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

Thank you very much, Mr. Chairman. New England continues to grow modestly, though recent data suggest that some caution is warranted. District employment growth remains slower than that of the nation. Most states in the region are back to their January ’01 levels of employment; but the largest states, Massachusetts and Connecticut, are not. The Philadelphia Fed indexes of overall state activity, which are based largely on employment- and wage-related data, suggest sluggish growth as well, with Maine and Massachusetts at or near the bottom of the index for the country as a whole. Even with slow labor growth, certain categories of positions are very hard to fill—in particular, finance, accounting, certain IT specialties, engineers, biotech, and skilled labor for manufacturing. In fact, one large aircraft manufacturer was quoted as saying that the labor situation as far as he was concerned was insane. Costs for acquiring certain kinds of labor are rising, but in general, we are not seeing increases across the board in overall expected labor costs. But given the kinds of labor that are very much an important part of the businesses in the First District, such increases may not be far off.

Housing markets are clearly contracting. We are part of the coastal situation. Through the second quarter, New England house prices escalated at only half the pace of the United States as a whole, and home foreclosures, while still fairly low, ticked up more significantly in the region than elsewhere. Permits have fallen sharply, down 25 percent from last year and 22 percent from the year before, though yesterday’s starts data were a bit better for the Northeast than elsewhere. Slower building is leading suppliers of housing products to project declining business later this year as their sales tend to lag a decline in residential real estate markets. Consumer confidence for the region as a whole dropped off at a faster pace than elsewhere in the nation in August compared with the year before.

So there are all those reasons for caution about the growth rate of the New England economy, but not all the data are bad. Consumer prices, in general, are escalating more slowly, even though energy costs are higher. Downtown and suburban office vacancy rates are down, and rents are rising. Hardware and software businesses that were contacted or that are represented on our small-business advisory group report fairly strong revenues and definite concerns about costs. Business confidence measures and surveys were positive both for Massachusetts and Connecticut, reflecting profitable trends and stronger sales and even some strength in manufacturing. As I mentioned at our last meeting, the growth in personal income in the region, despite slow job growth, is on a par with that of the nation. Reflecting this and strong corporate profits, state income, sales, and corporate tax revenues are up, in some cases by relatively large percentages. So even though we have some reasons to be concerned about New England, not everything is negative—though that is sort of hard to find in the local media and you certainly will not hear the politicians talking about it either.

Turning to the nation, I would agree that most incoming data since our last meeting have been on the subdued side. Auto sales, trade data, and certainly anything to do with residential real estate markets have been more subdued than was expected. Of course, price measures have been subdued as well, at both the headline and the core levels. But like New England, not everything is slow. I would look at employment growth as fairly solid, even though it has slowed from the beginning of the year. The surprise in wage and salary income may reflect largely the exercise of stock options, but it could also reflect some pressure on overall wage costs because hiring certain kinds of workers is getting difficult. Oil prices are down, and gasoline price declines act as a kind of bonus to the consumer. Consumer spending isn’t too bad. The latest retail sales data aren’t bad at all; and although confidence bounces around a bit, it seems to have recovered—at least as much as gasoline prices have recovered. Industrial production seems pretty good, with strong growth in some equipment categories. Business profits are good. Orders and shipment data suggest that business spending is solid.

I am sort of repeating everything you said, David, and I probably should not do that. But I seem to be at the same point as people you mentioned in your presentation might be—a little shocked by the slowness of expected GDP over the next couple of quarters. In fact, when we in Boston look at our baseline forecast, it is a good deal more optimistic largely because we are not seeing as much of a decline in residential investment. I found the briefing yesterday to the Board interesting, when you tracked your own forecast of residential investment. At one time we were lower than you were, but you far surpassed us. In fact, with your decline 50 percent greater than ours in ’06 and quite a bit larger again in ’07, we get a GDP that is 0.3 percentage point higher in ’06 and almost 1 percentage point higher in ’07. We also see a lower NAIRU, and we have a bit higher estimate of potential—so it does not affect the gap as much, but it does affect the headline number of GDP. I understand all the mechanics, but the staff forecast is lower than most private forecasts. I wonder, if growth is that low for that long, whether it might set off a chain reaction of actually higher saving rates than you project and lower confidence that could feed back more strongly than you have anticipated. In that regard, I found the recent estimates of a rising probability of recession interesting. I do not think we’re going to have a recession, but I do wonder about it if, in fact, we do realize the slow growth of the Greenbook forecast.

However, how much do we really know about how long residential investment will stay negative without a recession? Mortgage rates are not up that much—only 50 basis points or so from the beginning of the year. Incomes are rising, and nonhousing wealth is rising. At some point, buyers should recognize that housing has gotten more affordable and resume desired purchases, perhaps without further major price declines. Certainly speculative building is off, and investors have backed out of contracts, but how much more of that really will occur? The Greenbook would suggest another year and a half, but shouldn’t builders be acting quickly now to reduce the amount of overbuilding and to preserve price levels? Underlying demographics and other fundamentals have not changed either. So it is hard actually for me to see that residential investment will be that hard hit that long. I take Janet’s comments about the builders in her District. I imagine that, if I had talked directly to builders in the First District, they might have been pretty gloomy, too—again, given some reflection of the coastal situation. I did talk to Nick Retsinas at the Joint Center for Housing Studies, which Harvard runs, and he was not particularly negative. He felt that a correction is occurring but thought that it would be short-lived. Now, he did say that they were going to come out with some revisions and that he was still working on them, so his outlook may get more negative. But I am going to try to keep tabs on where they see things because they do stay in touch with all the large builders across the country. Again, the knock-on effects of lower residential construction may not be all that great. You mentioned that nonresidential construction is up, but the Greenbook says that it will slow soon. A good deal of that is oil related; and as long as people are working, incomes are solid, and financial conditions remain pretty accommodative, consumption ought to remain solid.

So I wonder whether the Greenbook baseline is really more of a worst-case scenario for residential construction and GDP, though I realize regional effects of the housing slowdown on employment and spending could be considerable. If growth is faster and if your estimates of the NAIRU and the participation rate are more or less on target, I also wonder about the risks of higher inflation over the forecast period than is the case in the baseline as resource pressures grow. Moderating energy costs are helping here, but they have been volatile in both directions, and I at least would like to see a somewhat longer period below recent highs before declaring victory. In sum, the rather benign baseline forecast may be the best; but as you noted, there are great ranges of uncertainty. There are downside risks to be sure, and it is impossible to rule out a recession given the slow growth forecast of the Greenbook. But I really think the risks to be concerned about lie in the area of stronger growth, more pressure on resources, and higher and more persistent inflation.

As many other people have commented, I, too, found the material on inflation persistence of some interest and very well done, though I take the point that it is hard to be confident either about the definition of persistence or about whether it is, in fact, lower or higher. I would argue here that it might be better to assume, as we consider the stance of policy, more rather than less persistence, in part because we are uncertain and in part because the costs of being wrong are somewhat asymmetric. If inflation is less persistent and we assume it is not and take a conservative policy stance, inflation should retreat quickly and help shore up our credibility. Choosing a weaker stance and being wrong about it could be quite costly. Given the uncertainties facing us, the nature of the incoming data, and the fact that we have already paused, it might not be time right now to take out more inflation insurance, but I certainly think it is time to be very vigilant. Thank you.

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