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

Thank you, Mr. Chairman. As in other regions of the country, the Richmond District economy is increasingly signaling a sustained economic expansion, at least as far as demand and production are concerned. Our sense is that holiday sales were solid. And service-sector companies in our District—there are many, including trucking companies, financial sector firms, and law firms, and we have a lot of law firms—[laughter] are all telling us that their businesses have strengthened most recently.

More important for our region, though, manufacturing activity appears clearly to have bottomed. We still have textile companies and apparel companies in the Carolinas that are hurting, but that’s largely the ongoing result of a secular adjustment. Other manufacturing companies in our region, especially high-tech companies but also manufacturing companies producing such things as construction equipment, indicate that they are doing better. New orders at factories have been rising at an increasingly rapid pace in recent months according to the monthly manufacturing survey that we conduct. That survey has an employment component, which in the month of December gave us the first non-negative reading that we’ve seen in about two years. That may be a sign that the long decline in factory jobs in our region is ending, at least in the aggregate. Related to this, the results of the capital spending survey that we did in response to the Board staff’s request were, as in other Districts, much better than those from the previous survey in the summer. I think that in general business decisionmakers are much more confident as to the durability of the expansion than they were earlier.

Finally with regard to the regional economy, despite the evidence of slightly firmer aggregate demand and increased production, we don’t see clear signs that our labor markets are firming significantly at this point. This relates to the central issue you were underlining, Cathy, and that we are all grappling with at the national level. However, as I said earlier, I see encouraging evidence that the hemorrhaging in the factory sector may now be ending.

With regard to the national economy, the broad contours of the Greenbook forecast have not changed a lot since December. To summarize what everybody knows, the forecast for real GDP growth is about 5½ percent for this year and 4 percent for next year. The Board staff still anticipates that the employment gap will be eliminated over the forecast period, but not completely until the end of next year. And core consumer inflation is expected to remain at about 1 percent. For me, the really interesting part of the Greenbook forecast discussion—and I suspect this is true for a lot of other people around the table—lies below the headline growth and inflation projections. Namely, the substantial increase in estimated structural productivity growth in 2002 and 2003 is expected to continue this year and next. The Greenbook now concludes that much more of the recent productivity surge is permanent than was thought to be the case before.

I find this reassessment of broad productivity growth very interesting. I have been worried for a while that the productivity surge may be longer lasting than had been assumed in earlier staff forecasts. The key point here, of course, is that this development certainly has the potential to move the employment gap in the wrong direction. That is, it could widen the gap or at least keep it from closing as rapidly as we would like to see. I think that risk is nicely summarized by the alternative scenario in the Greenbook that is labeled “temporarily faster productivity growth.” In fact, I thought the two alternative scenarios on productivity growth were very helpful, but the temporarily faster productivity alternative is the one that I would focus on here. It describes how the public may perceive the productivity gains as a one-time increase in the level of productivity rather than a sustained rise in productivity growth going forward. In the case of a one-time level increase, the public would not feel much wealthier, and aggregate demand would potentially fall short of the increase in aggregate supply resulting from the higher productivity growth. In that scenario, the output and employment gaps would widen rather than close, and inflation conceivably could fall further.

In this regard, I think it is worth underlining that, in this Greenbook forecast, the trend in the output gap stays fairly constant compared with the last Greenbook despite the significant increase in productivity. The reason, of course, is that the forecast assumes that the trend in labor force growth slows by about as much as the trend in productivity growth increases, with the result that the path of potential output is not changed. My concern here is that extrapolating the recent weakness in labor force growth forward may be a mistake. In fact, Part 2 of the Greenbook presents evidence that more workers may be discouraged by poor hiring prospects now than has been the case historically. I don’t know if the Greenbook mentioned this, but immigrant domestic workers could be discouraged in this situation. And the result could be that the overall U.S. workforce is now more cyclically sensitive than earlier, meaning that trend labor force growth may not decline, in contrast to the Greenbook assumption. In this situation, workforce growth would likely pick up strongly as employment growth begins to pick up. This means that it would take longer to absorb the labor market slack than the Greenbook projects. In that case, the risk of further disinflation would be greater than the Greenbook discussion might suggest, and that of course is where I was going with all of this.

My bottom-line concern, for the reasons I have just summarized—and I’m back to where I started—is this: Even though the real growth and inflation projections in the baseline forecast have not changed a lot since the December meeting, I think a good case could be made that the risk of further disinflation is greater in the current forecast than in the previous one. I’m not going to conclude from that assessment that we should ease policy, but this would be a basis for me to want to resist changing policy in the other direction. Thank you, Mr. Chairman.

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