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

Thank you very much, Mr. Chairman. The incoming data, as almost everyone has noted, appear to validate the confidence that emerged at the last meeting that a sustainable expansion seems most likely to be under way. Almost all components of domestic final demand seem to be on a relatively firm footing. Household consumption is clearly benefiting from stimulative policies and the effects of rising stock market and housing wealth as well as improved consumer confidence. Residential real estate investment also is on a solid footing, with recent declines in mortgage rates most likely to support a strong housing market for some time to come. Importantly, the expansion seems to have broadened out, as others have indicated. In the business sector, incoming data on new orders and shipments, when combined with survey and anecdotal data, do suggest that businesses are likely to increase their investment in a widening range of capital goods as opposed to retrenching. Finally, the firming that is under way domestically also appears to be occurring overseas.

Of course, this good news must be tempered by a clear understanding that firms are not yet creating jobs as quickly as we would like. However, even in the labor markets there are a few positive signs. Aggregate hours rose in the fourth quarter as a whole, which I think was the first quarterly increase since 2000. The unemployment rate has declined, and initial claims also seem to be shifting downward. The other small fly in the ointment is that core prices seem to have drifted somewhat lower during the intermeeting period, I believe in large part because of strong productivity growth—a theme to which I will return shortly. Given my reading of these incoming data, I think I can accept the contours of the baseline forecast in the Greenbook, which for me implies the desirability of ongoing patience with the current stance of monetary policy.

However, even against that benign outlook, there are a couple of risks that confront us, and I must say that they are in some sense inconsistent. On one hand, I have some concerns that the baseline Greenbook forecast has assumed a fairly large drop in the growth rate of structural labor productivity for 2004 and 2005 from its estimated level in 2003. I fully agree that productivity growth cannot pick up indefinitely. Trees don’t grow to the sky, as they say. However, if the rate of change in structural productivity were to come closer to maintaining its 2003 level instead of falling as in the baseline forecast, the outcome would be better captured by one of the two faster productivity growth scenarios in the Greenbook. Both call for somewhat lower inflation. I think that echoes the point that President Broaddus has already touched on and that we in fact discussed earlier today in the question and answer session right after President Minehan’s question. Now, it’s obviously very hard to know exactly what is going to happen to productivity, as the answers that Dave Stockton gave indicate. But if one looks at the special survey of Beige Book contacts that many have referred to, it’s quite clear that one of the major factors behind the capital goods spending plans for this year is the desire to replace either IT or other capital goods. Therefore, businesses will again have the possibility of capturing some efficiency-enhancing improvements that come with the technological capabilities embedded in some newer generations of equipment. If they do so, we may well find that productivity growth is stronger than in the baseline forecast; and against the backdrop of inflation, which is already at the low end of the range that I find acceptable, that clearly calls for some important discussion about what our policy should be.

On the other hand, I have another kind of concern, which has to do with the state of financial markets. During the intermeeting period, we saw quite a run-up in the prices of equities, as businesses proved that they indeed have a great deal of earning power if not much pricing power. Nonetheless, during that same period, interest rates dropped quite significantly. Risk spreads have come down, which is a good thing as Governor Kohn suggested but also may indicate an underappreciation of the risks that may be embedded. Frankly, to put it mildly, I think that the dollar carry trade has become extremely well entrenched and that the markets are looking to us perhaps more than they should be. One small piece of evidence in this regard is that the flows of the funds and the behavior of multifamily investments strike me as being somewhat out of touch with the fundamentals. This suggests to me that perhaps we are anchoring the yield curve more than we’d like, and in my mind we need to try to do two things simultaneously. One is to suggest that inflation risks, while they have receded from corrosive disinflation or deflation, still tend to be tilted a bit to the downside. The other is to suggest that markets should be looking at and calibrating more fully the incoming data and the underlying risks to the economy. I’m afraid that at this stage, given the high productivity possibilities, the fixed-income markets in particular are not in fact doing the appropriate job of pricing risks. We need in some sense to remove the anchor that we have placed on those markets. With that, Mr. Chairman, I’ll stop and look forward to the second half of our discussion.

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