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

Thank you, Mr. Chairman. Since our last meeting, economic activity in the Twelfth District has continued to expand at a solid pace but more slowly than earlier in the year. In most of the District, housing markets remain vigorous, but there have been scattered signs of cooling in some areas. High volumes of international trade have kept many seaports operating at capacity and have overburdened parts of the warehousing and distribution chain. So far, however, bottlenecks have been relatively minor. District job gains remain modest and well off the pace of earlier in the year. Looking forward, our contacts report that they expect to increase hiring in coming months to meet sales and output levels. Many comment, however, on the difficulty of finding workers with the requisite skills and experience. Relatively unskilled labor, in contrast, is perceived to be readily available.

Turning to the national economy, recent data suggest that the sharp slowing in activity in June was short-lived. The bounceback in consumer spending, including auto sales, is encouraging, and the drop in oil prices from recent highs should also help. While all of this is good news, we still haven’t seen real strength in job growth, and it’s not yet clear whether output growth will return to the robust rates of last year or something much closer to the growth rate of potential. These are key issues because of the slack remaining in labor and product markets. In this regard, the Greenbook presents a rather sober view of the economic outlook, despite its assumption of persistently low real interest rates.

I’m in sympathy with the Greenbook’s view. First, while the oil shock almost certainly had something to do with the recent weakness in the economy, I have yet to be convinced that its effects were particularly large. Therefore, we might not get a big boost to activity from its dissipation. Second, it seems likely that partial expensing is providing noticeable stimulus to equipment investment this year, which means that the underlying impetus in the recovery is not as strong as many think. Finally, I remain concerned about the potential for weakness in consumer spending, which could restrain growth even more than the Greenbook envisions. In spite of only modest income growth, consumer spending provided critical support for aggregate demand during the recession and afterward, and the saving rate remains at an extremely low level. With interest rates rising, households may seek to get their finances in order and bring the saving rate up to more normal levels. An alternative simulation in the Greenbook illustrates that this could be a potent factor in restraining growth over the next couple of years. In addition, mortgage refinancings have remained low, and the associated loss of cash flow to households could undermine spending for a time.

Turning to inflation, the data for July and August have been very favorable, especially following the May and June data, which also showed modest increases in core consumer prices. This development strongly suggests that the run-up in inflation last winter reflected temporary factors.

Overall, it’s a bit of a mystery why this expansion has not been marked by faster average growth together with a larger reduction in the amount of slack, given persistently easy financial conditions, including the low levels of real interest rates, as well as the decline in the dollar and the increase in equity prices over the past year or so. But, of course, continuing caution in the wake of September 11, the wars in the Middle East, and the corporate governance scandals are reasonable candidates for an explanation. The continuation of this pattern suggests that the equilibrium real federal funds rate remains quite depressed relative to its historical average, so monetary policy must remain accommodative for the foreseeable future. A pause in the process of raising the funds rate is, thus, likely to become appropriate in the near future, especially if inflation remains well behaved as expected. At the present time, however, the real funds rate is so low that a modest tightening at this meeting seems justified.

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