Thank you very much. Unfortunately, I think we find ourselves in an uncomfortable position like that of six weeks ago, with a continuing mix of inflationary pressures and decelerating economic growth at the same time. I think the fundamentals are in place for a continued moderation of growth but not a contraction, much as the Greenbook describes. Obviously, housing is a risk that everyone has talked about. But the key, as many people have also mentioned, is maintaining contained inflation expectations, and that comes down to thinking about whether some of the factors that we’ve been seeing have been more transitory or more persistent.
Let me first talk about growth and go through the C plus I plus G plus net exports. I would agree with the staff’s characterization that world economic growth is not quite as strong as some others have put forward. I don’t think we’re going to be seeing an enormous export boom. Also, as briefly mentioned, I see very little on the government stimulus side. Tax revenues, as Governor Warsh mentioned, were very high. Spending is being kept relatively tight. On investment, we’re seeing some strength in capital spending. My concern is, if consumption goes as low as the Greenbook suggests, what the return on this capital spending will be. Is it going into the right areas? I was a little concerned when President Poole mentioned that the air freight company is expanding rapidly but the on-the-ground delivery company is not expanding at all. So are they going to have to invest in parachutes to get these in? [Laughter] But that is precisely the concern that I have—that capital spending may not conform perfectly to what consumption demand is going to be. We certainly saw this in the late 1990s and early 2000s. I’m just a bit worried about that now, especially given the potential tension between slowing consumption and robust investment growth.
Now, regarding consumption—we’ve talked about the potential support from lower energy prices and some positive wealth effect from stronger equity markets, but obviously housing is one key here. It’s a key partially in overall investment but also in the uncertainty that it causes in consumers’ minds. Housing is one of the worst areas for data. It’s very difficult for us to have any concept of what prices are doing because it’s not a market like any other. We do have the Case-Schiller index, and we do have some better indexes that people are now betting on, but they’re still very poor indicators of prices relative to the indicators we have in other markets. We also know that there can be queues and that extras can be thrown in, so there’s a lot of uncertainty with respect to where prices are going. That concerns me quite a bit because I think we just don’t have a good handle on it. Permits and starts have continued to come down from where they were at our last meeting and are now at levels of the beginning of 2003 or even starting to slip into 2002. If they flatten out there, the housing sector is still historically reasonably good. But there’s no indication that we’re necessarily at a turning point and that things are going to flatten out. There is the wealth effect, the direct effect on people’s consumption behavior of lower wealth going forward, and also the confidence effect. We don’t have a perfect analogy with the previous times in which we’ve seen these housing downturns— we have a different context in that the economy is broadly more robust—and so I think it’s less likely that we’re going to see a major housing problem. But I think it is a real risk, and we have to be sensitive to it.
On the inflation outlook, we have to come back to transitory versus more-persistent components, as many people have mentioned in the discussion. Obviously, people are heartened that energy prices have come down, but I certainly would not put the same bet on the energy markets that one trader did in a hedge fund that got into a little trouble recently because we know that energy prices can move in ways we don’t expect. So I don’t want to take too much from that. I think it’s appropriate in the Greenbook to use the market’s expectations. What measure do we have other than market expectations? If we did have a better measure, then we’d be running one of those hedge funds. However, there’s a lot of uncertainty around that measure. So I certainly don’t want to bet on better inflation going forward just because we’ve suddenly seen a 15 percent decline in oil prices over the past six weeks. That said, it’s heartening that energy prices are unlikely to lead to greater inflationary pressures going forward than those when we paused six weeks ago.
The rise in compensation is obviously troublesome—not if you are an employee receiving the higher compensation, but from our point of view. However, a lot of tension is in those data because we have the compensation numbers versus the ECI. There’s a big statistical discrepancy between gross domestic income and gross domestic product. It’s possible that some of the increase in compensation will be revised away, and we’ll see actually higher productivity growth. We just don’t know, and it may be a while before we see it. Also, as we discussed a lot last time but not this time, the continuing fairly wide margins that businesses are experiencing may come under more pressure and may absorb some of the increases in labor compensation. How much is uncertain, but that may be one potential offset.
As many people have said, we can’t become complacent. Inflation expectations have behaved reasonably well since we paused at the last meeting, which is heartening in that the markets believe that inflation is reasonably under control in the near to medium term and even in the longer term. It’s hard to find evidence of increases in inflation expectations, but as many people have said, that does not mean that we don’t have to worry. We have to worry a lot because the key is keeping those expectations well contained. I think we’re in a situation in which we can do that. Slowing growth is not going to give us more of a benefit. The flatness of the Phillips curve, which people have talked about, is what the data have been over the past ten to fifteen years in the United States and most other countries. So even if there is a bit more slowdown, we are not necessarily going to get the potential benefit in significantly lower inflation pressures—maybe a little but not very much. So we still have to worry about the upside on inflation, and that’s why maintaining our credibility is of utmost importance.