Federal Reserve Vice Chairman Roger W. Ferguson on the Economic Outlook for the U.S.

Having said in this post that San Francisco Fed president Janet Yellen had spoken more directly in her speech than others have since the last FOMC meeting regarding the future course of monetary policy, this speech from Vice Chairman Roger Ferguson is at least as direct and comes to much the same conclusion. His bottom line, "For now, I believe that our policy of removing monetary accommodation at a "measured" pace is most likely to promote our broader objectives of price stability and maximum sustainable economic growth," though he is clear to say that the rate changes in the future will be highly dependent upon incoming data and that the main risk in the future are the same as those identified by Yellen, high energy prices and a slowdown in housing, and he also points to the risk of slower business investment:

Economic Outlook for the United States, Federal Reserve Vice Chairman Roger W. Ferguson: I appreciate the opportunity to speak to you today about the outlook for the U. S. economy. ... To jump right to the bottom line, I believe that the outlook for the economy remains solid despite the devastating blows delivered to the Gulf Coast by Hurricanes Katrina and Rita. ... Before the hurricanes, ... the outlook was relatively benign: continued moderate economic growth accompanied by little change in the underlying pace of core inflation. There were, of course, risks in this forecast. The cumulative impact of the rise in energy prices on inflation and activity ... was clearly one concern. So too was the ongoing rise in home prices and the possibility that this phenomenon is unsustainable. ... I do not think that a significant and widespread drop in home prices is the most likely outcome, but the situation will require careful monitoring in the months ahead. A further risk is the apparent deceleration in business spending on new equipment and software (E&S). ... Are businesses becoming more reluctant to invest?...

I'd now like to turn to the economic effects of Hurricanes Katrina and Rita. ... At this point, it seems likely that the hurricanes had, at most, a small effect on the supply side of the economy. ... The hurricanes have, however, adversely affected the outlook for inflation. ... Consumer energy prices are projected to rise substantially in the second half of this year, and some spillover into the prices of non-energy goods and services looks likely as well. ... In general, economists believe persistent changes in relative prices have a larger effect on economic activity than do temporary changes. ... A large, long-lasting increase in the relative price of energy will affect inflation for a time. ... The behavior of inflation expectations is the key ... If expectations for long-run inflation become unanchored ... the possibility of a wage-price spiral increases...

The reaction of the business sector to permanently higher energy prices is more complicated. ... ... firms tend, where possible, to substitute capital and labor for energy consumption. In the 1970s and 1980s, such substitution greatly reduced the amount of energy consumed ... I'd expect to see a similar response to the latest price run-up in the years ahead. ... Studies have shown that adjustments by households and businesses in response to higher energy prices reduce the long-run level of potential output in the economy. This reduction mainly reflects the tendency of production to become more labor intensive ... In essence, labor productivity grows more slowly after an energy price shock and that effect lowers the trajectory for potential output... What does all of this mean for the conduct of monetary policy? In my view, it reinforces the need for policy to continue to be dependent on the incoming data on output and prices and on our forecasts for how those variables will evolve over time. ... it is also important to recognize that the measurement of economic activity in the immediate aftermath of the hurricanes may give an incomplete picture. Since it began withdrawing monetary accommodation in June 2004, the FOMC has repeatedly stated that its future policy actions will be governed by the expected performance of the economy. ... For now, I believe that our policy of removing monetary accommodation at a "measured" pace is most likely to promote our broader objectives of price stability and maximum sustainable economic growth.