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

Thank you, Mr. Chairman. Economic activity in the Seventh District continues to pick up, and our business contacts are clearly more optimistic than they have been in years. On Friday, the Chicago purchasing managers will release their January report. The index will be at 65.9, the highest level in nearly twenty years; everything was strong except for inventories and employment. Of course this is confidential until Friday.

From our contact calls, we have heard three interesting themes regarding capital expenditures, labor markets, and prices. First, plans to increase capital spending have become more broad-based. And we were encouraged by our District’s results from the Board’s recent survey: 62 percent of respondents in our District plan to increase their capital outlays over the next twelve months, up from 37 percent last June. The survey and our other contacts suggest that, for firms in our region, replacement demand is still the driving factor rather than capacity expansion. Spending continues to be for equipment rather than structures. The survey also indicated that tax incentives are more important in our District than elsewhere, perhaps reflecting the longer lead time for our mix of industries.

We continue to hear good reports from producers of telecom equipment and heavy machinery, and orders for medium and heavy-duty trucks jumped dramatically as shipment load factors have improved. One automaker said that fleet sales to rental car agencies, which have been sluggish since September 11, 2001, finally picked up in the fourth quarter. For January, automakers expect light vehicle sales of 16½ million to 17 million units. As a cautionary note, there is still a good deal of uncertainty about the how the month will play out even though we are almost at the end of January. Our contact at General Motors pointed out that half of their monthly sales during 2003 took place in the last six days of each month.

The second theme that we are hearing is that labor markets are improving, with fewer reports of layoffs and more plans for permanent hires. Both of the large temporary-help firms that we contact have continued to see steady growth in workers on assignment. One of them noted that transitions from temporary to permanent positions have increased recently, and we are hearing some other reports of permanent hiring, but much of it involves replacing departing workers. In my District this is happening at all levels, including the highest ones. In fact, I am looking to replace four of my contacts who are among the ranks of the recently departed CEOs. [Laughter]

The third theme is that, despite robust demand, we are hearing mixed stories about the ability of businesses to increase prices. Several firms have been unable to push through modest price hikes. A large printer told us that paper suppliers tried several times to raise prices but none of the increases stuck. A specialty retailer reported that consumers are buying only if the product is on sale. And a major airline added a fuel surcharge to ticket prices but abandoned it eighteen hours later. A few firms, however, have been able to raise prices or reduce discounts. Last quarter one of the Big Three automakers increased their average net price—that is, the average sticker price minus incentives—for the first time in five years. In heavy equipment, one manufacturer pushed through a price increase, and more generally we are hearing of fewer price concessions. And, of course, strong demand internationally, especially from China, has boosted steel prices.

Turning to the national outlook, on balance the numbers have been strong. The strength in capital spending now extends beyond high-tech goods and into more traditional equipment. Consumer spending has held up well, and residential investment remains robust. The obvious exception to the recent positive news, as we were discussing earlier, is the payroll employment series. December’s data were particularly disappointing, especially in light of the encouraging claims numbers. Given the statistical uncertainties, we probably don’t want to place too much weight on the employment figures at least until we see January’s report.

More generally, our GDP outlook is close to the Greenbook’s. Over the near term the risks regarding inflation appear to be nearly balanced, as we said in December. I do not see any urgency for changing the funds rate target, but the key question is what to do about the phrase “considerable period” in our post-meeting statement. My preference would be to remove it at the earliest practical date. Our previous statement conditioned the phrase on low inflation and resource slack, so given this conditioning we probably should retain it until we see some more positive signs on employment, which I hope will be by our next meeting.

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