Category Archives: USA

More on ‘now vs the 70’s’

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Comments people emailed me and my responses:

Bob Hart wrote:

http://www.wtrg.com/prices.htm

This graph supports your statement below:
Prices fell from a high of maybe $40 per barrel to the $10-15 range for the next two decades

2008-02-21 Crude Oil Production OPEC Countries

Thanks!

“So, there is nothing the US can do to keep core inflation in check? Only the Saudis (and other oil producers) control US inflation?”

In this case, yes. If the Saudis keep hiking cpi goes up and an inflation begins via the various channels that connect energy with other prices. And in this case exacerbated by our pension funds.

Randall Wray wrote:

right: previous high inflations have always been: energy, food, and shelter costs. I haven’t looked at shelter costs this time around.

Haynes wrote:

Great piece. I’ve been thinking along the same lines over the last few weeks. I wish I had been a lot shorter the long end but think that trade still makes sense, especially given future deficits over the next 3-5 years. Having been born in the 1980s and not lived through oil embargos, stock market stagnation and hyper inflation, I am not exactly sure what the play is over the near-term and longer term. If you were to set up a portfolio that couldn’t be changed over the next 3 yrs / 5yrs / 10yrs what do you think the mix should be?

I like AVM’s current mortgage construction: buy FN 5’s versus tailored swap at LIBOR plus 25 basis points with a ‘free’ embedded put. Put it on and sit tight for Fed hikes. Worst case you get LIBOR plus 25.

Call your AVM salesman ASAP before the spread vanishes!!!

Do you buy TIPS / Broad based commodities indices (DJP) / Gold / Stocks / short end / long end?

‘Raw’ TIPS imply a low real rate. If the Fed decides to rais the real rate, you lose.

You could do a 10 year break even bit, especially in Japan, but I like the mortgage trade better.

Think that you could get killed owning bonds but input prices have already run so much its hard to buy commodities in a potentially declining demand environment. Do you buy stocks hoping they simply stay inline with inflation or do you just hold cash?

In the medium- and long-term the S&P will probably more than keep up with inflation, but help to get the right one and to get the right entry point.

Thanks for the help. I know you are busy but any insight would be much appreciated. thanks.

Philip wrote:

I agree entirely with the view that the 1970s was a question of energy prices, a supply-side phenomenon rather than anything else. The implications for policy are important; we might produce a problem where it does not exist if policy is predicated on the wrong interpretation of the problem.

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Now versus the 1970s

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Looks very much like the 1970’s to me.

Yes, the labor situation was different then – strong unions due to strong businesses with imperfect competition, umbrella pricing power and the like.

But it was my take then that inflation was due to energy prices, and not wage pressures. Inflation went up with oil leading throughout the 1970’s and the rate of inflation came down only when oil broke in the early 1980’s, due to a sufficiently large supply response. It was cost push all the way, and even the -2% growth of 1980 didn’t do the trick. Nor did 20%+ interest rates. Inflation came down only after Saudi Arabia, acting then as now as swing producer, watched its output fall to levels where it couldn’t cut production any more without capping wells, and was forced to hit bids in the crude spot market. Prices fell from a high of maybe $40 per barrel to the $10-15 range for the next two decades, and inflation followed oil down. And when demand for Saudi production recovered a few years ago they quickly re-assumed the role of swing producer and quietly began moving prices higher even as they denied and continue to deny they are acting as ‘price setter’ with inflation again following.

And both then and now everything is ultimately ‘made out of food and energy’ and hikes in those costs work through to everything else over time.

There are differences between then and now. A new contributor to inflation this time around are our own pension funds, who have been allocating funds to a passive commodity strategies as an ‘asset class.’ This both drives up costs and inflation directly, and adds to aggregate demand (also previously discussed at length).

Also different is that today we’ve outsourced a lot of the labor content of our gdp, so I suggest looking to import prices of high labor content goods and services as a proxy for real wages. And even prices from China, for example, have gone from falling to rising, indicating an inflation bias that corresponds to the wage increases of the 70’s.

