My own take on what “moderate pace” means is that real GDP is likely to increase by roughly 3 percent over the four quarters of this year—particularly if the housing market is near an inflection point and no longer a significant drag on growth. But I want to emphasize that fluctuations in growth are normal and that no policy action is necessarily indicated if growth comes in somewhat above or below that outlook. When data come in outside the range expected, we need to understand the reasons and the likelihood that the departure will be sustained unless there is an offsetting policy response. Only then does it make sense to consider a policy response.

Regarding the outlook for inflation, I’ve said for quite some time that it might take a while for underlying price pressures to recede. Recent inflation data themselves, and other information relevant to judging the inflation outlook, suggest that the inflation rate is likely to fall into a reasonable range this year. If, however, core inflation seems to be settling at a rate above 2 percent, then such an outcome would be unacceptable to me. I put a very high weight on the Fed’s responsibility to maintain low and stable inflation.

At some point we’ll almost certainly see some surprises in the data. Long experience with economic forecasts indicates that we need to consider as a standard feature of the environment GDP forecast errors in the neighborhood of 1½ percentage points on a four-quarter ahead horizon. Thus, a forecast of 3 percent GDP growth should be expressed as 3 percent plus or minus 1½ percent. From experience, an outcome in this range has a probability of about two-thirds. The other one-third probability is divided equally above and below the range. Thus, the probability of an outcome significantly different from the baseline forecast is not small. The FOMC is prepared to respond when the outcome promises to depart from the baseline in a sustained way.

One of these risks, as I’ve noted earlier, is the possibility that we might be underestimating the likely pace of economic activity.  If we get an upside surprise on GDP growth, then monetary policy may have to be tightened somewhat.

I expect real GDP to grow by about 3 percent, which I estimate to be its underlying trend rate. That kind of growth should hold the unemployment rate to just below 5 percent. The outlook for inflation is more uncertain. Inflation stopped accelerating in the last few months, but whether it will continue to recede in the coming year is not yet clear. Additional monetary policy action may be needed to keep us moving along the path to price stability. 

We've got what I call now a bimodal economy.  We have two weak sectors:  housing, which is contracting, and automobiles --  motor vehicle production, which is also a weak sector.  But the rest of the economy is doing just fine.  And when you put it all together into an overall economic picture, we have an economy that continues to grow ever so slightly below trend. 

Even if policy is now well positioned, as I think is likely to be the case, it will still take some additional time for inflation to unwind due to lags between policy actions and their impacts on economic activity and inflation. These lags can be anywhere from several months to a couple of years. This means that we have yet to see the full effects of the series of 17 funds rate increases—some are probably still in the pipeline.

In my view, real GDP growth is likely to gradually rise from 2 percent to 2.5 percent annually in the second half of last year to around 2.5 percent to 3 percent in 2007.

Growth will start the year on the low side, but should be back to about 3 percent by the end of the year. So my best guess right now is that real GDP growth will average between 2 ½ and 2 ¾ percent in 2007.  A month or two ago, this forecast would have been somewhat higher than the consensus of widely quoted analysts. But the data since then have been stronger than most observers expected, particularly the very robust data on consumer spending and employment. As a result, many analysts have marked up their forecasts, and so the projections I’ve presented today are now fairly mainstream.

... I see the economy growing at a more moderate pace over the next few years than we saw in the past couple of years. But there are risks to this outlook. The first risk is that the weakness in the housing sector spills over to other sectors of the economy, depressing overall growth. The second risk is that inflation remains stubbornly high...

The most recent price statistics have been encouraging, but not convincing...

...[T]here is still a risk that the underlying inflation trend will not continue to improve; in which case, the FOMC will need to respond with the appropriate policy actions.

``We are well-positioned where we are,'' Poole said at a press conference in St. Louis. He reiterated his stance that he sees an equal chance the Fed could raise or lower interest rates.

"Only if the information were pretty compelling would I want to take the position of lowering rates," Poole said. "But I absolutely won't rule that out."

From audience Q&A as reported by Bloomberg News

On Fed expectations discounted by markets:   "I've never fully understood what the case was the markets saw of why there would be such large and early rate" reductions."

"Many forecasters have been perplexed by the view of the future of rates that seemed to be embodied in the fed funds curve,'' she said, referring to interest-rate futures.

From audience Q&A, as reported by Bloomberg News

We have a pretty good cruising speed currently... We have seen some very encouraging news {about inflation}...  I am very comfortable with where we are now in terms of our policy. 

From a Bloomberg TV interview.

My predominant concern remains the risks to the inflation outlook. We've seen some welcome easing in inflation in the past couple of months, and I'm hopeful this development will continue. But there is still the risk that resource pressures or other factors, such as elevated inflation expectations, could prevent actual inflation from falling in a timely fashion.

Looking ahead, my baseline forecast is that GDP growth will pick up and over the next year or so will average a bit below its potential growth rate—where potential refers to the rate of growth the economy can maintain in the long run without generating increasing inflation pressure. Of course, that's an average—I do expect to see some volatility in the numbers.

Uncertainty about where we stand in the housing cycle remains considerable. In part, that is because this housing downturn has differed from some of those in the past in important ways. It was not triggered by a restrictive monetary policy and high interest rates; indeed, relatively low intermediate and long-term interest rates are helping to support the stabilization of this sector. But the current contraction in housing did follow an unusually large run-up in sales and construction and, even more so, in prices relative to the returns on other financial and real assets. Our uncertainty about what pushed home prices and sales to those elevated levels raises questions about how the market will adjust now that expectations of the rate of house price appreciation are being trimmed. And changes in the organization of the construction industry, with activity more concentrated in the hands of large, publicly traded corporations, may also affect the dynamics of prices and activity in response to the inventory overhang.

"The long-term picture of manufacturing is really impressive in the United States," Moskow said in a question-and-answer session following a speech to the Labor and Employment Relations Association.

As reported by Dow Jones News