My view is that the continued decline in residential investment has heightened the risk of a more significant downturn in the overall economy.  Falling housing prices further weaken the incentives for residential investment, but are also likely to dampen consumer and business confidence and spending.  Furthermore, falling house prices roil financial markets and financial institutions by exacerbating exposures to the housing market. 

Previous periods where residential investment declined for a year or more were either accompanied by, or closely followed by, an economic downturn. But history may or may not repeat itself, because this period of prolonged weakness in housing is distinctive in several other ways that add to uncertainty over its ultimate impact on the broader economy.

I am still optimistic that the economy will improve appreciably by the third and fourth quarters of 2008, and that is when any monetary policy action today will begin to have noticeable effects. Overall real GDP growth will be faster in the second half of 2008 as the economy begins to return to its longer-run trend growth of about 2-3/4 percent. On a fourth-quarter to fourth-quarter basis, I expect that the economy will grow about 2.5 percent in 2008, close to its pace in 2007, and that it will be growing more consistently near its longer-term trend in 2009.

Somebody asked me today was I open to rate cuts, further rate cuts in the future. Absolutely, I'm open to those.

From press Q&A session, as reported by Market News International

I don't think we've overshot yet. From press Q&A session, as reported by Market News International

I expect growth to be very weak for several more months, but to improve as we move through 2008. So if I had to guess – as my host, Henry, insists – I would write down that real GDP growth will be between 2 and 2 ¼ percent from the fourth quarter of 2007 to the fourth quarter of 2008.  

To sum up the story on the outlook for real GDP growth, my own view is that, under appropriate monetary policy, the economy is still likely to achieve a relatively smooth adjustment path, with real GDP growth gradually returning to its roughly 2½ percent trend over the next year or so, and the unemployment rate rising only very gradually to just above its 4¾ percent sustainable level.    

As for the dollar, it has been depreciating since early 2002, and has continued to do so since the financial turmoil began. This development will help to improve our gaping trade deficit and thereby offset some of the otherwise contractionary effects of the tighter credit conditions and lower equity values even though a weaker dollar diminishes the well-being of consumers by lowering their purchasing power.

Since the October FOMC meeting, financial conditions have deteriorated, and we have seen some unexpected softening in the economic data. These developments necessitate some rethinking of my growth forecast, and have highlighted the downside skew in the risks to that forecast. On the inflation front, I continue to expect core consumer prices to rise at a pace that is broadly consistent with price stability, although there are some notable upside risks that bear careful watching and consideration. Additional data bearing on the outlook will become available before the FOMCs meeting next week, and this information must also be factored into an assessment of the economys prospects.

[T]he current problems in the subprime market are heavily dependent on economic conditions particularly housing prices.[3] As a result, the outlook for how much worse this problem could become depends critically on the outlook for the economy and the housing market. We are currently expecting the economy to grow well below potential for the next two quarters, before gradually improving over the course of next year. Our research suggests that the foreclosure crisis will get worse before it gets better, but our forecast is quite dependent on how far house prices fall.

At present, Hoenig said he is "not at all opposed to necessary action either way." 

"So when I say, and I always do in my speeches, it is a matter of waiting watching and seeing, I really mean it this time," he said.

As reported by MarketWatch

We have a way to go before full recovery and must acknowledge that shocks and accidents might happen. Phrasing it politely, as an Aussie-Texan, I suspect some real "cow patties" remain in some prominent institutional punchbowls in the U.S. and abroad, and they will undoubtedly come to light before too long. I would submit, however, that we are on our way back to markets priced by reason rather than fantasy and that systemic risk has been lessened substantially.

As I mentioned, delinquencies will probably rise further for borrowers who have a subprime mortgage with an adjustable interest rate, as many of these mortgages will soon see their rates reset at significantly higher levels.  Indeed, on average from now until the end of next year, nearly 450,000 subprime mortgages per quarter are scheduled to undergo their first interest rate reset.  Relative to past years, avoiding the payment shock of an interest rate reset by refinancing the mortgage will be much more difficult, as home prices have flattened out or declined, thereby reducing homeowners' equity, and lending terms have tightened.  Should the rate of foreclosure rise proportionately, communities as well as individual borrowers would be hurt because concentrations of foreclosures tend to reduce property values in surrounding areas. 

BERNANKE: Mr. Chairman, as you noted, our forecast is for moderate, but positive growth going forward for the next few quarters. Economists are extremely bad at predicting turning points, and we don't pretend to be any better. We have not calculated the probability of recession, and I wouldn't want to offer that today.

During the Q&A session

At issue is the potential effect of the housing decline on consumer expenditures. The loss of wealth associated with the decline in housing prices, as well as the fact that mortgage payments will absorb a larger portion of disposable income for some consumers, might cause consumption—the largest component of GDP—to grow at a significantly slower rate. While the effect of a change in wealth on consumer expenditures has been notoriously difficult to identify empirically, some recent evidence suggests that changes in housing wealth do affect consumption.