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

Thank you, Mr. Chairman. I want to start my remarks today by reflecting on some results of the latest Duke University CFO survey. This survey is only about six or seven years old, but the one that was just concluded on September 10 has CFOs’ optimism at the lowest levels in five years, and so it’s continuing to show an erosion of their confidence. I found the CFOs’ number 1 worry—weak consumer demand—interesting because it wasn’t there before, and that uncertainty is part of what the CFOs are worrying about. Their second biggest concern is rising labor costs, which they attribute primarily to the scarcity of labor. They are anticipating that the scarcity is going to continue to drive labor costs higher. In terms of their hiring plans, they are planning now to hire fewer people than they hired last quarter. They are expecting to increase employment over the next twelve months 0.8 percent; last quarter’s survey showed 1.3 percent, so that’s quite a slowdown. However, they’re going to increase outsourced employment 4.3 percent. Thus what is showing up is the uncertainty—wanting to use an adjustable labor force to get the flexibility because of the uncertainty. They are also trimming their capital spending plans over the next twelve months to 5.1 percent, compared with 7.5 percent last quarter. Thus the survey indicates that CFOs have growing concern; they are still optimistic overall, but I think that caution is there.

Now, in looking at the numbers myself, I’m perhaps not quite as pessimistic. Again, as several of you have said—and Dave commented in his remarks—except for housing, the economy really does look good. As you know, I’ve been worried about the mortgage market and housing for quite a while. In an endeavor to find something good to say, I have noticed that, in the past couple of months, the Mortgage Bankers Association index of new loan applications for purchase mortgages looks as though it’s starting to level off. Very often that could be a leading indicator, so that could be a positive sign. However, as some of you have remarked, there’s a lot of speculation in the housing markets that has to unwind. All the folks who bought housing for investment have to do something as they see housing prices slowing and the financing costs to carry their investments going up. How that unwinding will occur, given the substantial size of the speculative positions in some markets, is something that will need very close monitoring. I know that our supervisory staff is focusing on that, too.

People are focusing on the fact that delinquency rates in mortgages still look good. However, we’ve seen a very rapid increase in debt service ratios since 2004. I’m concerned, again, with the amount of adjustable-rate mortgages out there that will reprice in the months ahead. If, as we think, some of these loans, particularly subprime loans, were made mainly on the collateral value of the house and not on the affordability of the mortgage, we could see more distress in the borrowers’ markets coming forward. If that’s the case, it could have spillover effects on consumer spending more broadly.

On the positive side, payroll growth has been good in the past three months—128,000. It has picked up a bit, and it is significantly above the Greenbook forecast, and that gives me some optimism. It’s putting more income in people’s pockets to spend, and the unemployment rate has been stable. Hourly earnings, however, are rising faster. While that acceleration can support consumer spending, it contributes to my concern about where we’re going in the long run on inflation.

As I look at the Greenbook forecasts since May, we’ve been continuing to project more and more inflation going forward. The private sector has basically been doing that in their forecasts as well. When I look at those forecasts, I’m concerned that for various reasons we have reduced our estimates of the trend rate of growth. As we bring down the trend rate of growth— and I realize that, as several have said, we’re at the lower end of the private-sector growth forecasts—I worry about the disconnect. Are we seeing a slowdown in potential that others aren’t? Or if we’re right that potential growth is lower and the private forecasters are right that real growth is going to be faster, then we could have more inflation pressures going forward. For the first time, we are also looking at prices in 2008, and they continue to rise at over 2 percent. They’ve been over 2 percent for two years. I worry, from the standpoint of our credibility, about what having such a long period above 2 percent means. So I believe we will see moderation of inflation, but I think it’s important to preserve our flexibility and be able to respond if these worst-case scenarios that I laid out become more troubling to us going forward.

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