Costs of production have been going up as indicated anecdotally by corporate data and by indicators such as the PPI and its components. These costs at first may have resulted in some margin compression, but recent earnings releases seem to confirm pricing power is back and costs are pushing up final prices, even as the US GDP growth slows.

US policies (discussed in previous posts) have contributed to a reduced desire for non residents to accumulate $US financial assets. This plays out via market forces with a $US weak enough to entice foreigners to buy US goods and services, as evidenced by double digit growth in US exports and a falling trade gap. This ‘external demand’ is providing the incremental demand that helps support US gdp, and corporate margins via rapidly rising export prices.

World demand is high enough today to support $100 crude, and push US cpi towards 5%, even with US GDP running near zero.
As long as this persists the cost push price pressures will continue.

Meanwhile, markets are pricing continued ff rate cuts as they assume the Fed will continue to put inflation on the back burner until the economy turns. While this is not a precise parallel with the 1970’s, the era’s were somewhat similar, with Chairman Miller ultimately considered too soft on inflation during economic weakness. He was replaced by Chairman Volcker who immediately hiked rates to attack the inflation issue, even as GDP went negative.

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February 19 recap

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Might be a revealing day coming up.

I’m watching for markets to begin to link higher oil prices to the potential for higher interest rates, rather than the reverse as has been the case since August.

With oil up to the mid 97 range this am, the question is whether short term interest rates move higher due to possible Fed concerns about inflation, even with weak growth and continuing financial sector issues. Even Yellen recently voiced concerns about energy prices now feeding into core inflation measures which are now above her ‘comfort zone.’ And Friday Mishkin said more than once in a short speech that the Fed had to be prepared to reverse course if inflation expectations elevate.

Yes, credit spreads are a lot wider, but when, for example, I ask the desk if any of the wider AAA’s are ultimately money good, I get a lot of uncertainty. So it seems to me in many cases markets are functioning to price risk at perceived potential default levels? So some of the current spreads may be wider than they ‘should be’ but maybe not all that much?

Yes, the financial sector has been damaged (and damnaged).

Yes, housing is weak without the bid for subprime housing of 18 months ago.

And yes, the consumer has slowed down some.

However, exports are booming like a third world country- growing around 13% per year, also do to financial market shifts, this time away from $US financial assets.

This is offsetting weakening domestic demand and keeping gdp positive, at least so far.

Meanwhile, it looks like a full blow 1970’s inflation in the making if food, fuel, and import/export prices keep doing what they are doing.

And with Saudi production continuing to creep up at current pricing, seems demand is more than strong enough for them to keep hiking prices.

And suddenly Yellen and Mishkin, both doves, substantially elevate their anti inflation rhetoric, as core levels have gone just beyond even their comfort zones.

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Year over year export growth

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Year over year export growth is looking strong and today’s Dec number revises Q4 GDP estimates to up 1% (vs initial government report of up 0.6%).

Also note that Q4 lost 1.25% as inventories built in Q3 were drawn down. Smooth the inventory numbers for Q3/Q4 and that implies Q3 would have been up 3.65% and Q4 up 2.25%.

This also supports the upwardly revised December payroll number.

The likelihood of strong January exports is one factor that leads me to suspect the January employment number will be revised up as well.

And if exports continue to grow at current rates though Q1 it will also be higher than expected, with exports continuing to pick up the slack from housing.

2008-02-14 YoY Export Growth

YoY Export Growth

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Government spending may be accelerating

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US Jan budget surplus narrows as spending hits record

by David Lawder

WASHINGTON, Feb 12 (Reuters) – The U.S. government posted a $17.84 billion budget surplus for January, less than half the year-earlier surplus, as spending hit a record for the month while receipts fell from a year ago, the U.S. Treasury said on Tuesday.

The January surplus narrowed compared to a year-earlier surplus of $38.24 billion and also missed the $23.5 billion surplus forecast by economists polled by Reuters.

