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

Thank you, Mr. Chairman. The New England economy is in a growth mode, but the pace of that growth is a bit subdued. Employment levels for the region as a whole are now above those of a year ago. It’s the first time in the last two or three years that that has been the case. Most industries and states have added jobs over the last year, and we have even had some positive recent reports on manufacturing employment. We think that reflects the strong growth that has occurred in merchandise exports—probably in response to the decline in the dollar, however small it has been, that has already occurred. The tourism industry appears to have done fairly well this summer, though cool weather affected both the Maine coastal region and Cape Cod. Finally, commercial real estate markets remain flat in terms of vacancy and rental rates. This hasn’t affected prices on premier office buildings, however, which remain in the stratosphere, according to one contact.

Discussions with our Bank’s board of directors and a group of the region’s small businesses revealed considerable variation. Most of our directors, whether they were bankers or industrialists, focused on the recent slowdown with concern. Their collective level of caution is higher now than earlier. The smaller businesses on our advisory council, however, mostly had more business than they could handle and complained of shortages of technical staff, high benefit costs, and rising prices for energy, steel, rare metals and alloys, plastics, and paper products. Similarly, discussions with temporary-help firms suggest a good deal of regional strength, but readings of business confidence overall have been lumpy. Business confidence is better than last year but reflects a great deal of uncertainty and some concerns about rising costs. Clearly, some businesses and industries are doing quite well, especially smaller firms and those with military and export markets; others are more cautious and defensive in outlook. And uncertainty about geopolitical events, terrorism, and the upcoming election continues to be a factor.

Turning to the nation, incoming data have been mixed as well. We in Boston have had for some time a take on overall growth that is a little less optimistic than the Greenbook, and we now find that our two forecasts are just about identical. So I can’t find much to object to. Both forecasts depend greatly on a rate of employment growth that remains, at this point, more a hope than a reality. And we see this as an important source of downside risk.

As I think about policy at this point, I find myself in a bit of an internal argument. On the one hand, as Part 2 of the Greenbook makes very clear—as did Dave at the beginning of his comments—the expansion has regained some vigor. There is continued labor market slack, to be sure, but it’s also not clear where things such as the labor force participation rate and the employment–population ratio ought to settle after the employment boom years of the late ’90s. Productivity growth continues to be relatively strong, and industrial production has picked up except for high-tech goods. And in some areas such as truck and rail shipping, as well as primary processing industries, capacity is in short supply. Consumers seem ready to spend on autos and houses, and they’re willing to take saving rates to record lows in the wake of substantial appreciation in housing prices. Clearly, this could turn around and is a potential source of downside risk.

Businesses have probably added enough to inventories to hold them for a while. They are likely to purchase non-high-tech equipment at a faster pace over the rest of the year to get in under the wire of the investment tax credit change of next year, and that will borrow some strength from 2005. But overall the underlying fundamentals don’t suggest a complete washout in business spending in 2005—not by a long shot. So the economy seems poised to grow over the coming quarters at 3½ percent or better according to almost all forecasts, with unemployment in the low to mid-5s and negligible inflation. Not a bad outcome at all.

Clearly, there are some challenges. I think the fiscal deficit poses a problem, and we’ve talked about the external deficit as well. But in this context, I ask myself, Is this an economy that still needs negative real fed funds rates as a stimulus? Or do such rates have the potential to cause real problems for both inflation and financial stability? The answer to the latter question may be “not any time soon,” but we may now have an opportunity to avoid those problems at little cost. So that’s one side of my internal argument. The other side takes into account how far we are in terms of economic growth from where we could, and maybe should, be. Every forecast I know of, the Greenbook included, has significantly written down growth for the last half of this year and for 2005. Estimates of excess capacity, whether that is measured in output or by employment, have been raised a bit over the summer. And now the Greenbook expects that such gaps will not close until later in the forecast time period—mid-2006—with less tightening than that expected by the markets.

Inflation has fallen off a bit in the first half and seems likely to stay low absent a major acceleration in oil prices, which likely would have more of an effect on growth than inflation. With the fiscal stimulus from the partial-expensing tax provisions removed next year and with profit growth moderating, the forecast seems to hinge primarily on levels of employment growth that we just haven’t seen yet.

I usually conclude this part of my internal argument with this question: Aside from the fact that we’ve just about told the markets that we’re going to increase rates by 25 basis points today, why is that necessary? In the end, I find myself continuing to come down on the side of removing policy accommodation slowly, at least for now. I don’t think negative real rates are consistent with an economy that is growing at the solid pace ours is. Real funds rates are marginally negative, depending on how one calculates them, and will be less so, or even slightly positive, after a 25 basis point move.

As I said at the August meeting, I really don’t know where neutral is, and I think it would be good to have a discussion about this whole concept of neutral at some point. But to quote President Santomero from the last meeting, it is probably above where we are. I don’t think we should go to neutral soon, but getting out of negative territory has appeal to me. Markets expect a change today, and halting now could make things seem worse than they are. I must say, though, that if the data don’t start to get better soon, especially as they relate to employment, I think we should take the pause that the Greenbook anticipates.

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