Some would dismiss these rising inflationary pressures as temporary.  I believe they are more serious.  Energy prices have been trending up for the past five years, and there are good reasons for thinking that higher food and commodity prices are not being entirely driven by temporary supply and demand imbalances.  However, the bigger concern is that these increases are beginning to generate an inflation psychology to an extent that I have not seen since the 1970s and early 1980s.  Measures of inflation expectations in surveys and financial markets are moving higher, and businesses are increasingly passing on higher input and commodity prices to consumers and business customers.  In this environment, in my opinion, there is a significant risk that higher inflation will become embedded in the economy and require significant monetary policy tightening to reduce it.

As you know, the past eight months have been a very difficult period for the U.S. economy. A sharp slowdown in growth has put the economy at the brink of a recession while, at the same time, rising commodity prices have caused inflation pressures to rise considerably. And, to make matters worse, these events have occurred against the backdrop of a collapse in housing markets that has shaken financial markets around the world.

The Federal Reserve has responded to these developments aggressively. It has taken unprecedented actions to provide increased liquidity to banks and other financial market participants to maintain the functioning of financial markets. And, it has eased monetary policy considerably to try to ensure that the disruptions in financial markets do not spread to the broader economy.

Despite current difficulties, in my view there is room for optimism about the near-term outlook for the U.S. economy. Financial markets appear to have stabilized somewhat, and the economy should pick up in the second half of the year as fiscal and monetary stimulus take hold. The damage to financial markets is severe, however, and it is likely to be some time before they are able to function normally. Indeed, I believe that major changes in industry practices and a significant rethinking of financial regulation will be required if we are to avoid similar problems in the future.

Earlier, I mentioned the potential impact of the recent financial market disruptions on growth. Indeed, concern with the effects of these disruptions and, in particular, the possibility they could lead to a severe credit contraction was the principal motivation for the aggressive easing of monetary policy by the Federal Reserve over the past several months. ... Although credit conditions have tightened considerably in recent months and some markets for asset-backed securities have shut down, we have not seen as large a credit crunch as some anticipated. Indeed, outside of some mortgage markets, consumers and businesses with strong credit histories have continued to have access to credit on reasonable terms. Consequently, in my opinion, financial markets disruptions, while noteworthy, are not the major story behind the recent weakness in economic activity. Energy price increases and housing dominate this slowdown.

[T]here are reasons that suggest the economic slowdown will be short-lived. Part of the pickup in growth will likely come from the tax cuts that are going into effect currently, part from the monetary policy stimulus provided by low interest rates and part from a boost to exports from the lower dollar. Forecasters also see moderation in energy and food costs later this year, which would provide a boost to growth but also lead to lower inflation pressures.

As I indicated earlier, we are also seeing signs of stabilization in financial markets, with improved liquidity and more transactions. Still, many markets are not functioning normally, and it will take additional time for the damage to be assessed and repaired.

As to monetary policy, the current accommodative stance should be sufficient to cushion the economy from a deeper slowdown and the risks that financial disruptions could spill over to the broader economy. As the economy recovers and credit conditions improve, however, it will be necessary for the Federal Reserve to remove the policy accommodation in a timely manner. How fast this occurs will depend on whether inflation pressures moderate or intensify in the period ahead.

My recommendation is that you take it [the April 30 FOMC statement] at face value. There are risks on both sides. There are tail risks, as the economists like to call them, on both sides.

We're in the business of risk management in that sense. We have a dual mandate. We have to (monitor) growth and inflation. The readers can study our entrails all they want. That's what makes it interesting. It says what it says, and that's all I'm going to say.

Personally, for me to change course, given that I stopped (supporting rate cuts) at 3 1/2 percent, I'd have to see a very dramatic economic slowdown going on beyond what I'm already discounting.

I'm already discounting significant anemia,

Personally, I"m concerned about inflation and the negative feedback loop, which is that inflation leads to changes in consumption and business patterns that further retard economic growth as well as to pressures in the foreign exchange markets.

So I think there is a risk of a negative feedback loop that derives from cutting rates. So that's one of the reasons I've been resistant.

It may be that the recent statements made by the Open Market Committee and the recent actions are engendering greater confidence in the dollar. We'll see over time.

... [Currency markets are] manic depressive ... they overshoot. We've had some volatility there, and I'd like to remind people that a lot of people made a mistake by selling the U.S. economy short for a long time.

[Fisher said he is] entertained when I read that today the dollar was weak or yesterday the dollar was weak because the U.S. economy is showing slower growth, then the next day it says it's because inflation was reported higher. I always feel like screaming, "Guys, make up your mind!" So I"m not surprised that the dollar strengthened. The question is what is the trend over time. ... You have to keep in mind that these are manic depressive mechanisms that overshoot on both sides. They're very emotional.

Most Americans are paying their mortgages on time and are not at risk of foreclosure.  But high rates of delinquency and foreclosure can have substantial spillover effects on the housing market, the financial markets, and the broader economy.  Therefore, doing what we can to avoid preventable foreclosures is not just in the interest of lenders and borrowers.

As my listeners know, conditions in mortgage markets remain quite difficult, and mortgage delinquencies have climbed steeply.  The sharpest increases have been among subprime mortgages, particularly those with adjustable interest rates:  About one quarter of subprime adjustable-rate mortgages are currently 90 days or more delinquent or in foreclosure.¹  Delinquency rates also have increased in the prime and near-prime segments of the mortgage market, although not nearly so much as in the subprime sector. 

Nationally, as of the fourth quarter of 2007, the rate of serious delinquency, as measured by credit records, stood at 2 percent of all mortgage borrowers, up nearly 50 percent from the end of 2004.²  The fourth quarter of 2004 is a useful benchmark, because general economic conditions were fairly normal and the lax underwriting that emerged later was not yet evident.

Former Federal Reserve Chairman Alan Greenspan said the U.S. has slipped into an ``awfully pale recession'' and may continue to languish for the rest of the year.

As reported by Bloomberg News

[W]e certainly cannot rule out the possibility of continued market difficulties. We cannot be sure how long it will take for financial intermediaries to complete the process of re-evaluating the risks in their portfolios and restructuring their balance sheets accordingly. Moreover, further mortgage defaults due to declines in house prices and the fact that many sub-prime adjustable rate mortgages will see their rates rise over the next few months could have negative feedbacks onto housing and financial markets. Furthermore, there remains a good deal of uncertainty about the creditworthiness of many key market participants.

You have to put into perspective the way I behaved on fed funds in the context of how the system works or does not work. When we got to 3.5% [at January’s unscheduled policy meeting] and were starting to go below that, my personal bias was to make sure we got all of the plumbing working. The question really is about the efficacy of the system. Will consumers and small businesses benefit from these rate cuts?

When asked about his "strong reluctance" to further easing.

The thing that I admire about Ben [Bernanke] is that right away – without a nanosecond’s time — he was thinking through these issues that I think should’ve been thought through before. But they weren’t; there were other priorities. The question is: what is the efficacy of further rate cuts?