Anthony Santomero

Over the past decade or so, a number of central banks around the world have, to good effect, adopted inflation targeting as a means of achieving both price stability and credibility as inflation fighters. The monetary authorities of more than 20 countries, including New Zealand, the United Kingdom, and Canada have adopted explicit inflation targets.

...Our neighbors to the north speak well of explicit inflation targeting. In Canada, the economic boom at the end of the 1980s, together with an oil price shock and the introduction of their goods and services tax, led to fears that inflation would escalate. Against this backdrop, the Canadian government and the Bank of Canada agreed on explicit targets for inflation reduction in 1991.

The first formal targets aimed to bring inflation down to 2 percent by December 1995. Inflation declined more quickly than anticipated and was already closing in on its target by January 1992 — almost four years ahead of schedule. Since then, with year-over-year inflation almost always in the 1 to 3 percent target range, the policy has been widely regarded as a success.

While the Fed has not adopted explicit inflation targeting, the policy strategy it has followed over the past 20 years generated many of the benefits inflation targeting offers...

My colleague Fed Governor Ben Bernanke has described the current policy framework as "constrained discretion." But, as I mentioned, I prefer the term "flexible commitment." Under flexible commitment, the central bank has been free to adjust monetary policy to stabilize output and employment during short-term disturbances, while maintaining a strong commitment to keeping inflation under control.

For those of you who did not have an opportunity to hear my earlier remarks, you might ask why the U.S. should move forward on inflation targeting now. For 25 years, the Fed has steadily reduced inflation and inflation expectations, without resorting to an explicit inflation target...

However, having achieved price stability, there is still the matter of maintaining it. I believe an explicit inflation target can help us do that.

...My inflation targeting proposal is this:

The Fed should establish a target band of 1 to 3 percent for annual inflation, as measured by the 12-month moving average rate of change in the core PCE deflator.

I have outlined several risk factors that could alter the short-term dynamics of the economy - oil prices, the trade balance and the federal budget. The course that these factors take will figure into the precise path the Fed follows.

Looking ahead, I expect real GDP growth to be in the neighborhood of 4 percent for 2005. Given this scenario, the Fed should continue moving monetary policy toward a neutral stance at a measured pace and thus keep inflationary pressures well-contained.

The declining value of the dollar, combined with reasonable growth in the economies of our trading partners, should help stabilize our net export position in 2005. As the trade deficit stabilizes, solid growth in spending by U.S. consumers and businesses should translate directly into solid growth in GDP.

It's hard to say exactly where the neutral point in monetary policy is. It has to be data driven.

We know that neutral rates have traditionally in the U.S. economy been positive. And they have changed as technology changes, as savings change, as government deficits change. So we really have to look at the dynamics of the economy and try to move monetary policy in a manner that allows us to get the potential growth and allows us to sustain this price stability era.

As we are in the fourth year of recovery, we have to be vigilant. And as long as the Fed is, people are aware that we are watching closely, I think the expansion can move in a very constructive way through 2005.

I think releasing the minutes earlier is one more step in the transparency and openness of the Central Bank. I think it'll take a while before the markets understand the context of the conversation [at the FOMC meeting]. This was the first time. By its very nature, it's going to take a while. But markets learn.

If the economy evolves as I expect over the next year or so - with continued output growth, steady increases in employment, and reasonably low inflation - then I expect we will continue to move the federal funds rate toward neutrality at a measured pace.

The precise course the Fed takes very much depends on the precise course the economy takes. As I have said before, if signs of price pressure emerge on a consistent basis, we will need to consider quickening the pace at which we move toward policy neutrality.

Looking forward, I expect real GDP to expand at a 3.5 to 4 percent rate through 2005.

Clearly the trade situation is an imbalance that has to work its way out.  The movement of the dollar in the past several quarters will take time to work through the economy and improve our competitiveness...It'll also put some pressure on the stability of prices as imported goods become more expensive. But at the end of the day we must realize that the U.S. economy is still dynamic...the U.S. economy is likely to continue to be a place of where capital allocation continues from abroad to the U.S.

A scenario of solid output growth, at or just slightly above the economy's long-run potential, and steady job gains, which gradually bring the labor market into better balance, is consistent with a relatively stable price environment.  Accordingly, I expect inflation, to remain well contained in 2005, both overall and by core measures which exclude food and energy prices.