A Treasury spokeswoman said January is more often a deficit-producing month, with January deficits in 34 of the past 53 years.

Federal outlays last month grew to $237.38 billion — a record for the month of January — from $222.37 billion in January 2007.

Might be back on the 7% growth trend as 2007 spending my have been delayed and moved forward to 2008.

But after years of consistently strong year-on-year growth, government tax receipts dipped to $255.22 billion in January from $260.61 billion from the same month a year earlier.

Could be a sign of economic weakness.

I don’t have the details yet – there can be a lot more to these numbers than the headlines indicate.

Economic data has shown a substantial slowing of the U.S. economy in recent weeks, including a decline of 17,000 non-farm jobs in January. The White House has forecast that the full-year budget deficit will more than double to $410 billion this year due to the revenue slowdown and a $152 billion in fiscal stimulus spending package.

Now a $169 billion package.

The deficit for the first four months of fiscal 2008, which began Oct. 1, widened to $87.70 billion, from a $42.17 billion budget gap for the same period a year earlier. (Reporting by David Lawder; editing by Gary Crosse)

Government spending and exports now supporting GDP and offsetting some of the consumer weakness.

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Stagflation

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Yes, the below analysis has also been the Fed’s position, up until this week’s speeches.

It’s been about a crude/food/$ negative supply shock, supported by Saudis/Russians acting as swing producer and biofuels linking crude prices to food prices.

The fed has called the price hikes relative value stories that they don’t want turning into an inflation story. They feel they have room to cut rates as long as expectations stay well anchored, which includes wage demands but other things as well.

Yellen the dove, along with the hawks, now saying inflation expectations are showing signs of elevating, and saying energy costs are being passed through to core inflation is a departure from previous Fed rhetoric and may signal they are at or near their limits regarding ff cuts (data dependent, of course).

Also, Bernanke pushing Congress and the President to add to the deficit could also be a sign he is reaching his inflation tolerance regarding lowering the FF rate. The mainstream belief is that inflation is a function of monetary policy, not fiscal policy.

Now with the ECB perhaps throwing in the towel on inflation as well, look at how the commodities are responding. ‘Cost push inflation’ is ripping, and the perception is the CB’s around the world will act to sustain demand, including pushing for larger fiscal deficits.

Difficult to explain why so many have stagflation on the brain It is difficult to explain why so many folks still have stagflation or inflation on the brain just because wheat prices have soared to new highs. We have to distinguish between relative and absolute pricing. Not only that, but unlike the 1970s, the current ‘inflation’ backdrop is much more narrowly confined. The key is the labor market. And here we have a 4-quarter growth rate in unit labor costs of a mere 1% in 4Q (a three-year low), which compares to 4% heading into the 2001 downturn. In other words, as far as the labor market is concerned, inflation is less of a threat to the economy than it was at this same stage of the cycle seven years ago. In fact, heading into the 1990 recession, the trend in ULC was also 4% – the Fed sliced the funds rate from almost 10% to 3% that cycle, for crying out loud. In fact, scouring more than 50 years’ worth of data, at no time in the past has the year-to-year trend in unit labor costs been as low as it is today heading into an official recession. Make no mistake, deflation is going to emerge as the next major macro theme.

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U.S. Job-Market Weakening Is Led by Self-Employed

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Keeps getting stranger by the day.

Next thing they’ll be saying is GDP really fell in Q3 and Q4, but the drop was all in off the books transactions.

By the way CNBC actually put positive, overstated spin in the headlines on a couple of things. They said mortgage applications were the highest in years where previously the same news would have headlined that refis fell and purchase applications were still below the spike of a couple of weeks ago.

Also, they headlined Plosser’s tough talk on inflation, rather than his statement that there could be more room to ease.

This is the first time I’ve seen this since August.

Claims tomorrow. If they stay up it will be a very different day than if they drop.

