(I)t strikes me as reasonable to expect the U.S. economy to regain positive momentum sometime in 2009, for several reasons. First, monetary policy is now quite stimulative and real interest rates are quite low. Second, the energy and commodity price shocks that dampened economic activity last year have subsided already or are in the process of doing so. And third, as I said, the drag from declining residential investment seems likely to diminish significantly in the next year. In fact, I would be surprised if we don’t see a bottom in housing construction sometime in 2009.
While the downturn in real economic activity is going to pose challenges for monetary policy in the period ahead, it’s essential that we not let inflation drift from view. Since 2004, overall inflation has trended upward, and has been higher than I would like over the last few years. Much of the acceleration we saw last year reflected energy prices, however, and with oil prices down, we have seen overall inflation subside in recent months. Moreover, many economists are forecasting relatively low inflation in the months ahead, on the grounds that widening economic slack is generally associated with declining price pressures. I would be cautious about relying on this correlation as a causal relationship, however, even though it is detectable in many datasets.6 There have been times in the past when inflation declined only temporarily when activity slowed, and re-accelerated when the recovery began. And while it may seem premature to be worrying about how inflation behaves after the recession is over, we need to be sure our policy remains consistent with a strategy that does not allow inflation to ratchet up over the business cycle.