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

Thank you, Mr. Chairman. First, I want to make a comment about state and local finances, an issue that several people have mentioned. I think that is going to be a concern for some time. The census numbers for the State of Ohio indicate that during the decade of the 1990s—between the 1990 census and the 2000 census—there was a 12 percent absolute decline in the 19 to 44 age group, which doesn’t seem to bode well for the future. And the projections for the next decade are that we will have the second lowest population growth and employment growth on record, which means that the tax base is eroding. A clear implication for the governor, the legislature, and many journalists is that Ohio needs to raise taxes significantly in order to address its problems. So I hope everybody else also will raise taxes because this strategy is not going to work too well otherwise.

Within the region, economic activity is generally characterized as slowly improving. While the levels of sales and production are up from their recent lows, the pace of increase is certainly slow. The recovery in trucking and shipping has been earlier and stronger than was expected at the beginning of this year; but employment, especially at the parts suppliers, has not yet started to rise. Several of the manufacturers in the region believe that they will be able to exceed prior peak levels of production with significantly fewer workers. I’m going to come back to that point in just a minute.

In the automotive sector, the combination of continued strong sales and optimism expressed by senior management is not translating into either capital spending or employment increases so far. Instead, both parts and assembly plants are reporting that considerable overtime is being paid. Reports from two specific companies are worth mentioning because they offer a hopeful indication of what would be nice to start hearing from others. Timkin reports that its efforts over the last couple of years—the company has gotten rid of some plants, downsized, shrunk its labor force, and so on—will be reflected in much better earnings this year. The firm also says that both its domestic and its international business have been improving recently. Pittsburgh Plate and Glass notes that demand from both the residential construction and the automotive sectors remains strong and now its chemical business is recovering after a two-year slump. Moreover, the weaker dollar is helping exports, and overall profitability is now rising.

The tourist destinations in the region are off to a strong start, and industry observers believe that traffic will easily exceed last year’s levels. But group sales, mainly blocks of tickets sold to companies that use them for their employees, are down. Hiring at these tourist locales has been much easier this year. And contacts say that wages paid have remained flat for the third year in a row, but they are still able to raise ticket prices.

One large retailer headquartered in the District, Federated, continues to struggle but seems to accept that their problem may well be simply that their business model doesn’t fit the current environment. Another director who sits on the Kohl’s Department Stores board always provides a cheerful and optimistic report to offset the downbeat report that we get from Federated. In retail categories, furniture, appliances, electronics, and jewelry are all reported to be strong. In view of the low reported levels of inventories in these categories, retailers are reporting fewer sales promotions and markdowns than a year ago at this time.

The housing market at the lower end of the price range is reported to be doing very well throughout the region while the upper end of the housing market is characterized generally as being dead in the water. Lots and lots of million dollar houses that were built don’t have owners or they have “upside down” owners. The bankruptcy of a large residential builder in the greater Cincinnati area is creating a lot of problems because it involved a very major fraud. We don’t know the magnitude of it yet, but it’s very large. So there are a lot of single-family and multifamily housing projects throughout the region that are unfinished and abandoned. This has caused at least three dozen banks to incur significant losses and has left more than 200 homeowners with prior claims or construction loans against their houses. We think there is one bank whose survival is very much in doubt and two others whose capital has been severely impaired.

With respect to capital spending plans, even companies that are described as sitting on piles of cash—that’s the way their bankers describe them anyway—have taken a wait-and-see attitude. And the reason given is that management is still unsure how much productivity and efficiency can be wrung out of prior investments before additional capacity can be justified. That raises an intriguing question: If at the micro level individual firms simply claim not to know their potential or their capacity, how can we be very confident about those measures at a macro level? It also says something at the micro level of the firm: There must be a shift under way in Okun’s law, and where it will end up we don’t know at this point.

At a recent meeting of our Community Bank Advisory Council, several bankers described their business customers as sounding more pessimistic than their actions imply. Nevertheless, it is generally asserted that business customers continue to pay down old loans and are attempting to build liquidity. The almost total absence of reports of either business or personal bankruptcies seemed to surprise even the bankers. It appeared that there was a tendency for each member to believe that his own bank’s experience was the exception and that somebody else must be incurring a lot of losses. But nobody claimed that that was happening at his or her bank.

Let me turn to the national economy. Whatever the problems of various sectors, regions, or industries in this country or whatever the problems plaguing many foreign economies, there certainly are limits as to how far highly expansionary monetary policy can go to be helpful before going too far and becoming part of the problem. At some point, and I tend to think it will be sooner rather than later, it is going to become essential for us to move to a more neutral stance of monetary policy and to find the patience to wait for other necessary adjustments to work through the system.

I want to say something about the idea of risk versus uncertainty in the classic sense. Risks, of course, are at least potentially quantifiable in some probabilistic way. The staff does a good job of sensitizing us to the various risks to the economic outlook, and that’s very helpful. But uncertainties are quite different. We face an environment where the uncertainties are more important than the various risks that we can identify. There are uncertainties associated with almost certain events in the Middle East, but we cannot quantify those uncertainties in any useful way. There are uncertainties in the form of “Enronitis” associated with the legacy of the last few years. How much of that has carried into the present and how long it is going to hang over this economy and our markets is something that I don’t find very easy to contemplate in a quantifiable way. The implication for me is that we are going to be event driven and we are going to be reactive for quite some time, and in my view that’s the best that we can hope to do. Thank you, Mr. Chairman.

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