As long as the public remains confident in the Fed’s commitment to essential price stability — and the Fed conducts its policy in a manner consistent with that commitment — transitory adjustments in prices will not generate persistently higher inflation.

The U.S. economy, as I indicated, is growing in 2004, the data says, slightly less than four percent. I’m predicting 3.5 to four percent. That's slightly above potential.

The recent decline in the value of the dollar may lessen the competitive pressure on domestic producers that has until now limited their pricing power.

As productivity growth returns to trend, unit labor costs will probably start to rise, potentially putting pressure on prices. We already saw some indications of a shift down toward long-run productivity growth at the end of last year. Moreover, higher prices for oil and other commodities may exacerbate price pressures, as producers try to pass on some of their higher input costs.

The overwhelming data suggests [inflation is] going to be driven, to a large extent, by unit labor costs.

But at the end of the day we have to realize that the U.S. economy is still dynamic, that the financial markets are still a place of choice internationally, and given that that's the case the U.S. economy is likely to continue to be a place where capital allocation continues from abroad to the United States

[The dollar's weakness] is not a crisis or a concern at this point, it's a matter of working through the dynamics of the previous price movements.

... I expect them to continue increasing at a rate of 150,000 to 200,000 jobs per month this year. With those kinds of employment gains, the unemployment rate should continue its gradual decline.

We have had a very accommodative monetary policy stance. And as the expansion continues, we have been moving toward a more neutral one.

Looking ahead, productivity growth is likely to remain relatively strong as technology continues to become cheaper and more powerful — but it is not likely to be as strong as it has been over the past few years. That is why I expect demand growth to generate steadier employment gains going forward.  

At this broad trading range, the economy seems to be able to continue its expansion without any significant trouble...[but] if oil prices spike, it will have an implication both on production costs and on consumer spending.

I believe we have reached a point where institutionalizing inflation targeting simply makes good sense from an economic perspective.

Unlike some in the marketplace, I don't think there is a unique number we are going to. I think the neutral fed funds rate will depend on the economy, spending and technology.

The current level of interest rates in the U.S. is still accommodative.

While [inflation targeting] requires more public debate and discussion, it may be an idea whose time is approaching.

The demographics suggest there's an increase in demand for housing...in general there isn't much evidence to suggest there is a problem with the level of prices in the housing sector.

The United States continues to be a desirable place to invest both in terms of equity returns and, increasingly, in terms of fixed income returns.

I'm bullish on the U.S. market, and the U.S. economy.

Inflation pressures as measured by our core price indexes have remained surprisingly well contained throughout the business cycle.

I think we have to be vigilant on inflation, but what I'm hearing from businesses is that they continue to feel pressure in the market place from competitors and find it difficult to transfer increasing costs into final prices.

If we tell the markets openly which target we are aiming at and let us be measured by this and whether we stick to it, we will increase the credibility we have achieved over the past 25 years. This would be another logical step on the Fed's path toward transparency.

It is understandable that the markets ask what happens when a central banker of this caliber goes. But they will find out that the FOMC has 19 members and that our decision process remains mainly unchanged.

It is neither usual nor necessary that the Fed, or any other central bank, announces its longer term course in its policy statements.

[Inflation targeting] would co-ordinate the FOMC's decision making processes, it would improve communication with markets and strengthen the public's trust that prices will stay stable long-term.

First, it [gradualism] guides the economy in a particular direction but probably will not allow policymakers to overshoot the goal. Second, by moving slowly, policymakers have time to assess the effects of their actions on the economy and update their views on what further action needs to be taken.

I think we have to recognize we're in the fourth year of a recovery and we have to remain vigilant on the inflation front.

I think inflation is worth watching. I wouldn't yet characterize (risks) as having shifted to the upside.

As Chairman Greenspan has explained, monetary policymaking is risk management. The case for gradualism rests on the assessment that the cost of taking too large of an action is larger thn the cost of taking too small of an action. However, the story does not end here. While it is true that moving in a gradual manner reduces the chances of overshooting with all its attendant costs, the policymaker cannot afford to be consistently behind the curve. Given that monetary policy affects the economy with long and variable lags, there is a chance that by acting in this attentuated fashion we will undershoot the optimal policy stance. This can be at least as costly as overshooting. Our challenge is to weigh these costs and respond appropriately to the data and attendant risks involved. Our experience during the most recent business cycle underscores the need to be flexible in choosing the speed with which we respond to unfolding economic developments.

