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

In the international economy, the striking development over the intermeeting period has been the rapid and substantial drop in crude oil prices and in prices for some nonfuel commodities. The spot price of WTI crude reached a recent high of about $77 per barrel on August 7, following news of problems with the BP pipelines at Prudhoe Bay. Since then, it has declined to less than $62 in trading yesterday, decreasing about $15 per barrel. The far futures price is down somewhat less, nearly $10 per barrel, leaving a barrel of WTI crude for delivery in 2012 priced about the same as a barrel of crude in the current spot market.

As has been our practice for many years, we have assumed for the Greenbook baseline forecast that oil prices over time will match those contained in the futures price curve that held when we finalized the forecast last week. The timing of our forecast this Greenbook and last and the smoothing from quarterly averaging results in our forecast path for the oil import price shifting a bit less than did the spot price of crude. The downward revision in the oil import price amounts to nearly $12 per barrel in the near term and narrows to somewhat more than $8 per barrel by the end of 2007.

Some other commodity markets were remarkably volatile over the intermeeting period as well. The spot prices for gold declined more than $60 per fine ounce since the time of the August FOMC meeting. Many of the industrial metals also moved down sharply in the past week or two, but in some cases these declines merely retraced run-ups earlier in the intermeeting period and resulted in only small net changes.

Regarding the implications of the lower oil prices for our forecast, it is helpful to remember that our assumed price for WTI crude in the fourth quarter is near, but still more than $1 per barrel above, the average price that prevailed in the first quarter of this year, when we regarded oil prices as very elevated. In addition, the forecast path for WTI now rises into 2007 and then is about flat at close to $70 per barrel through the end of 2008. It also is relevant for constructing the forecast to ask why oil prices have come down as they have. The new developments that triggered the reaction in market prices seem to be importantly about the risks attached to future supply. Some aspects of geopolitical tensions, such as the conflict in Lebanon and the ongoing dispute with Iran over its nuclear program, seem to have eased. The Atlantic Ocean hurricane season has pleasantly surprised, with fewer storms than previously expected and none so far threatening the Gulf of Mexico. One factor that likely influenced the price reaction to the apparent lessening of risks to supply is the high level of inventories of crude oil at the present time. Current demand and supply plus market expectations of future demand and supply combine to determine spot and future prices plus desired inventories. With inventories already high, news that future supply is less uncertain sharply lowered the price required to clear the spot market and the premium that buyers are willing to pay to ensure future access to oil. Nevertheless, the positive slope to the futures curve over the forecast period suggests that, on balance, market participants are not expecting future supply to be as abundant relative to demand as is the case currently.

With respect to the implications for our forecast of foreign growth and inflation, we needed to consider the direct effects of lower energy prices and also to ask whether actual or prospective slowing of global economic activity and, hence, demand for oil and other primary commodities have contributed to the downward shift in these prices. On balance, our outlook for real GDP growth abroad generally remains quite strong. However, we do expect a decrease in the average rate of growth of foreign real GDP from about 4 percent at an annual rate in the second quarter to 3¼ percent in the second half of this year and over the remainder of the forecast period. In both the industrial countries and the emerging-market economies, the pace of real growth was particularly vigorous during the first half of this year and contributed to continued strong demand for oil and other commodities. Monetary policy has been tightened in response to concerns of inflation and overheating in many countries, measures to tighten fiscal policy have been passed in some cases, and officials in China have imposed additional administrative measures to restrain growth. Prospective moderation of the rate of foreign growth was a feature of our forecast in August. Data from Canada and Japan already provide evidence of a lessening in the rate of growth in those countries. However, available data on activity in the euro area, China, and Mexico continue to be buoyant.

In putting the pieces of the forecast together, we have concluded that the lower oil

prices are consistent with overall foreign growth remaining moderately strong and

will help to ensure that it remains so. At the same time, the projected pace of global

economic activity is consistent with oil prices remaining quite elevated and rising

somewhat into next year. We judged that the implications for foreign growth of the

downward revision to the outlook for U.S. real output growth were partly offset by

some boost to foreign growth that we otherwise would have incorporated in response

to the reduced energy costs, although these factors differ across countries. As a result

and given data received since the August forecast, the path for foreign real GDP

growth was little revised on balance from that in the previous Greenbook.

We have revised down our forecast for headline consumer price inflation abroad a

few tenths for the second half of this year and next as a consequence of the lower path

for energy prices. We project that in the industrial countries other than Japan

inflation will move down somewhat over the forecast period. In contrast, Japanese

inflation is expected to edge up but to remain below 1 percent. Some

emerging-market economies in Asia still have controls on or subsidies of domestic

fuel prices, which delays any pass-through of higher energy prices into domestic

inflation. Accordingly, we project that increases in global oil prices earlier this year

will push inflation in emerging Asia temporarily above 3 percent during the first half

of next year. We look for inflation in Latin America to remain contained near present


We see the risks to this forecast in many respects as balanced. We have been

surprised on the upside by the strength in foreign real activity during the first half of

the year, and strong domestic demand in some regions could push off into the future

some of the slowing that we are projecting. Alternatively, foreign activity may be

more sensitive to the U.S. slowdown than we currently envisage. We feel especially

uncertain with respect to the outlook for oil prices, given market reaction to recent

events; the sharp change in prices caught us and the futures market by surprise.

Although we are once again assuming that oil prices will follow the path implied by

futures prices, we recognize that a much larger move up or down is quite possible.

David and I will be happy to answer any questions.

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