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

Once again I find myself reporting to you that movements in global oil prices are among the developments during the intermeeting period that were factors in our deliberations about the external sector. Global crude oil spot and futures prices fell further following our September projection but by differing amounts over the maturity spectrum. When we finalized the current baseline forecast, spot prices and very near term futures prices had moved down more than $4 per barrel; futures contracts that mature at the end of 2007 had recorded price declines of about $2; those maturing at the end of 2008 had price declines of about 50 cents. Indeed, for contracts maturing beyond 2009, prices actually rose such that the far-dated contract for December 2012 had moved up about $1 per barrel in price. We adjusted our projection for U.S. oil import prices by amounts similar to these changes in futures prices. The differential movement in prices implies that, even though prices have moved down all along the path through the forecast period, this path now slopes up more steeply than it previously did. So our outlook is for oil prices to rise rather sharply over the forecast period, although from a lower starting point than in the September Greenbook. The reasons for the additional decline in prices during September and October include the return of production to near previous rates at Prudhoe Bay, the absence of any sign of late-season hurricanes in the Gulf of Mexico, and awareness of current high inventory levels. These inventories are by their very nature transitory; hence, market participants seem to believe that some of the current abundant supply will diminish over time, leaving limited spare production capacity and chronic risks to production in Nigeria, Iran, Iraq, and elsewhere. Late last week, OPEC announced production cuts of 1.2 million barrels per day as of November 1. Although the size of actual cuts by individual OPEC suppliers remains to be seen, we judge that significant cuts, albeit not as large as those announced, are needed for prospective demand to be consistent with prices in the futures curve. Those prices remain elevated—around the levels expected at the start of this year.

We again asked ourselves how the substantial drop in oil prices since their August peak matters for the U.S. economy. As Dave mentioned, some of the near-term variance in U.S. real GDP growth reflects the path of real imports, including oil imports. The nominal trade deficit is clearly narrowed as a consequence of lower oil prices. We expect that the average oil bill in the fourth quarter will show an improvement from the third quarter of $60 billion at an annual rate. The net trade balance on nominal goods and services will improve by just about the same amount as other trade components experience small, offsetting changes. As oil prices rise going forward, the nominal value of oil imports should move back up; but for 2007 as a whole, we expect that the total figure will be about the same as the total for this year, followed by a moderate increase in 2008.

With respect to our forecast for exports, we again expect that real exports of goods and services will expand at an annual rate of about 4½ percent through early 2008 and then will accelerate slightly, to about 5 percent, over the second half of 2008. We see this pace of export growth as reflecting moderately strong growth of trade in both services and merchandise. These components in turn reflect solid average growth of around 3¼ percent in foreign real GDP. The projected acceleration in real exports in 2008 reflects a boost from relative prices as U.S. export price inflation moderates. This projected pace of export growth is somewhat below that observed in recent years, particularly in the first half of this year. To some extent, the double-digit growth of U.S. real exports early this year reflected rapid real GDP growth abroad at that time. But our models cannot explain all the strong growth, and a sizable positive residual has emerged in our model. During the first quarter, exceptionally rapid growth of real GDP was widespread abroad as most industrial countries and many emerging-market economies in both Asia and Latin America recorded particularly robust real expansion.

The rapid growth moved many foreign economies closer to potential and was not sustainable over the long run. We read recent indicators of activity abroad as generally confirming our expectation that slowing from those very rapid rates would occur through the year. According to the data, among the industrial countries, Canada and Japan have GDP already decelerating in the second quarter. In contrast, the pace of expansion strengthened in the euro area; but with further tightening of monetary policy and an increase in the value-added tax in Germany to take effect at the start of next year, our outlook calls for a slowdown in growth there as well. For the emerging-market economies, the most important news is Chinese third-quarter real GDP growth, announced just after the Greenbook was distributed. Based on the data and our best estimate of a seasonally adjusted series for the level of Chinese GDP, real growth in China was at an annual rate of about 5½ percent in the third quarter from the second quarter, following two quarters of growth above 12 percent. These data are only approximate as they are inferred from the annual growth rates published by the Chinese authorities. However, it does seem clear that the measures implemented by Chinese officials to cool the economy have had some effect. We are projecting that growth going forward will return to rates between 8 and 8½ percent. Of course, the band of uncertainty around this forecast is significant. We judge growth at that pace to be consistent with Chinese potential and acceptable to Chinese officials. This picture of real output growth abroad is a benign soft landing. We are projecting slowing that does not overshoot in many foreign economies, including importantly the euro area, Japan, and China. We believe that domestic demand growth in Canada, Japan, the euro area, and Mexico will continue to sustain their domestic expansions and growth in the global economy and will underlie ongoing moderate strength in U.S. exports.

With respect to the current quarter, trade data for August surprised us with the strength of exports and led us to revise up by more than 2½ percentage points our estimate of the annual rate of growth of real exports in the third quarter. The surprise was widespread across categories of merchandise trade other than computers and semiconductors and included strong exports to most of our trading partners, with the important exceptions of Canada and Mexico. With no special stories or specific components of interest, we have projected that real export growth will revert to its historical relationship with foreign output and relative prices. However, the positive surprise in August reminds us that there is upside risk to our forecast for real exports as well as downside risk should foreign growth slow more than expected. Real merchandise imports in August came in above our expectation as well. We have accommodated that surprise in part by reducing real imports projected for the fourth quarter, particularly real oil imports.

All in all, our baseline forecast for the combined contribution of imports and exports to U.S. GDP growth over the forecast period is for a small negative effect during the second half of this year that becomes slightly more negative through the second half of 2008, reaching about 0.4 percentage point as strengthening U.S. real GDP growth boosts import growth above that for exports. David and I will be happy to answer any questions.

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