U.S. Job-Market Weakening Is Led by Self-Employed, Data Shows

by Carlos Torres

The increase in U.S. unemployment that’s jeopardizing economic growth is being driven by a drop in the number of people working for themselves, government figures indicate.

Hours worked by the self-employed dropped at a 15.5 percent annual pace in the last three months of 2007, the biggest decrease in 15 years, according to data provided to Bloomberg News today by the Labor Department.

The decline “is probably related to the housing downturn, since one in six workers in construction is self-employed, twice the average for all industries,” said Patrick Newport, an economist at Global Insight, a Lexington, Massachusetts, forecasting firm.

The figures may be another indication of how the deepest real-estate slump in a quarter century is filtering through the economic statistics. The Labor Department said today that worker productivity grew more than forecast last quarter as hours for all employees, including those who work for themselves, fell at a 1.5 percent pace, the most in five years.

The number of people running their own businesses dropped by 365,000 last quarter, compared with the same period in 2006, according to separate Labor Department numbers.

The decline in the number of hours worked by the self-employed last quarter reflected a 9 percent annualized drop in employment combined with a 7 percent decrease in average weekly hours for those still with work, the department said.

Data Discord
The issue may also help resolve some discrepancies among various labor statistics, economists said.

The unemployment rate, calculated from the household survey that covers the self-employed, jumped 0.3 percentage point in December. The increase prompted some economists to predict the U.S. was already, or would soon be, in a recession.

Even as the jobless rate rose, revised figures from the survey of businesses, which doesn’t track single-employee companies, showed hiring accelerated on average from the third quarter to the last three months of the year. Payrolls dropped in January for the first time in more than four years.

“Self-employment, as only calculated by the household survey, is probably reflecting the slump in the subprime mortgage market,” said Michael Englund, chief economist at Action Economics LLC, a forecasting firm in Boulder, Colorado.

Mortgage Brokers
Many mortgage brokers involved in the subprime industry work for themselves, Englund said, citing anecdotal evidence and conversations with clients.

Self-employment may also help explain why first-time applications for jobless benefits have yet to reach levels normally associated with a weakening labor market. A four-week moving average of claims has ranged from 306,000 to 345,000 since July. Most economists believe it takes readings in excess of 350,000 to indicate an increase in firings.

Self-employed Americans, although they may file claims, are not eligible for benefits under the unemployment insurance system, according to the Labor Department.

“This could really help explain a lot of the conflicting signals in the data,” said Englund.

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Plosser Speech

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Plosser is perhaps the most hawkish Fed president.

Look for a dove to speak soon to soften this stance?

(intro remarks deleted)

The FOMC and Monetary Policy Objectives

In conducting monetary policy, the FOMC seeks to foster financial conditions, including growth of money and credit and a level of
short-term interest rates, consistent with achieving two goals: price stability and maximum sustainable economic growth.

Note this general policy statement:

I believe that the most important contribution the Fed can make to sustained economic growth and employment rests on credibly committing to and achieving long-run price stability. In fact, without a credible commitment to maintaining price stability, the Fed’s ability to promote sustainable growth would be seriously undermined. Moreover, price stability is not only an important element in achieving sustained economic growth, it is also critical in promoting financial stability.

That is the mainstream view, and the view the Fed has presented to Congress over the years regarding how it complies with its dual mandate: get price stability right and markets function to promote optimum long-term growth and employment.

The primary tool for implementing monetary policy is the federal funds rate,

(SNIP)

It is important to recognize that the influence of changes in the FOMC’s targeted funds rate on inflation and economic growth occurs with a lag, so by necessity the FOMC must be forward-looking in setting an appropriate funds rate target. It must forecast future economic growth and inflation based on available economic data and financial conditions, including a particular path for the fed funds rate.

(SNIP)

A change in the economic outlook is what was at work in the last two weeks when the FOMC decided to reduce its target fed funds rate in two steps to its current level of 3 percent.

Let me elaborate on recent economic and financial conditions and my current outlook for the economy and inflation.

