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

From the perspective of the global economy, one of the important revisions in this forecast from last time is the projected path for crude oil prices. We have incorporated into the baseline forecast a path for both West Texas intermediate (WTI) prices and the U.S. oil import price that is more than $5 per barrel higher in the fourth quarter of this year and nearly $7 higher by the fourth quarter of next year than was the case in the June Greenbook. It is still true, however, that the projected path, based as usual on market futures prices at the time the forecast was made final, is quite flat.

The sizable jump in oil prices this time reflects the volatility that we have seen in market prices for oil since late June, when the previous Greenbook was being finalized. Spot prices for WTI moved from below $70 per barrel at that time to a recent peak of $77 in mid-July and again yesterday, following BP’s announcement that pipeline repair in Alaska will shut in about 400,000 barrels per day of crude oil. Price fluctuations during the intermeeting period reflected market concerns about the potential effect on supply of ongoing events in the Middle East, some disruptions to production in Nigeria, and a slight reduction in output by Saudi Arabia, as well as an awareness that hurricane season has arrived. No doubt the underlying strength of the global economy is contributing by maintaining overall demand as well. As of close of business yesterday, the futures path for WTI oil prices during the remainder of this year and next year was about $2 per barrel above the Greenbook baseline path. Clearly, further moves in oil prices are a risk to the forecast.

Another important element in the foreign outlook is the continued elevated level of nonfuel commodity prices, especially the industrial metals. Metals prices are down from their highs in May, but they are also up from their near-term lows in June. During the intermeeting period, spot prices for copper and zinc rose through mid-July and then partially reversed their recent increases but since have moved up again. On balance, metals prices are modestly higher since the time of the June Greenbook, but prices of other primary commodities are somewhat lower. As a result, our projected path for nonfuel commodity prices in this forecast is very similar to that of last time. The elevated level of these prices means that they will continue to have lagged effects on U.S. import and export price inflation for a time. The flatness of the path going forward means that we anticipate that the implications for import price inflation will abate noticeably in 2007, contributing to a sharp drop in the rate of inflation for core imports. Further fluctuation in the prices for these global commodities is also a risk to our baseline forecast.

These developments in global commodity prices, both fuel and nonfuel, along with other data released over the intermeeting period, led us to revise up some our forecast for inflation abroad through mid-2007. We expect that the upward pressures on inflation in the industrial countries will be felt in the near term, particularly this quarter, whereas those in the emerging market economies will be evident later this year and into next. The revisions are small, in part because foreign industrial countries have to date been very successful at containing the inflation consequences of higher crude oil prices and several have tightened monetary policy and in part because emerging market economies have continued to suppress domestic energy prices, delaying their effects in the process. Some monetary policy tightening has also been implemented by a number of Asian central banks.

We continue to read the evidence for foreign real GDP growth as indicating a solid pace of expansion, with the possible exception of Canada, where output growth slowed in the second quarter. We have fine-tuned our outlook for expansion abroad a bit—strengthening last quarter and this quarter and lessening the pace just a little next year; but the overall path for foreign real GDP is about the same as in June. Indicators from most of our important trading partners—for example, from Japan, the euro area, and China—suggest considerable momentum in foreign economic expansion at the present time.

Global financial markets confirm a generally favorable climate for continued strong growth, and many of the signs of increased risk concerns and heightened volatility from earlier in the year have faded. Over the intermeeting period, stock prices in many of our trading partners have risen. Equity price indexes in emerging market countries, in particular, have rebounded from the lows of mid-June but generally have not returned to the levels reached in early May. Other than in the United Kingdom and Japan, yields on ten-year sovereign bonds have moved down 10 or more basis points in the major foreign industrial countries since your June meeting, and spreads on dollar-denominated emerging market sovereign debt have partially retraced previous increases and are not far above the lows observed in early May, with the exception of spreads for Turkish debt. On balance, the dollar is down just a little over the period.

The bottom line is that the staff’s picture of the global economy implies an

essentially neutral effect of the external sector on U.S. GDP growth over the forecast

period, although one must remember that there are risks on both sides to that picture.

The arithmetic contribution of real net exports to GDP growth for the rest of this year

and next year is essentially zero—with a small positive contribution over the second

half of this year, unusual for us, followed by a small negative contribution in 2007 as

a whole. Exports of both goods and services are expected to grow strongly, supported

by steady expansion of real GDP growth abroad. The step-down in U.S. real GDP

growth should restrain import growth somewhat over the next six quarters.

The nominal trade deficit on goods and services is projected to widen about

$75 billion from the estimated figure for the second quarter to that for the fourth

quarter of 2007. The change in the non-oil nominal trade balance accounts for only

one-third of that $75 billion. This change in the overall trade balance is sufficiently

small that the projected ratio of the trade deficit to GDP is steady at about 6 percent.

Nevertheless, the current account deficit is projected to exceed $1 trillion at the end

of 2007, and the ratio of the current account deficit to GDP rises from 6.5 percent to

7 percent next year. A growing net deficit in investment income flows largely

explains the further deterioration in the current account balance. That change, in turn,

is accounted for by a substantial widening of the deficit on portfolio income that more

than offsets a gain in the balance of direct investment income. The financing

requirements of our external deficit remain large and will continue to grow as long as

the level of the trade balance remains far from zero. David and I will be happy to

answer any questions.

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