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

I am flattered that you asked, given that I am still trying to figure out what happened in the first quarter of this year. [Laughter] So let me answer your question first and then provide some of the caveats or background. Basically, we do construct something we call a Greenbook extension that goes beyond the current Greenbook horizon of 2008. We do that for two reasons. One is that we have to forecast long-term interest rates, and we also have to be thinking a bit about where the economy is going, and we use that extension to help inform our thinking. We also use it in some of the analytical tools that we provide to the Committee, such as the optimal control exercises that we report from time to time.

There is a logic for the Greenbook’s current forecast period: Most of what we are doing in macroeconomic forecasting is trying to get some purchase with a few gross correlations in the data and their dynamics, and a forecast period through the end of 2008 pretty much lets those dynamics play out. Beyond that, the Greenbook extension is what I call a model-informed construction. I had actually hoped a few years ago that we could start presenting this more frequently. My model staff wisely persuaded me not to do it yet. The reason is that the longer-run extension—for example, of what the equilibrium real rate is going to be in 2009, 2010, or 2011—in a model as large as FRB/US often changes for obscure reasons. For example, it may change when we re-estimate the energy production equation. In that case, all of a sudden we may get a ¼ point change in the equilibrium real rate that takes us a week to figure out why it happened, and ultimately the explanation would probably seem unsatisfying to you. We have been working on a project over the past year to systematize the rules that we use in constructing that longer-term outlook so that we could present it to you and have more confidence that when we do that we could both understand it ourselves and explain it to you. So I think what you are looking for is something that is high on our agenda.

Now, if we had to talk about 2009 and 2010, we are ending this forecast period with a modest output gap. That output gap would, all else being equal, be pushing inflation down from the 2 percent range with which we end up in this forecast to something below 2 percent. So you would be on track with that. But when you construct these longer-term ranges, the first thing you will encounter is the need for a dollar forecast. Over the length of the Greenbook period, Karen can talk about a dollar forecast that is roughly a random walk with a little bit of a nod in the direction of some depreciation. When we construct a ten-year extension of the forecast, we actually have to take a very precise stand on that. In these Greenbook extensions, right after the end of 2008, we basically have to build in something like a 4 percent real exchange rate depreciation of the dollar. Then in the extension, even though we are running with an unemployment rate of roughly 5¼ percent, we are not getting any further disinflation out of it because that output gap is just offsetting the inflation consequences of the anticipated dollar depreciation.

So if I were to characterize the forecast a few steps beyond the end of the current Greenbook forecast, it would be one in which you have a positive output gap, maybe a 5¼ percent unemployment rate, and not really making much progress beyond the 2 percent inflation with which we end the forecast period.

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