The fact is that the standard error for the one-month change in payroll numbers is nearly 70,000, and making too much of any one monthly number is ill-advised...it is important to not overemphasize short-term deviations while ignoring long term trends.

The fact that there is uncertainty surrounding the state of the economy and new economic information becomes available on a nearly continuous basis supports the notion that it makes sense for policymakers to move in a slow and cautious manner.

In the months following the sharp stock market decline, it was unclear how rapidly economic activity was decelerating. Once it became clear, the Federal Reserve responded aggressively...On the other side, in light of the uncertain and attenuated pattern of recovery and expansion, the Federal Reserve has taken a gradualist approach to removing the monetary accommodation and returning to a more neutral policy stance.

Personal saving is the difference between two aggregates, disposable personal income and personal outlays. These two series are collected from distinct bodies of data...Among the immediately available data, the more complete and reliable data are on the demand or product side; this is the source of GDP. Income side data are aggregated to gross domestic income, conceptually the same as GDP, but in practice differing by as much as 2.3 percent...Typically income is undercounted. All this suggests that our measure of the saving rate is both somewhat suspect because of substantial measurement error and subject to substantial revision. In fact, large variations in personal saving across time have typically been revised away.

Academic research has shown that estimates of NAIRU are very imprecise and are subject to significant standard deviations…My own research department estimated that the NAIRU was between 3.4 and 5.9 percent between 1983 and 2004 with a 95 percent confidence level. This is a fairly wide band of uncertainty. The problem is that estimates with this level of imprecision are of limited use when conducting monetary policy. When policymakers are attempting to evaluate whether there is still slack in the labor market, or if any further decrease in unemployment may lead to inflationary pressures, it clearly would be preferable to have more precise estimates of NAIRU.

We have succeeded in reducing inflation expectations over the past 15 years. Although some measures of near-term inflation expectations have shown an uptick over the past month, longer-run expectations are that inflation will remain well-contained.

Maintaining confidence in sustained price stability is crucial to fostering the most productive saving and investment decisions. In addition, it affords the Federal Reserve considerably more latitude to take short-run policy actions to help stabilize economic growth...[but] it cannot in and of itself force stronger growth than the economy is capable of delivering. Trying to push an economy beyond its potential may temporarily accelerate growth, but it also creates imbalances and increases inflationary pressures that must be addressed, and so boom leads to bust.

In the months following the sharp stock market decline, it was unclear how rapidly economic activity was decelerating. Once it became clear, the Federal Reserve responded aggressively...On the other side, in light of the uncertain and attenuated pattern of recovery and expansion, the Federal Reserve has taken a gradualist approach to removing the monetary accommodation and returning to a more neutral policy stance.

This gap [between potential and actual GDP] is important in that it not only provides an output objective, but it also provides information about possible future inflationary pressures. If the economy were to grow faster than the growth in potential output for a sustained period of time, inflation would be expected to accelerate over time. By contrast, economic growth slower than potential would lead to less than full employment.

According to many researchers both inside and outside of the Federal Reserve, the accuracy of contemporaneous measures of potential GDP is not encouraging…One Fed Researcher, Athanasios Orphanides finds that more recent measures of the output gap lie almost uniformly above the contemporaneous estimates: The real-time estimates of potential output over this period were systematically overly optimistic.

The fact that there is uncertainty surrounding the state of the economy and new economic information becomes available on a nearly continuous basis supports the notion that it makes sense for policymakers to move in a slow and cautious manner.

The fact that there is uncertainty surrounding the state of the economy and new economic information becomes available on a nearly continuous basis supports the notion that it makes sense for policymakers to move in a slow and cautious manner.

The U.S. economy is again on a path of sustained expansion.

With gasoline prices rising to substantially over two dollars a gallon, consumers may find that growth in their discretionary spending must slow in order to accommodate the increased cost of filling their gas tanks. Similarly, rising energy costs could curtail businesses’ capacity to increase their investment spending. The bottom line is that oil prices persistently in the $50 per barrel plus range could slow the pace of domestic demand growth this year, though they should not jeopardize the expansion itself.

The Federal Reserve has already begun the transition from an accommodative policy stance to a neutral one, more consistent with sustained non-inflationary economic growth. If the economy evolves as I have suggested here, then I expect we will continue on our present course of moving the federal funds rate toward neutrality.

