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

Thank you, Mr. Chairman. Since our last meeting, I made a special effort to talk with my directors and business contacts about two topics—developments in housing markets and inflation. My District has been growing at a slower pace than most other parts of the country; consequently, housing prices in the District never appreciated as much as those in the hot markets in the country. Nonetheless, a major Realtor in our region told me that houses in his market, which includes the northern half of Ohio and the western half of Pennsylvania, are taking longer to sell and that the average price of houses sold from January to August is down about 2 percent compared with the same period last year. His view is that nationally the housing market still has a way to go before conditions stabilize. Nevertheless, right now he sees only a limited possibility that the adjustment process will cause serious harm to the U.S. economy.

Apparently people are not leaving much to chance. I heard a report yesterday morning that sales at religious stores for statues of St. Joseph have been soaring. [Laughter] It seems as though people who are trying to sell their homes are buying statues of St. Joseph because he’s the patron saint of real estate, and they’re burying him next to the “For Sale” sign. Unfortunately, there is no patron saint for central bankers. [Laughter]

Some forecasters, like the Greenbook, are expecting strength in the commercial construction sector to offset much of the weakness in residential building. One of my directors, who represents a large national commercial construction firm, has indicated that commercial building in the past few years has been boosted by the growth of health and education sectors. His entire book of business increased 10 percent in real terms this year compared with last, and he is looking to next year to have the book of business increase 3 to 4 percent. However, he is expecting it to be flat in 2008, and his story squares with what I am hearing from bankers as well—namely, that the flow of commercial loans in the pipeline, although not rapidly falling off, is slowing, and it hasn’t been building as it was. The Greenbook baseline captures very well the pattern that I’ve been describing in its projection for nonresidential investment over the next few years.

Now, turning to inflation, the two CPI reports that we received during this intermeeting period have not provided me with enough evidence that inflationary pressures have meaningfully diminished. The reports, however, have encouraged me to think that the forward momentum has been broken, but I’d like to see the next few CPI numbers be at least as good as those for July and August, if not better, to be convinced that that momentum has been broken. I’ve heard some hopeful comments regarding inflation in the past few weeks from several of my directors. Just a few months ago they were indicating that elevated energy prices and material prices had provided them with an opportunity to get more-generalized price increases, and they had wondered whether that was going to be a one-time catch-up opportunity or whether it would be persistent. Now it appears to have been a one-time opportunity, which is passing or has passed.

Several of my directors reported last week that they have resorted to unbundling their prices to cope with the rising prices of energy and material costs. On their invoices, they are breaking out the price increases that are due to the increased cost of steel, copper, energy, and shipping in order to pass them on. Apparently, their customers are willing to accept price increases that are due to those increased energy and material costs. But the expectation on the part of both buyers and sellers is that, as energy and material costs dissipate, the ability to pass on price increases will be removed. Several of my directors said that they are not planning any price increases for the next year and that they suspect their commodity costs will be lower than they were this year as well.

As others have mentioned, there has been some interest in the elevated unit labor costs in the second-quarter productivity and cost reports. As Dave noted, the compensation growth underlying unit labor costs was boosted when the BLS took on board the first-quarter unemployment insurance tax records. There is some suspicion that the dramatic increase in compensation had a lot to do with stock options and incentive pay, but the underlying data are not available yet, so we don’t know for sure. My staff was able to get some summary figures for Ohio. Compensation has been growing steadily in Ohio over the past several years, but the preliminary figures are flat for the first quarter of 2006. However, there was double-digit growth in three sectors—management of companies, finance and insurance, and utilities. These sectors are often the ones that show substantial growth in the first quarters because they pay out stock options and that’s often when those stock options are realized. So at least in my District there is no evidence of any broad-based acceleration in compensation, and I tend to agree with the staff’s view that it’s too early to incorporate those higher unit labor costs into the inflation outlook.

At our last meeting, I expressed the opinion that whatever weakness we would see in GDP was more likely to reflect demand factors than supply factors, and therefore I saw risks to both our objectives. The current Greenbook baseline projection for GDP is even lower than it was at the time of our last meeting because of revisions, as Dave mentioned, to both supply and demand factors. I still think that, if the Greenbook projection comes true, softer demand is likely to be the more dominant explanation. Nevertheless, I would like to see further evidence that inflationary pressures have been checked, if not actually reversed, before I would conclude that the risks to our objectives are evenly balanced. Thank you, Mr. Chairman.

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