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

On the international side, two major developments during the intermeeting period merit some further discussion this morning: the rapid and sizable run-up in global prices for crude oil and the significant depreciation of the exchange value of the dollar in the second half of the period. Those developments occurred against a background of continued strong global growth, with some economic indicators again surprising us on the positive side for some countries. As a result, we are still expecting moderately strong foreign real GDP growth at an annual rate of 3½ percent over the forecast period, with inflation projected to remain contained although upside risks are a concern.

When we finalized the March Greenbook forecast, the spot price of WTI was just over $60 per barrel. Last week, as we completed the forecast for this meeting, that price reached about $75 per barrel before partially retracing. The intervening seven weeks had witnessed almost daily tales of woe of higher prices, with the supply problems in Nigeria proving more persistent and serious than earlier thought and tensions over the nuclear program of Iran adding to heightened pressures on energy prices. In addition, outages of U.S. crude production as a result of the hurricanes continue, as do issues regarding supply from Iraq and Venezuela. Events in Bolivia have also rattled the energy market. As a result, and consistent with the shift in futures prices for the rest of this year and next, we raised the projected path of the U.S. oil import price about $10 per barrel. As in March, that path rises slightly through the end of this year and then is about flat in 2007.

One significant and direct consequence of the higher oil prices is an increase in the U.S. oil import bill from that forecast in March. In the baseline forecast, the value of oil imports has been revised up $34 billion for this year and $48 billion for next. As a consequence, of the approximately $150 billion widening of the U.S. nominal trade balance that we now project from the fourth quarter of last year to the final quarter of 2007, just about one-third is accounted for by the enlarged oil bill. The overall trade deficit is now expected to be about 6½ percent of GDP at the end of next year.

A second consequence of higher global oil prices is that the revenues to the world’s oil exporters have significantly increased. This positive change to the external revenue of these countries has raised a number of questions about their propensities to import and from whom and their decisions about how to hold the funds that they have received and have not as yet spent on goods and services. Data on the portfolio allocation of oil revenues by many exporting countries are sparse; in many cases, the funds are held by national oil companies or in special stabilization funds, neither of which are likely to be included in reports of foreign official reserves. Moreover, officials in some of these countries tend not to reveal detailed information about their holdings. A case can be made that increased revenue flows to these countries over recent years likely added to overall global net saving and contributed to low long-term interest rates globally. It is still uncertain whether their behavior has had or will in the future have a systematic influence on exchange rates.

From U.S. TIC data, we have some limited information about some categories of dollar holdings that are current through March of this year. As was reported in Part 2 of the Greenbook, inflows of foreign official assets in the United States held by OPEC countries were quite strong in the fourth quarter of last year and in January. However, in February and March those inflows dropped sharply, as did aggregate official inflows from other non-G-10 countries. For total portfolio inflows to the United States that combine public and private investors, funds from oil exporters (including the Middle East, Mexico, Russia, and Norway) were more than $25 billion in the first quarter—a pace comparable with that in 2005. The $25 billion inflow compares with estimates of the net oil revenues of the oil exporters of about $200 billion in the first quarter. Again, the monthly data show a sizable step-down in the size of inflows after January. Among the oil exporters, there is some variation across countries in their inflows into the United States. After showing positive inflows in the previous two years, net outflows were recorded for both Russia and Venezuela in the first quarter. In contrast, inflows from Middle East oil exporters, Mexico, and Norway were strong. All told, although total inflows for oil exporters remained near rates in 2005, there are some hints of possible diversification away from assets held in the United States by some oil-exporting countries, especially in more recent months. I should note that these countries may hold dollar assets outside the United States; changes in such holdings are not captured by the TIC data and may give rise to entries for countries such as the United Kingdom that are the location of major global financial intermediaries.

We have only extremely partial data for U.S. financial inflows in April, so it is not possible to relate the recent sharp depreciation of the dollar to any pattern in such data. The exchange value of the dollar fell significantly against all the currencies of our index of major industrial country trading partners as well as against the currencies of Brazil, Korea, Chile, and most other Asian emerging-market economies. This broad-based decline reflects a significant change in preferences on the margin among at least some global investors and may alter expectations of some of those holding large amounts of dollar assets. Over the intermeeting period, U.S. long-term nominal interest rates moved up nearly 40 basis points. But rates rose 20 or more basis points in most foreign industrial countries. Real long-term interest rates taken from inflation-indexed, sovereign securities in Japan and the euro area also rose about 20 basis points, comparable to the change in U.S. inflation-indexed rates. A significant decrease in the market value of the dollar with no evident change in relative real rates of return on comparable fixed-income securities could indicate an increase in the risk premium attached to holding dollars, or it could signal a change in perceptions of the long- run real exchange value of the dollar.

Even given lags in the underlying relationships, the weaker projected path of the dollar does show through in our forecast. For real exports of core goods, the drop in the level of the dollar to date and the slightly faster pace we now project for real dollar depreciation imply that relative prices will boost growth of these exports about 1 percentage point more over the remainder of the forecast period than we thought in March, based on our model. For real exports of services, the story is similar. For core import prices, our equations imply a positive effect, concentrated in this year. However, when incoming data and other factors are taken into account, our projection for import price inflation is only a little above that in the previous Greenbook, and so the net effect on real imports is negligible. For real imports of services, a negative effect from higher relative prices is evident in the baseline projection.

For the nominal measures at the end of the forecast period, total exports are revised up, but total imports are up more. The enlarged oil bill accounts for virtually all of the upward revision to nominal total imports. As a consequence, the trade deficit has been revised to a somewhat larger figure. That change is significantly offset by the effects of the lower dollar on projected investment income. The lower dollar is positive for investment income as it translates earnings abroad of U.S. firms into more dollars. In addition, in our forecast those earnings are directly boosted by higher oil prices. All told, our outlook for the current account deficit is for more-rapid deterioration this year than we previously thought but a deficit at the end of 2007 that is only slightly larger than we had been expecting in March. David and I would be happy to answer any questions.

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