The Outlook
Since last August, financial and economic conditions have deteriorated. As that occurred, policymakers revised downward their forecasts for 2008 economic growth. This took place in several steps as new data were released and, in turn, led the FOMC to lower the federal funds rate in a series of steps.

By last September, we had already seen a cumulative deterioration in the housing sector during the earlier part of 2007. In addition, the disruptions in financial markets in August caused by the problems in the subprime mortgage market raised the risk of potential adverse effects on the broader economy from a further tightening of credit conditions. As a result, I lowered my projection of economic growth for the fourth quarter of 2007 and the first half of 2008. In particular, the adjustment to my forecast involved pushing back the turnaround in residential construction, as low demand for homes meant it would take longer than expected for the economy to work off the inventories of new and existing homes for sale. The continuing high prices of oil and other commodities also suggested the potential for some slowing in the pace of economic activity, as well as hinting at increasing inflationary pressures — a point I will return to later. As the outlook changed, the FOMC lowered the fed funds rate target by 50 basis points in September, and then by another 25 basis points in both October and early December.

Since the Committee’s meeting in early December, the economic data have indicated that the deterioration in the housing market has continued unabated. Although that by itself was discouraging, other economic indicators also showed signs of an economy that was weakening. The renewed widening of some credit spreads in financial markets, along with weaker figures for retail sales, manufacturing activity, and job growth in December, led many forecasters in early January to further mark down their forecasts for 2008. The sharp rise in December’s unemployment rate, which was released in early January, also heightened many economists’ concerns about the economy’s health. What’s more, the Philadelphia Reserve Bank’s closely watched manufacturing survey recorded a surprisingly steep decline in industrial activity in January, to a level not seen since the last recession.

Although the economy’s resilience to past shocks makes me cautious about making changes to my outlook based on just one or two pieces of economic news, the string of weaker than anticipated numbers released in late December and in January had a cumulative effect on my own assessment of the 2008 outlook. While I would not be very surprised if the economy bounces back more quickly than many forecasters are now projecting, I am now, nevertheless, anticipating a weaker first half of 2008 than I did in October. This downward revision to the economic outlook is what led me to conclude that a substantially lower level of interest rates was needed to support the process of returning the economy to its trend rate of growth. Consequently, I believe the recent reductions in the federal funds rate were a necessary and appropriate recognition of this changed outlook.

The ongoing housing correction and the volatility and uncertainty in the credit markets are significant near-term drags on the economy and I expect growth in the first half of the year to be quite weak, around 1 percent. As conditions in the housing and financial markets begin to stabilize, I expect growth to improve in the second half of the year and to move back to trend, which I estimate is around 2.7 percent, in 2009. Overall, I am now anticipating economic growth in 2008 of near 2 percent.

Confirming ‘trend’ GDP at 2.7%.

Given the slowdown in economic growth this year, payroll employment will rise more slowly than last year and will remain below trend for much of the year before picking up in 2009. Slower job growth will also lead to an unemployment rate near 5-1/4 percent in 2008, after fluctuating between 4‑1/2 and 5 percent in 2007.

Two adjustments will continue to be needed to help work down the large number of unsold homes: further cuts in construction and declines in housing prices. I expect the decline in housing starts will bottom out in the middle of this year, but starts are likely to then be quite flat through the end of 2009 as the inventory of unsold homes is reduced gradually.

Interesting how long he thinks starts will stay around one million.

Of course, as was the case in 2007, how quickly housing bottoms out remains one of the main uncertainties surrounding any forecast in today’s environment. It seems that ever since last spring, the turnaround in housing was always six months away. Well, nine months later, it is still six months away. Simply having housing stop contracting will help economic growth. In 2007 the decline in residential construction took 1 percentage point off real GDP growth, which turned out to be 2.5 percent for the year (4th quarter to 4th quarter). Once residential construction stops declining, it will cease subtracting from overall growth. But housing is unlikely to make a positive contribution to economic growth until 2009.

