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

The economy in the Eleventh District continues to expand at a modest, or maybe even a measured, pace. At our Board of Directors meeting a little over a week ago, one of our directors summarized it best by saying that the economy is going nicely—not great, but nicely. Her theme was echoed by many other directors and by members of the Advisory Council on Small Business and Agriculture. I also met with a number of CEOs for breakfast that same week, and what was most interesting to me was that none of them had much to say about the economy. It was neither so strong nor so weak that it deserved much in the way of comment. What they were almost obsessed about, though, were the rising costs of health care to their businesses, with little hope for improvement, and related issues of tort reform.

Even though most of my contacts are telling me that the economy is doing okay, I sense a certain reluctance on the part of business people to make long-term economic commitments—a point others have mentioned already this morning. One of our Houston directors, who is in the petrochemicals business, has been raising prices for months. His company has been running close to full capacity in several product lines. He raised the question of whether he should be investing in new plants, given that his current plants are running full out. For a variety of reasons, his answer was “absolutely not.” One of our agricultural advisory council members made a similar point regarding cattle ranches when he said, “Just like in chemicals, no one wants to build new plants.” It’s my view that these remarks reflect an underlying caution—call it lack of business confidence, if you will—that may act as a brake on economic growth going forward. In the case of large publicly traded companies, we can blame some of this caution on Sarbanes– Oxley. But this reduced appetite for risk-taking and long-term investment has spilled over to smaller, more entrepreneurial, privately held businesses as well.

Having said all this, I should point out that the Texas economy has continued to improve throughout 2004. Job growth has picked up steadily, and the gains are fairly widespread across most industries. After three years of massive declines in high-tech employment, reasonably steady gains have taken place thus far in 2004. One of our advisory council members from Austin’s high-tech sector noted that Austin is finally off the bottom. It is a “feeling better” economy but not yet a “feeling good” economy.

The national economy seems to reflect the same pattern of slow, modest growth and decelerating inflation that has emerged in the Dallas District in recent months. I have no reason to differ in any significant way from the staff’s GDP outlook. I think we’d all be pleased to have the baseline scenario unfold. Average real GDP growth of just under 4 percent in the fourth and fifth years of expansion is pretty good.

If the staff’s inflation outlook for 2005 and 2006 is correct, or even just in the right ballpark, the U.S. economy will remain in the zone of price stability in the near future. As I look at the staff’s inflation projections under the alternative simulations, I can’t help but notice that all of the inflation projections are for core PCE to come in under 2 percent, with many of the projections centered closer to 1 percent. It was not that long ago that this Committee was agonizing over the threat of deflation when our inflation measures were pointing to core inflation around 1 percent. I’m not recommending that we agonize again, but the similarities are striking. As I looked at the table on page 2 of the Greenbook supplement, I was struck by the three- month change in the annualized rate of various measures of inflation for the period ending in August. CPI inflation is running at 1.3 percent, core CPI at 1 percent, PCE inflation at 0.9 percent, core PCE at 0.7 percent, finished goods PPI inflation at minus 1.1 percent, and core PPI for finished goods at 0.5 percent. Were this pattern to continue, the Committee would be facing an inflation pattern not very dissimilar from the one we were looking at in the spring of 2003.

For many months now, the Committee has been saying that its policy stance is accommodative. I won’t dispute that conclusion; I’ve been saying it myself. If we’re measuring the degree of how accommodative we are by the real federal funds rate, then it’s critical to get the right measure of anticipated inflation into the equation. If the staff’s inflation projections are correct, then policy is much less accommodative than it would be if we assume inflation expectations are well anchored in the 2½ to 3 percent range as in the University of Michigan survey. If the last few months of inflation data reflect a return to the inflation patterns and trends of the last few years, there may be less policy accommodation to be removed than the Committee has been assuming, and there may soon be room for a pause in the measured pace of policy changes. I think our current policy of measured withdrawal of policy accommodation is correct for now. But with inflation low again and falling again, I have to remind myself why I think so. The reason seems to have changed from “to contain inflation” to “because the economy is strong enough to tolerate it.” In other words made famous recently, we may be doing it because we can. After today, we may want to reassess that.

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