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

Thank you, Mr. Chairman. Economic activity in the Third District continues to expand. Our region did not experience the June lull seen in other parts of the country, but in the last month we’ve seen some easing in the pace of growth—perhaps a delayed lull rather than a new trend. Manufacturing is a case in point; our business outlook survey index of general activity fell to 13.4 in September from a robust 28.5 in August. In contrast, the index of new orders strengthened in September, and shipments remained very high. It’s fairly unusual for us to get disparate readings across the general activity, orders, and shipments indexes.

I will note that the comments we received from respondents were generally positive and more consistent with the readings on new orders and shipments. In a special question this month, we asked how firms’ investment spending had been affected by the special tax depreciation allowance. About a quarter of our firms said that the allowance led them to increase their spending on capital equipment this year, and it appears that these firms have smoothed out the spending over the year. Consistent with the continued strength in new orders, half of our firms report that they expect to spend more on capital equipment in 2005 than they did last year, and a quarter of them expect to spend significantly more.

Each of the three states in our region experienced positive job growth in the first two months of the third quarter. Employment growth in the third quarter has slowed from the second quarter but is about the average of the first two quarters combined. After five consecutive quarters of decline, the three-state unemployment rate edged up to 5.2 percent on average in July and August. Despite the increase, the statewide unemployment rates in each of our three states remained below the national average, and we continue to receive reports that some firms are having difficulty finding qualified workers. I thought that’s where President Stern was going on the hiring story because I keep hearing that story in the Philadelphia District.

Retail sales of general merchandise have been rising in the District, although year-to-year gains have eased from earlier in the year. Some of the year-to-year weakness in August was to be expected because last August’s sales were significantly buoyed by the tax rebate checks that were received around that time. Commercial real estate markets in the region remain soft, but we’re beginning to see a slight improvement in nonresidential construction. This is concentrated mainly in warehouse construction, with office construction still quite flat. Residential activity is now beginning to moderate from the very strong pace earlier this year, but home sales remain strong, and house appreciation continues at a high rate in our three areas. We continue to get readings of rising prices in our region, with firms expressing concerns about rising fuel prices and mental and other health care costs. The outlook among the contacts in the region’s business community is for continued improvement this year, with modest gains anticipated. Our staff’s leading indexes of economic activity are all signaling output growth in the three states in the region over the next three quarters and stronger employment growth as well.

Turning to the nation, incoming data suggest that the economy is emerging from the soft patch. Consumer spending has picked up, although it is not growing as strongly as it was earlier this year, as several people have noted. Manufacturing activity has rebounded, and business investment continues to expand at a good pace. Payroll employment gains improved in August after two months of weak reports.

Despite oil prices hitting $50 a barrel in mid-August, inflation has eased somewhat from levels seen earlier this year, and long-term inflation expectations remain steady. The economic fundamentals continue to suggest that inflation will remain in check. However, I am not as sanguine about the inflation outlook as the Greenbook. The Greenbook has GDP growth above potential for the next two years. At the end of that period, the output gap is eliminated, yet monetary policy remains accommodative, with the fed funds rate below neutral. It’s difficult for me to believe that the inflation picture could be as favorable as the Greenbook suggests unless the fed funds rate is at or above neutral at that point.

On balance, the data suggest to us that growth for the year will likely be 3½ to 4 percent, in line with what President Stern indicated. In my view, this is a reasonably good showing, although I must admit it’s about 1 percentage point weaker than we had forecast at the beginning of the year. At this point, I believe the FOMC should remain on the course of continuing to remove policy accommodation at a measured pace. The real fed funds rate will remain negative even if we move ¼ percentage point today; thus, monetary policy will remain expansionary and will help ensure the sustainability of the recovery despite higher oil prices and diminishing fiscal stimulus. Finally, I see no reason to alter our risk language at this time. I think it gives us the necessary room to deviate from the measured pace in either direction, if that proves to be necessary. Thank you, Mr. Chairman.

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