Business investment should continue to increase this year, but at a slower pace than in 2007. Outside of autos and housing, there isn’t a large inventory overhang in the economy to be worked off. This is actually good news. Recessions are often preceded by periods of large inventory accumulation and much of the decline in production during recessions reflects a working off of an inventory imbalance. The absence of such an inventory overhang is encouraging.

The biggest component of GDP is consumer spending. With slower growth of employment and personal income in the first half of 2008, and as the decline in the value of homes and equities diminishes households’ net worth, consumer spending is likely to grow more slowly before picking up again in 2009.

One piece of good news has been the growth in exports. The trade sector supported economic growth last year as domestic demand weakened in the U.S. while foreign growth remained strong. The declining dollar also helped fuel a rebound in our exports. The net export component of GDP should continue to improve this year, although more slowly than it did in 2007 because we are likely to see somewhat slower growth among our major trading partners this year.

Inflation
Let me now turn to the outlook for inflation. Unfortunately, I expect little progress to be made in reducing core inflation this year or next, and I am skeptical that slower economic growth will help.

My understanding is the Fed was forecasting weakness that would bring down inflation.

All you have to do is recall the 1970s when we experienced both high unemployment and high inflation to appreciate that slow economic growth and lower inflation do not necessarily go hand in hand. I anticipate that core inflation (which excludes the prices of food and energy) is likely to remain in the 2 to 2‑1/2 percent range in 2008, which is above the range I consider to be consistent with price stability. If oil prices stabilize near their current levels, I expect headline, or total, inflation to decrease to around the 2 to 2‑1/2 percent range in 2008.

That is not a welcome forecast for the FOMC. They don’t want to conduct policy that lets core get that high.

(SNIP)

As the FOMC’s January 30 statement said, it will be necessary to continue to monitor inflation developments carefully. Most measures of inflation, including the core CPI and core PCE price measures, accelerated in the second half of 2007 compared to the first half. With inflation creeping up, we have to be particularly alert for rising inflation expectations. It is important that inflation expectations remain stable. If those expectations become unhinged, they could rapidly fuel inflation.

Again, that is the mainstream view. The expectations operator is key to a relative value story turning into an inflation story, as they say.

Moreover, as we learned from the experience of the 1970s, once the public loses confidence in the Fed’s commitment to price stability, it is very costly to the economy for the Fed to regain that confidence. The painful period of the early 1980s was the price the economy paid to restore the credibility of the Fed’s commitment — we certainly do not wish to go through that process again.

The mainstream often states it this way: ‘The real cost of bringing down inflation once expectations elevate is far higher than the cost of a near term recession.’

Fortunately, so far inflation expectations have not changed very much. But they bear watching because there are some signs that they, too, are edging higher. These may be early warning signs of a weakening of our credibility, and we must be very careful to avoid that.

The Fed is divided here. Most say that if expectations begin to elevate, it could be too late -the inflation cat is out of the bag- so, that much be avoided at all costs. Others say you can let them elevate a little bit, but must then act quickly to bring inflation down.

Monetary Policy Going Forward

(SNIP)

Over the course of the last five months, as forecasts for economic growth have been revised downward, the FOMC has lowered the fed funds rate by 225 basis points — from 5.25 percent to 3 percent. Taking expected inflation into account, the level of the federal funds rate in real terms — what economists call the real rate of interest — is now approaching zero. That is clearly an accommodative level of real interest rates. The last time the level of real interest rates was this low was in 2003-2004. But that was a different time with a different concern — deflation — and we were intentionally seeking to prevent prices from falling. Recently we have had reason to be worried about rising inflation, not declining prices.

This is a very strong statement – real interest rates are near zero, which was maybe appropriate given deflation fears in 2004, but he says not that is not the issue.

The FOMC’s reductions in the federal funds rate have been proactive in responding to evolving economic conditions that led to the deterioration in the outlook for economic growth. My inclination to alter monetary policy depends on whether the accumulation of evidence based on the data between now and our next meeting causes me to revise my forecast further. Weaker than expected data might lead to a downward revision, while stronger than expected data may lead to an upward revision to the forecast.

