Fortunately, despite the housing risks I have described, other sectors of the economy still look pretty good.  For the most part, consumers are still buying things.  Businesses are still investing in new plants and office buildings.  And foreign economic activity also remains strong, which provides an additional source of demand for our goods and services.  Certainly the tone in labor markets has been very positive lately.  Continued hiring suggests a high level of business confidence about economic growth next year.

            Think of it this way.  We seem to have two economies at work - the housing economy, which is experiencing a very large adjustment, and the "everything else" economy, which is performing fairly well. 

On balance, the 95 percent of the economy outside of housing remains on good footing. Employment has been increasing near its long-run sustainable pace. Productivity trends remain solid. Recent declines in oil prices should give household budgets a boost. Economic growth in other countries should increase demand for our exports. And current financial conditions are not very restrictive by historical norms.

My baseline forecast is that GDP growth will pick up from the weak third quarter and average somewhat below its potential growth rate over the next year or so. Of course, that's an average—I do expect to see some volatility in the numbers.

"We're flying at a less than optimal altitude in terms of the speed of the economy ... and the good news is that ... some inflationary pressure has been released," Fisher told Reuters in an interview.

"I'ld like to see us gain a little more altitude.  But I'm very comfortable with where we are right now in terms of monetary policy."

From an interview with Reuters News

'[Q3 GDP] was a little stronger than I expected. Housing was a big drag. Business-side spending was pretty good. We are still not seeing spillover from housing.''

"I am expecting growth to return to potential sometime next year.''

"I am not hopeful a lot of slack is going to open up before we return to trend."

As reported by Dow Jones

We would like to see the economy slow some to relieve wage pressures... Frankly, the economy seems pretty strong outside of housing.  The job market remains healthy.  The risks with respect to growth are two-sided."

From Q&A session as reported by Reuters

Some declines in residential investment could be large, and could contribute to some volatile numbers for overall GDP growth on a quarter-by-quarter basis. But currently we do not see the slowing in housing markets spilling over into a more prolonged period of weakness in the overall economy. So on balance, we expect GDP growth to average somewhat below potential over the next year or so...

But we cannot forget the plus side of the ledger. Outside of housing, there do not appear to be any imbalances that would foreshadow large adjustments in spending in other sectors. And, as I noted earlier, income growth and spending should be supported by the trends in productivity, recent oil price declines, and improved growth prospects for many of our trading partners.

Over the next year, I expect the economy to expand, on average, somewhat below its long-run sustainable growth rate.

I think that the risks to my outlook for economic activity may be skewed a bit to the downside, while those to my forecast of gradually declining inflation are tilted to the upside. In my view, in the current circumstances, the upside risks to inflation are of greater concern.

Based on the data we now have, the growth of real GDP in the third quarter appears to have remained as subdued as it was in the second quarter and may well have slowed further.

[C]alculations about the sustainable level of housing starts based on demographic factors, such as population growth and household formations, suggest that starts may be closer to their trough than to their peak. Although such calculations are, in general, not particularly useful for near-term forecasting, they do suggest that any overbuilding in 2004 and 2005 was small enough to be worked off over coming quarters at close to the current level of housing starts.

Mr. Bernanke, answering questions after a speech in Washington, said the housing sector is undergoing a "substantial correction" that will likely shave about "a percentage point off growth in the second half of the year" from what it would otherwise have been "and probably something going into next year as well," estimates close to private forecasters' views. Mr. Bernanke also said there is "limited evidence" the falloff in housing activity had spilled over to other parts of the economy. "To this point, other parts of the economy are remaining relatively strong."

As reported by the Wall Street Journal

Most forecasters believe that growth slowed further in the third quarter because of another decline in residential investment and more moderate business investment in structures and inventories....

While hiring has slowed, the unemployment rate was quite low in August at 4.7% of the labor force.  This unemployment rate is below the level that many economists believe is consistent with full employment and stable prices. 

'The outlook for the U.S. economy is for some slowing as we move through the fourth quarter' amid 'adjustments' in a housing sector that's clearly been cooling off, Hoenig told a local group in Lincoln, Neb. He added that falling energy prices are 'favorable for the outlook' and will aid what is likely to be a 'move back towards our potential as we move into 2007,' he said. 

Hoenig also said a drop in resource utilization means that inflation will 'systemically ratchet down...to lower levels this year and into next.' The bank president said his projection is a 'fairly optimistic outlook, and it's a reasonable outlook.' 

From a Dow Jones Newswire report

The way I look at the forecast and the situation with the economy is quite positive in the sense that what we’re seeing, really, is a return to normalcy and a more balanced economy. The excesses in the housing sector seem to be unwinding in an acceptable way, so I think it is quite reasonable in terms of the Greenbook forecast to think that the spillover here is not going to be a big problem because we’re actually moving resources from a sector that had too much going into it, into sectors that need to have more resources at the present time. So in that sense, I’m actually quite positive.

I have emphasized the strength of business construction, which is going gangbusters in many parts of the country.  The economy is really not fragile.  It's robust.

In informal remarks to reporters after his speech.