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

Thank you, Mr. Chairman. Economic conditions in the Third District continue to improve, and business sentiment is positive. Manufacturing activity in the region continues to expand, and the index of general activity in our January business outlook survey showed a strong rise to 38.8 percent, the highest level we have seen since the early 1990s. The indexes of new orders and shipments were a bit lower in January than in December, but they also are at the highest levels we’ve seen since the early 1990s. Gains were broad-based, with only textiles and food products showing net negative readings.

We, like the other Districts, participated in the Board staff’s survey on capital spending plans. We surveyed sixty-nine firms in the manufacturing, finance, trade, and service industries in our District. Fifty-five percent of the respondents said that they plan to increase capital spending in 2004, whereas only 15 percent plan to decrease spending. The margin of “increasers” over “decreasers”—I don’t think those are words, by the way—[laughter] is larger than it was last June, when only 33 percent planned increases and 25 percent planned decreases. In our District the most common reasons cited for the rise in capital expenditures were higher sales growth and the need to replace capital goods. The latter was a point that came out in one of the slides shown by the staff this morning. I should add, however, that most of the firms we contacted indicated that the year-over-year increases in capital spending would be slight to moderate. I would also note that the majority of firms in the national survey that planned increases have already placed orders associated with that planned spending. This is true in the Third District as well, but firms in our region appear to be waiting a bit longer to place orders than firms in the rest of the nation.

Retailers in our District reported that sales growth during the holiday period was solid, meeting or exceeding their expectations. On average, sales were up 4 to 5 percent from year-ago levels in area stores, though our retailers had expected 3 to 4 percent growth rates. The last time we met I reported that business lending in the Third District was beginning to pick up. This has continued. Several of our bankers reported that they have seen more optimism among business customers and expect business lending to continue to expand.

Construction activity maintains the pattern it has shown since the recovery started. Residential construction and home sales continue to show strength while commercial real estate markets remain soft. The job market in our region continues to outperform that of the nation as a whole but still must be characterized as weak. For the three states in total, payroll employment basically has been flat since the start of the recovery compared with a 0.6 percent decline nationally. And the tri-state unemployment rate averaged 5.3 percent for the fourth quarter according to the data released just yesterday, compared with 5.9 percent for the nation. In summary, the economic recovery continues to build momentum in our District. This is being reflected in the improved mood and sentiment of business contacts in our region, who are projecting further improvement this year.

Turning to the nation, economic activity continues to expand at a strong pace, although employment remains soft. The consumer continues to support the recovery, while investment spending is coming back, supported by strong profit growth. The recent weakness in job growth is the biggest disappointment, as we all have pointed out here. These data seem to be at odds with the survey evidence—including the business outlook survey, which suggested that firms are beginning to add to their payrolls. Nonetheless, we can only respond to the data we have. The Philadelphia staff forecast sees stronger job growth going forward, though less strong than the Greenbook does. Although productivity growth is unlikely to match the 5 plus percent pace we have seen, we believe it will remain strong enough that the near-term improvement in labor markets will be moderate but positive. In our forecast, job growth is expected to be around 2 percent this year and next. That pace of payroll growth translates to about 200,000 jobs per month over the next two years. This picks up on the theme that President Minehan mentioned earlier about the Greenbook forecast for employment gains being much stronger than that. The job growth we forecast is a bit slower than pre-recession numbers—job growth averaged 2½ percent in the late 1990s, for example—but it is consistent with the reports we are getting from our business outlook survey respondents and other firms about their hiring plans. We forecast a modest decline in the unemployment rate to 5½ percent for the fourth quarter of this year and 5¼ percent for the end of next year.

Our forecast for GDP growth is similar to that of the Greenbook, with consumption growth in the 4 percent plus range supported by improved job prospects. The higher tax refunds expected this year lead us to forecast somewhat stronger consumer spending in the first half of the year compared with the second. Our forecast for business spending is slightly stronger than that of the Greenbook, but both can be characterized as robust. We expect the expiration of the investment tax credit to pull some investment forward to 2004 from next year. Growth abroad is also expected to strengthen next year, and in our judgment, this combined with the lagged effect of dollar depreciation means that export growth will accelerate over 2004 and 2005 whereas import growth will decelerate over 2004 and 2005. Thus, we believe that trade will be less of a drag on GDP growth in 2004 and may make a small positive contribution.

Our view on inflation differs only a bit from the Greenbook. Like the Greenbook, we expect strong productivity growth and only slow improvement in labor markets to keep inflation low this year. However, we are forecasting a small acceleration next year. Even so, inflation in our forecast remains very low—in the 1¼ to 1½ percent range—over the next two years. As with all forecasts, there are risks. But to my mind the risks seem to be smaller, and they also appear to be balanced. Given all of this, I see no reason to change our policy stance now. However, given the lags in monetary policy, the time for a change is approaching. So I believe we need to think about the conditions that would cause us to adjust policy and what we need to do now to increase our flexibility to respond to changing events. It could turn out that there will be a surprise on the upside, and we have to be prepared for that. Thank you, Mr. Chairman.

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