To make this point concrete, last Friday the Bureau of Labor Statistics reported that the economy lost 17,000 jobs in January. This was not an encouraging number. However, it was consistent with my forecast of weak employment growth in the first quarter of this year. Thus, by itself, it does not lead to a substantive revision to my forecast. We must look at the accumulation of data from a variety of sources to assess how the outlook may have changed relative to what was expected.

The payroll number did not change his forecast.

I also want to note that in early January there was much concern when the BLS reported only 18,000 jobs were created in December. Yet in the employment report last Friday that preliminary number was revised up to 82,000. Thus, we have to realize that economic data are subject to revision, and we have to be very careful not to rely on any one statistic or data series in assessing current economic conditions or our outlook.

Looks like he recognized January may be also revised up as December and August were.

There are those who have expressed the view that in times of economic weakness, the Fed must not worry about inflation and should focus its entire effort on restoring economic growth by dramatically driving interest rates down as far and as rapidly as possible. To borrow a line attributed to that famous, or perhaps infamous, Union Admiral David Farragut at the Battle of Mobile Bay, it is sort of a “damn the torpedoes, full speed ahead” approach to policy. But the Fed has a dual mandate for a reason. Price stability is a necessary component for achieving sustained economic growth. Ignoring price stability during times of economic weakness risks undermining our ability to achieve economic growth over the long run. It fuels higher inflation down the road and risks inappropriate risk taking and recurring boom/bust cycles. This would be counterproductive.

Again, this is the mainstream view.

Although it might be tempting to think that monetary policy is the solution to most, if not all, economic ills, this is not the case. I think it is particularly important, for example, to recognize that monetary policy cannot solve all the problems the economy and financial system now face. It cannot solve the bad debt problems in the mortgage market. It cannot re-price the risks of securities backed by subprime loans. It cannot solve the problems faced by those financial firms at risk of being given lower ratings by rating agencies because some of their assets are now worth much less than previously thought. The markets will have to solve these problems, as indeed they will. But it will take some time. However, the Fed can and should help by offsetting some of the restraint created by tightening credit conditions and the sharp reduction in housing investment. The Fed can and should also promote the orderly functioning of financial markets.

Going forward, then, my approach to making monetary policy decisions will be to look at incoming information and ask whether it is consistent with my outlook and the achievement of the Fed’s dual mandate. My outlook for 2008 already incorporates the fact that we will be receiving quite a few weak economic numbers in the first half of the year. However, to the extent that economic conditions evolve differently than expected, we will need to be prepared to incorporate those changing conditions into our policy decisions in a manner that is consistent with our dual mandate.

He uses the term ‘dual mandate’ to stress the importance of price stability.

Conclusion
In conclusion, my own forecast for economic activity has been revised downward since last October as economic conditions have evolved. I believe the recent reductions in the level of the federal funds rate target will be supportive of the economic adjustment process and a return to trend growth near the end of this year and on into 2009. The Fed has been aggressive in making this adjustment in rates, which will mitigate some, but not all, of the problems the economy and financial markets are facing. Some problems will simply take time for the financial markets to work out.

Seems his opinion is that unless the economy weakens more than currently forecast, the Fed is done.

In taking aggressive action in supporting the economy’s eventual return to its trend growth rate, I continue to believe we must not lose sight of the other part of the Fed’s dual mandate – which is price stability. We cannot be confident that a slow-growing economy in early 2008 will by itself reduce inflation.

The FOMC has been banking on this happening, Plosser is not so sure.

I am also convinced that we need to keep our eye on both headline as well as core inflation in assessing how well we are doing in achieving our goal of price stability.

Going forward, monetary policy decisions will depend on how the economy unfolds and whether further changes in the economic outlook are necessary.

Again, let me thank Philip Jackson and the Rotary Club for inviting me to return to speak here in Birmingham.

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