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

In constructing our outlook for the rest of the world this time, the task we faced was basically the same one we confront each Greenbook: We needed to determine to what extent the information we had received over the intermeeting period was consistent with our forecast in March and to what extent it represented unexpected developments that appropriately required some adjustments to our projection for this year and next. Although the task was familiar and routine, the challenge was particularly difficult this time as so much of what has happened since your meeting in March was driven by the extraordinary events in Iraq. For the last three to four weeks, since the phase of major hostilities in Iraq wound down, global financial markets appear to have responded to fundamental economic news more than was the case earlier in the intermeeting period. Nevertheless, we have little hard evidence on developments in the real sectors of foreign economies since the most acute geopolitical risks substantially abated.

Developments in global oil markets are the most straightforward to evaluate. Relative to our forecast in the March Greenbook, we are now projecting the average spot price for WTI oil in the current quarter to be $9 lower. The same comparison for the fourth quarter of next year yields a difference of less than $1. Thus events have largely pulled forward in time a reduction in world oil prices that had been expected to occur but more slowly. The most direct effect of that change is on the total cost of imported oil for most countries, including our own, and we have visibly reduced the U.S. external deficit this year and next year accordingly. For major U.S. trading partners who are also oil exporters, such as Mexico, we have incorporated a negative hit to their trade balance and to their aggregate income.

The indirect effects of the lower path for global oil prices are less straightforward. We judge that confidence on the part of consumers and businesses abroad should be boosted by the rapid fall in oil prices and the consequent benefit to real disposable income and business costs. That difference should be greatest in the near term. To date we have limited evidence on confidence abroad since the end of hostilities, and what we do have presents a somewhat mixed picture. On balance, we saw the lower oil prices as a moderate positive for consumer and business spending abroad, particularly for the rest of this year.

The foreign exchange value of the dollar fluctuated somewhat widely in the days just before and following your March meeting, mostly in response to developments within Iraq. Since early April, however, the dollar has trended down on balance and in terms of the index of major foreign currencies has recently moved below its March 12 low point. No doubt more by luck than any forecasting skill we might have, fluctuation of the dollar–euro rate left that pair about in line with the path we wrote down in March. We have adjusted down the U.S. dollar in terms of the Canadian dollar and the Mexican peso. In contrast, we have adjusted the dollar up in terms of the yen. Taken together, these changes imply a slightly weaker level for the real value of the dollar in terms of our broad index of trading-partner currencies, but the rate of change from here through the end of the forecast period is projected to be about the same as in our previous forecast.

As in the United States, stock prices in most major foreign economies have rallied in recent weeks. Equity prices are now up for the year in many European markets. The average across Europe represented by the DJ Euro Stoxx price index is back to no net change for the year, after reaching a low of 20 percent below its late December level on March 12. Stock prices are up on balance this year in major Latin American emerging-market countries also, including Mexico and Brazil. For those countries, EMBI+ spreads on dollar bond rates are down substantially as well. We interpret these favorable developments in financial markets as consistent with an improvement in confidence over time and a strengthening of real GDP growth. For now we judge these developments to be in line with the pace of strengthening that we projected in March but not a reason for revising upward our growth outlook for these countries.

Stock prices in Japan and emerging Asia are the exception to the general picture of rising equity values. In Japan, stock prices touched new twenty-year lows on several occasions during the intermeeting period. Although some prices rebounded near the end of the period, the major stock price indexes remain well below their values at the start of this year. We attribute the downward trend in Japanese stock prices to the domestic concerns that continue to dog the Japanese economy, plus some possible spillover from rising tensions with respect to North Korea and the effects of SARS on Japan’s major trading partners in the region. The latest data have left us slightly more optimistic about the pace of economic activity in Japan this year, but we do not detect any evidence that would call for a major revision to our outlook for economic activity in that country.

One new element in the global economic picture since your March meeting has been the emergence of SARS as a major economic threat to most of the emerging Asia region. Even though we have no expertise in anticipating the course of the disease, construction of the Greenbook baseline forecast required that we make a set of working assumptions about its implications for economic activity. As we reported in the Greenbook, we incorporated into the forecast the likely consequences of SARS based on the information known at that time. In large part that involved limiting the effect of SARS primarily to key service sectors such as travel and entertainment and positing that its adverse effects would be felt mainly in the current quarter. We have added some small positive payback later this year and in early 2004 as the lost travel and sales are partially recouped. This approach yielded an estimate of a downward revision to growth this year in developing Asia that averaged about 0.5 percentage point owing to the SARS outbreak. Based on the information we have to date, we see the effects as largest for Hong Kong, somewhat less but still quite visible for China and Singapore, and much smaller for various other Asian emerging-market economies.

The end product of our attempts to incorporate these various developments into the baseline forecast is a projection for total foreign output growth of about 2 percent in the first half of this year—¼ percentage point lower than we had in March—followed by growth of 3 percent in the second half of this year and about 3.5 percent next year. As is the case with the domestic forecast, despite quite favorable outcomes of many events related to the Iraqi conflict, we have revised down the path of foreign GDP. Most of the downward revision is due to our estimate of the near-term effects of SARS on global growth. The weaker projection for U.S. real output growth is a factor as well, particularly for Canada and Mexico. The more favorable oil price developments and some buoyancy in global financial markets provide a small offset. That concludes our remarks. We’d be happy to answer any questions.

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