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

Thank you, Mr. Chairman. Economic activity in our Southeast region also remained sluggish over the intermeeting period. Both retail and auto sales have been weak, while manufacturing has been soft except for defense-related production. Excess capacity still exists in the commercial real estate sector, and state governments continue to struggle with strained budgets. Labor markets were largely unchanged in March, with the District unemployment rate at 5.1 percent. Firms remain reluctant to hire new full-time employees. We’re not hearing reports of significant increases in the use of temporary workers either. On the brighter side, Florida tourism and single-family construction and home sales in most of our markets remain at healthy levels.

To get a handle on the effects of uncertainty on business investment, we specifically asked our thirty-five Branch directors who met with us last week whether the resolution of the war was affecting investment plans. The answers we got suggest both that it was too soon to tell and that people were now turning their heads to reassess domestic economic fundamentals, which at least in some sectors still didn’t favor expansion. Reportedly, most investment continued to be concentrated on replacement rather than expansion. That said, there was clearly a more optimistic business tone concerning the near term. I was perhaps most fascinated by comments I got at a lunch meeting of Atlanta CEOs last week. Four different CEOs came up to me individually as we gathered for lunch to comment on encouraging signs or developments in their business. Interestingly, during the lunch when the host asked the group for comments about the economy, those same individuals sat quietly. [Laughter] I’m not sure what that tells us. Putting it all together, I found little in either the available data or the anecdotal information from our region that clarifies whether the current thinking and behavior are a result of uncertainty or are simply a realization of the downside risks. It seems that it’s just too soon to tell.

This is how I read the incoming data at the national level as well. While it’s easy to be at least a little disappointed that we haven’t yet seen concrete evidence of growing momentum, the data are just not sufficiently distant from the war period to allow us to parse the economic consequences of resolving war-related uncertainty from the economic fundamentals. The consensus among most private forecasters as well as the Greenbook and my own forecast all make a reasonable case for growing momentum as we move through the year and into next year. But I agree with the Chairman’s observation in his recent testimony that the future path of the economy is likely to come into focus only gradually.

The outlook for inflation is always an important part of our policy deliberations, and there continues to be a debate about the potential dangers of deflation. I take these concerns seriously also, but I am not yet convinced that deflation is our foremost risk at this time. Briefly I’m going to indicate why. The deflation issue is not simply about a declining price level but rather reflects concern about the potential for a significant and widespread weakening in real activity and the disruptions to financial intermediation that accompany it, like those we experienced in the Great Depression. The Great Depression deflation was in my view the result of widespread real economic weakness, policy errors, and extreme domestic financial distress, along with international financial shocks that together formed the “perfect storm.” The question is whether we see similar preconditions today for such an episode and if so, what is the supporting empirical evidence.

We clearly have experienced significant external shocks. But the real economy is recovering, albeit slowly. It is not contracting. Some sectors do continue to suffer. Prices are falling for output in certain industries—the airlines, telecom, high-tech and manufactured goods generally and for some commodities. These are relative price declines, however, and do not reflect across-the-board deflation. In most instances the causes are easily explainable by idiosyncratic shocks or industry-specific circumstances. The price declines flow from productivity increases, overcapacity, increased global and local competition, outmoded business models, and secular industrial change.

As a consequence, the relative price declines particular to these sectors are going to occur no matter what we do in the monetary policy area. Even so, the concern for policy may be that the weakening of relative prices will feed through into a general deflation. To date, however, there is no sign that this is happening. Inflation is still positive. Furthermore, none of the expectations measures either from surveys or the term structure signal that deflation is on the horizon. Lastly, the fall in the value of the dollar relative to the currencies of countries experiencing inflation is not consistent with a deflationary scenario for the United States.

What about policy mistakes? In the Great Depression, the money supply contracted over 30 percent, and financial intermediation came close to shutting down. Today, monetary policy is quite accommodative in my view, the monetary aggregates continue to grow, and bank balance sheets and capital positions are favorable. Financial conditions today appear far more positive and simply aren’t comparable to the distress situation observed during the Great Depression. Intermediation is taking place, and creditworthy borrowers continue to fund themselves through depository institutions and capital markets. What we are seeing now in the financial distress indicators such as measures of default, chargeoffs, and delinquencies are within the range of standard recessions and are not in my view symptomatic of a debt deflation, nor are they a concern to banking supervision at this time.

For some there is the specter that what happened in Japan may also happen here. My reading of the conditions in Japan, however, suggests that they parallel the problems of our Great Depression. The main difference is a matter of degree, timing, and the willingness of the government to prop up economically insolvent institutions with implicit guarantees. Real economic activity in Japan has declined for nearly a decade, and a gradual deflation appears to be expected. Financial distress in Japanese depository institutions is the most significant and well-known problem. Were it not for implicit government guarantees, these institutions would likely have failed a long time ago, and the economy may have gone into a tailspin. In the meantime, Japan continues to consume its accumulated wealth. Again, the features of this experience are not in my view comparable to our own situation at this time.

Looking ahead to our policy discussion, I would observe again that interest rates are already low, monetary policy is already stimulative, fiscal policy is stimulative and likely to get more so, and most forecasts are showing growing momentum as we move through the year and into next year. It seems to me that we have time to let the war-related uncertainty unwind and to wait for the path of the economy to become clear. Thank you, Mr. Chairman.

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