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Wednesday, November 16, 2005

Chicago Fed's Moskow: U.S. Economic Outlook

Here's more from the Fed today in addition to the testimony by Bernanke and the speeches by Fed governors Olson and Ferguson. This next speech is from Chicago Fed President Michael H. Moskow. Unlike the other two speeches which do not address current policy, he is fairly specific about his view of the economic outlook and where interest rates are headed in the future. The economic outlook is the standard view heard in recent Fed speeches:

  • GDP is somewhat above potential growth
  • Much of the slack in the economy has been eliminated
  • There are two risks to growth, a slowing of the housing market and high energy prices
    • He is not particularly worried about housing since the effects of a decline are slow allowing time for a policy reversal
    • He is not particularly worried about energy prices either since they've been higher in the past and are showing signs of moderating
  • Inflation is at high end of the comfortable range and inflation expectations are okay for now, but a worry going forward

The bottom line for policy: It will likely entail further removal of accommodation (code for rates are going up), and if expectations of inflation show signs of increasing, a stronger response may be needed. But like other recent speeches, there does seem to be the sense that an end is in sight even if the timing is not yet clear. Note also the key phrase "As we move into 2006 and try to determine whether we have removed enough accommodation..." implies a rate increase in December is fairly certain in his mind:

U.S. Economic Outlook, by Michael H. Moskow, Chicago Fed President: Over the last two years real Gross Domestic Product has been growing an average of 3.7 percent each year. This is somewhat faster than potential, or the rate of GDP growth that can be sustained without creating inflation pressures. ... [M]uch of the slack has been eliminated. The unemployment rate has fallen to 5 percent; ... a level ... roughly consistent with an economy operating at potential. In addition, the capacity utilization rate in manufacturing is only slightly below its historical average. This indicates that there may be some slack remaining in manufacturing, but probably not much. Finally, core inflation has changed little in recent months. Currently we're not seeing the kinds of disinflationary forces that would be associated with a substantial degree of resource slack ...

As we move into 2006 and try to determine whether we have removed enough accommodation, the FOMC will have to answer two critical questions: One, will the economy continue growing near its potential? And, two, will there be persistent pressures on core inflation? ... Abstracting from the effects of the storms, current economic growth appears to be self-sustaining because the underlying economic fundamentals continue to be sound. ... According to the Blue Chip consensus, GDP is expected to grow by 3.5 percent in 2005 and by 3.3 percent in 2006—numbers on the high side of recent estimates for potential. ... While this forecast is good, there certainly are risks. One relates to home prices. ...[M]any analysts warn that housing is overvalued. ... I am starting to hear more anecdotes ... and seeing more reports that home prices are increasing at a slower rate. If housing does prove to be overvalued and home prices fall, residential construction would be adversely affected. But history suggests that the impact on overall consumer spending would be more modest. Moreover, the changes in wealth ... likely would be gradual. ...[I]t seems likely that these gradual aggregate changes would allow time for any appropriate recalibration of policy... But, it's far from certain what will happen to home prices. ...

Another risk to the outlook relates to energy prices. ... Higher energy prices have had some effect on growth in the U.S., but to date, it's been relatively modest. ... [because] solid productivity growth and accommodative monetary policy have offset some of the negative effect of rising oil prices. ..., the increase in crude prices, after adjusting for inflation, is smaller than during the 1970s, and the level remains well below the peak reached in 1980 ..., [a]nd ..., the U.S. economy is less dependent on oil today. ...

In addition to the risk to growth, rising energy prices are a risk to the outlook for inflation. ... The latest reading of the core price index for personal consumer expenditures, the Fed's preferred measure of inflation, shows an increase of 2 percent over the last 12 months. This is at the upper end of the range that I feel is consistent with price stability. One question about inflation is whether businesses will pass through the recent increases in energy costs to the prices ... [U]nless energy costs continue to rise, such pass-through would just result in a one-time increase in prices and a temporary spike in the core inflation rate, not a sustained higher rate of core inflation. ... Furthermore, although energy prices are still high, they have been falling recently... There is another worry however. If we indeed start to see a string of higher inflation numbers, then people may begin to expect permanently higher inflation. Such expectations could become self-fulfilling ... And this would have adverse effects on longer term economic performance. Fortunately, current financial market data and consumer surveys suggest that long-run inflation expectations remain contained.

Nonetheless, it will take appropriate monetary policy to keep inflation and inflation expectations well contained. For me, at this time such policy likely entails further removal of policy accommodation. And if inflation expectations did become unhinged, this might require a stronger response. ...

    Posted by on Wednesday, November 16, 2005 at 12:31 AM in Economics, Fed Speeches, Monetary Policy | Permalink  TrackBack (0)  Comments (0)


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