to Brian, who will introduce the policy discussion.

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