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

Your next exhibit discusses key trends in the labor market. As Larry noted in his first chart, until very recently, payroll employment has been notably weak in this expansion. As shown by the blue line in the top left panel, gains in payroll employment have run well below the typical postwar cyclical experience and have now diverged even from those in the jobless recovery of the early 1990s. Of course, the flip side of the lack of employment growth has been the spectacular increases in labor productivity in recent years. In putting together our forecast, we have again reassessed our outlook for the supply side of the economy in light of these latest developments.

With the comprehensive revision to the national income and product accounts not changing the underlying picture of productivity growth in the past few years, and with the gains in payroll employment remaining on the anemic side, we have raised our estimates of structural productivity. As indicated in the top right panel, we now estimate that structural multifactor productivity increased almost 3 percent last year, as businesses met increases in demand by better management of their existing capital and labor resources. We don’t think increases in structural MFP of last year’s magnitude are likely to persist, but we have boosted our projections for the growth of structural MFP this year and next. Even with these revisions, the estimated level of actual productivity (shown in the middle left panel) lies above its structural trend. We expect actual productivity to run about parallel to the trend early in 2004, resulting in continued modest gains in payrolls (the middle right). But with businesses becoming more optimistic about sales prospects, we anticipate that hiring will pick up, bringing the level of actual productivity back into line with the estimated structural trend in 2005. Returning to the top left panel, you can see by comparing the slopes of the three lines that, once hiring picks up in earnest, employment grows at about the same rate as in preceding business cycles.

Despite the lack of gains in the payroll survey of employment, household employment has increased, and the unemployment rate (the black line in the bottom left panel) has fallen. I should note that, although it has outpaced the payroll survey measure, growth in household employment in this expansion also has been weak relative to its normal cyclical pattern. Moreover, with the labor market perceived to have little vitality, the labor force participation rate (the red line) has moved lower, on net, over the past four years. As is illustrated in the bottom right panel, this pattern seems consistent with past cyclical movements in participation about its estimated trend, and we are anticipating some upward movement in participation in the not-too- distant future in response to the past and prospective firming in economic activity. However, such an increase in the participation rate still remains a forecast, and we clearly cannot rule out the possibility that further declines in participation will result in a more rapid decline in the unemployment rate than we are projecting in the January Greenbook forecast.

Your next exhibit presents our current projections of potential GDP. As can be seen by comparing lines 1 and 3, we did not raise our estimates of potential by as much as our estimates of structural productivity. This reflects three key considerations. First, post-revision rates of wage and price inflation seemed consistent with our earlier estimates of resource gaps. Second, our model of Okun’s law, shown in the middle panel, remained solidly on track after the comprehensive revision. Third, based on the persistent differences in the growth of hours worked in the household and payroll surveys, we reduced the so-called technical factor (shown on line 6) that accounts for the differences in the trend growth of hours in the household and payroll surveys. As can be seen in the bottom panel, the resultant forecast of the GDP gap is little different from the December Greenbook. And we continue to project the elimination of slack in both product and labor markets by the end of next year.

Your next exhibit presents recent data on inflation. After an energy-related bulge at the beginning of 2003, consumer prices—as measured by either the CPI or the PCE price index—slowed significantly, on net, over the remainder of the year. There also was a broad-based slowing in measures of core consumer price inflation (the top right panel) to a pace of about 1 percent. In contrast, as shown in the middle left panel, food prices accelerated over the course of last year. The pickup was related to stronger foreign and domestic demand for beef as well as to some delays in the supply response to higher prices. The middle right panel illustrates how this excess demand bid up the prices of live cattle until the discovery of mad cow disease in the United States in late December (shown as the vertical line in the panel). After a few days of significant declines, spot cattle prices stabilized at their levels of last summer and then ticked back up a bit. Futures prices suggest some downward pressure on spot prices in the first half of this year. As far as labor costs are concerned, we will get the ECI for the fourth quarter on Thursday. Wage inflation, as measured by average hourly earnings in the bottom left, fell to a 2 percent pace in December, reflecting the slack in labor markets and relative stability in expected inflation, shown on the bottom right.

Your next exhibit outlines our outlook for inflation. Overall PCE inflation is expected to slow to a 1 percent pace, on average, over the projection period. The decline from last year’s pace reflects smaller increases in food prices and renewed declines in energy prices. Core PCE prices also are projected to rise at about a 1 percent pace—a tad higher than last year. Although non-oil import prices are expected to give a slight boost to inflation this year, continued strong growth in structural productivity, stable inflation expectations, and some remaining slack in resource utilization are expected to keep core inflation contained. The middle right panel presents the outlook for ECI compensation per hour, which is projected to increase about 3¾ percent per year in 2004 and 2005—a bit below the pace in 2003. We expect the contribution from wages and salaries to fall slightly as the influence of labor market slack is almost offset by somewhat greater pass-through of productivity gains into wages. Pressure from rising health insurance costs and a cyclical increase in bonuses is responsible for the rise in the contribution of benefit costs over the projection period. The bottom two panels update our FRB/US-based estimates of the probability of deflation. As you will recall, we have presented two definitions of deflation in the past. We defined “effective” deflation to be PCE price inflation of ½ percent or less. “Pernicious” deflation adds the additional requirement that the unemployment rate exceeds 6 percent. As shown on the bottom right, although both probabilities have fallen significantly since your June 2003 meeting, they still remain nontrivial risks to the staff forecast.

Finally, at the risk of inflicting further psychological trauma on the Chairman, the last exhibit presents your forecasts for 2004. [Laughter] The central tendency of your projections for real GDP is 4½ to 5 percent, which you forecast will result in a decline in the unemployment rate to between 5¼ and 5½ percent. You project consumer price inflation to be little changed this year at a pace of 1 to 1¼ percent. That concludes our report. My colleagues and I would be happy to answer any questions you might have.

Keyboard shortcuts

j previous speech k next speech