Yes, the brilliant new chairman! I am concerned, though, that we’re starting out this year in a soft spot, unlike the last two years when we had stronger growth in the first half of the year. Hours worked are continuing to decline in this soft period, employment is falling, and production in the manufacturing sector in particular is showing significant weakness. The main impetus for the recession was the weakness in business fixed investment, and the forecast for BFI has again been revised downward in the Greenbook for this meeting.
I agree with some of the comments that have already been made around the table that, while corporations are cautious, they haven’t been inactive. We’ve seen significant improvements in inventory control, advances in productivity, and increased liquidity as firms have moved to longer-term funding and as cash flows have risen because of improving profit margins. But as I look at this picture, I’m still relatively pessimistic as to what is going to happen to spark business confidence again. So I tend to believe that the risks are biased toward weakness, especially given that I accept the forecast that economic growth will be below potential even beyond the 2004 forecast horizon.
What about the outlook on the inflation front? As several people have already remarked, the Greenbook assessment that the probability of deflation by the end of next year is 35 percent clearly is a statement that catches one’s attention. Further, I know that the staff has been doing work on the confidence intervals for various measures of inflation and the measurement bias. That work shows all three major inflation measures at the top of the confidence band of about 1 percent by the end of next year. This concerns me. We don’t need to see deflation because disinflation—getting the inflation rate down to 1 percent—is a significant enough issue.
There has been a lot of talk that businesses don’t have the confidence to invest because of concerns raised by governance issues. I think the lack of confidence relates to the continuing outlook for very weak pricing power. Business management tries to commit to the marketplace that their company will show earnings growth. They commit to that by expecting some type of top line revenue growth. But we’re sitting here expecting economic growth over the forecast period to be below potential, with inflation at 1 percent. That means that if a corporation makes a serious commitment to growth, they have a very small margin of error. When cash flow from top line growth provides a robust level of new incoming revenue, companies are more able to take the risk of investing in new business lines and new plant openings. But with an outlook for continued sluggish economic growth and overall inflation at 1 percent or less, in effect we confront a disinflation risk world that at some point cumulatively slows growth going forward. Therefore, I support the comments that President Santomero made about the importance of averting a disinflation psychology in the period ahead.
So I’m concerned that we have risks on both fronts right now—the risk of real growth below potential for quite a long time and also a risk of further disinflation that is considerably stronger now than we would like. I don’t think I can identify a bias or say that the risks are balanced or unbalanced. In my view we don’t have a Phillips curve situation. I think we have two negatives facing us.