With the exception of the deterioration in the external imbalance, our view of the outlook has not changed significantly since the last meeting. The inflation news seems better. The growth news seems somewhat reassuring but not exciting. There do not appear to us to be any compelling signs at this stage of a deeper and more protracted deceleration in growth that might raise concern about the sustainability of the expansion.
Relative to the tone around the room, I’d put myself at a slightly more optimistic point on the continuum. On the expectation that we will continue to move monetary policy toward a more neutral stance at a pace that matches present market expectations, we expect the economy to grow at the pretty solid rate of around 4 percent in real terms for the balance of this year and at a pace of just over 3½ percent in ’05 and ’06. And we see core PCE staying close to a range of 1 to 1½ percent during that period.
The fundamentals of the staff forecast remain as they have been. There is reasonably steady improvement in the labor market, with healthy growth in compensation supporting consumer confidence and consumption. Productivity growth reverts only gradually to the still- impressive average of the ’90s surge. Global demand growth remains quite broad-based—at close to potential—though not strong enough to help exports provide a positive contribution to U.S. growth. With strong balance sheets, enterprises commit more resources to investment and to employment growth and compensation. Unit labor costs accelerate modestly, and firms absorb some of that increase with lower margins, as competitive pressures contain pricing power. We see the probability of a higher or lower trajectory to this outlook of 3½ to 4 percent real growth and 1½ to 2 percent on the core PCE as roughly balanced for both growth and inflation, though perhaps we should be uncomfortable on how moderate and benign this outlook looks.
This leaves us with slightly lower growth than the Greenbook and slightly higher inflation, but those differences are not particularly large. The main differences in our views involve the path of monetary policy and its consequences. The Board’s staff sees a considerably more gradual move upward in the fed funds rate, with the consequence that the real fed funds rate stays low relative to most measures of neutral or equilibrium for a longer time, without inducing much in terms of a surge in growth above potential or in terms of accelerating inflation. In this sense, Janet raises the right question. I think she has the right answer.
To us the greatest sources of uncertainty involve the issues of whether households decide to save more of their income, whether enterprises show less tentativeness in spending, and whether the process of arresting and reversing the deterioration in our external imbalance will be traumatic or benign. Higher household saving, of course, would be a rational response to a number of forces, including an increase in debt with interest rates rising, the prospects of lower future returns on housing, the expectation that individuals will bear more of the burden of rising health care costs and more of the risk in accumulating a viable pension benefit going forward, and the prospects of higher taxes over the medium term.
We don’t have a good explanation for the degree of tentativeness among U.S. businesses that remains. Perhaps it will fade. Businesses nationally are showing somewhat less confidence in the strength and sustainability of this expansion than we seem to think is justified. The virtue in this, of course, is that they’ve gotten themselves less overextended. Our Empire survey, for what it’s worth, shows a significant recovery in September in sentiment about present and prospective business conditions and almost every other indicator that we asked our survey respondents about. Hopefully this portends good things for the nation.
The deterioration in our forecast for the external imbalance puts us in very uncomfortable territory, more vulnerable to a shock to confidence. The fact that the dollar has been broadly stable and long-term rates have fallen in the context of the large upward revision to the expected path of the current account deficit may suggest that the risks in this area have diminished, but I suspect that is not the case. And just because a problem has no apparent solution does not mean it’s not a problem. [Laughter]
I think we should be quite comfortable with the path of the fed funds rate now priced into the markets; and we should be pleased with how responsive the slope of that path has been to changes in the data. My view is that we should seek to leave that path unchanged in our signal today. We don’t see evidence of upside risks at this point that would justify inducing a steeper path. And absent a major change in our confidence about the strength of future demand, I think we should be careful not to induce expectations of a more gradual tightening until we have established a more definitively positive real fed funds rate and have moved closer to the range that defines neutrality. Thank you.