Thank you, Mr. Chairman. Economic growth in the Fifth District softened further in recent weeks, but we don’t see any indications that the expansion is off track. Manufacturing shipments and orders continue to expand, although manufacturing employment appears to be flat or declining in our District. Retail activity in our region has been soft lately, consistent with the national figures. Outside the retail service sector, activity has been flat overall since August, but our District continues to outpace the nation in residential construction. We’re hearing complaints about the cost of construction materials, and the scarcity of heavy- equipment operators appears to be limiting construction work in some areas. More broadly, while our directors and other contacts report expanding economic activity across a variety of sectors, there is a lingering sense of unease about the pace of this recovery. Several contacts say that firms are reluctant to add workers, and many attribute this to concerns about the continuation of the recovery.
Turning to the national economy, in spite of the encouraging net job growth in August and the upward revisions to the data for the two previous months, the September Greenbook has written down expected job growth this year from what was anticipated in August. The end-of- year output gap is correspondingly a couple of tenths wider than in the prior projection, and there’s a commensurate reduction in the expected path for core consumer prices both this year and next. I think it’s reasonable to project that the labor market will gradually improve and that the output gap will close by the end of 2006, helped along by a less aggressive rise in the funds rate as built into the Greenbook forecast. That said, though, I think that the recent data have clouded the picture enough to suggest substantial downside risk in the outlook. Evidently we’re not returning just yet to the growth rates that we had been anticipating prior to the recent soft patch. Thus, some markdown in the expected funds rate path seems warranted.
Much of the financial market nervousness about inflation evident earlier in the year seems to have receded. Nevertheless, financial markets still expect a funds rate about 75 basis points higher by the end of 2006 than does the Greenbook. That expectation continues to keep long-term interest rates higher than they otherwise would be. The Greenbook anticipates that long rates will come down as we follow through and raise the funds rate on the expected path. The result is something of a central banker’s dream—a rising policy rate accompanied by falling long rates. However, should the economy truly need the greater stimulus assumed in the Greenbook, we should be alert to other possibilities in the period ahead. Markets might again get more nervous about inflation, and long rates might rise rather than fall as we indicate a less aggressive rate of increase in the funds rate. Clearly, that would be counterproductive.
Accordingly, I think we should be cautious about sending such signals. We could well find that our credibility for low inflation is sufficiently secure that signaling our intention to move the funds rate up less aggressively succeeds in lowering long rates and stimulating the economy. On the other hand, we might be unpleasantly surprised.