The precise course that we take depends on the precise course the economy takes. If signs of heightened price pressure emerge on a consistent basis, we will need to consider quickening the pace at which we move toward policy neutrality

The Fed can maintain the credibility of its commitment to price stability and avoid sharp changes in public expectations about monetary policy by being as transparent as possible about its own decision-making.

It should be remembered that the United States economy enjoyed a remarkable run in the 1990s. Then, it stumbled as we came into the new century and struggled to find solid footing, going through numerous fits and starts early in the new millennium. Now, in 2005, the recession and recovery phases of the current cycle are behind us, and the economy has entered an expansion phase that I expect will carry us forward for some time.

As the economy moves along this path of self-sustaining growth, the Federal Reserve is steadily removing the accommodative monetary policy that had been in place over the past few years and is moving toward a more neutral policy stance.

On the demand side, consumers will continue to spend at a good pace...Looking forward, steady job growth and rising household incomes will fuel continued growth in consumer spending, replacing the stimulative effects of low interest rates and tax rate reductions, which were key to the earlier period of continued consumption growth.

As the U.S. economy began on its path to a slow recovery, accounting scandals and corporate governance issues created new uncertainties, and what some referred to as another “soft spot” in the economy.

The National Bureau of Economic Research has determined that the U.S. economy fell into recession in March 2001...On the fiscal policy side, the Bush administration's first round of tax cuts was enacted in the spring of 2001, and the first tax rebate checks were in the mail by July. With the benefit of hindsight, the timing of this fiscal stimulus was quite fortuitous.

Looking forward, the economy appears to be on course for a sustained period of solid expansion. I expect real GDP to grow at an annual rate of around 4 percent this year and next, with payroll employment increasing by 150,000 to 200,000 jobs per month.

Like the introduction of new technologies, the globalization of the marketplace has been and continues to be a good thing. It fosters greater specialization and gains from trade, affording everyone higher living standards.

Higher prices for oil and other commodities may lead producers to try to pass on some of their higher input costs, potentially exacerbating latent price pressures.

I would contend that remarkably aggressive policy action was a defining characteristic of this business cycle. Indeed, monetary and fiscal policy worked together particularly well this time around to provide ample and rapid stimulus during the economic downturn.

Recently I have been hearing from my contacts around the District that price pressures are building and there has been some evidence of firms passing on higher costs into final product prices.

Evolving to explicit inflation targeting from our current implicit target has significant potential benefits, and the costs may be minimal if we can implement it in a constructive manner.

The counter-cyclical monetary policy the Fed implemented gave consumers the opportunity to borrow at relatively low interest rates, and they certainly seized it. Households increased their purchases of homes and durables at record rates, dampening the breadth and depth of the past recession.

Fiscal policy also played a key role in the dynamic of this cycle. Well-timed tax cuts and tax rebates helped sustain consumer spending during the recession and the early stages of the recovery. However, the application of fiscal stimulus is notoriously hard to time properly. The tax cuts enacted in this cycle had been proposed not as counter-cyclical measures but as part of a long-term shift in tax policy. Their timing was fortuitous.

Monetary policy works best in a stable price environment. In such an environment, the central bank can reduce interest rates without the fear of increasing inflation expectations. Consumers and businesses perceive the reduction in real interest rates as temporary, and so see it as an opportune time to shift spending forward. By doing so, they dampen the recession. Then, as the recovery proceeds, the private sector can anticipate the actions of the central bank and its plan to return short-term rates to more normal levels.

As productivity growth returns to trend, unit labor costs will probably start to rise, potentially putting pressure on prices.

Expectations matter, and they play an important role in the conduct of national monetary policy.

Optimal monetary policy is not simply a matter of establishing a stable price level today, but of ensuring stable prices — and expectations of price stability — into the future. Only then can consumers and investors be confident in the environment in which they must make decisions that have implications far into the future.

Beyond the financial markets' reaction, these revelations also triggered reforms legislated under the Sarbanes-Oxley Act. The act was designed to boost investor confidence in corporate America by improving the quality of corporate disclosure and financial reporting and increasing the role and responsibility of corporate officers and directors...While this may have been appropriate and necessary, it also has diverted companies' attention from new investment projects and slowed plans for future expansion.

The recent decline in the value of the dollar may lessen the competitive pressure on domestic producers that has until now limited their pricing power.

It remains to be seen whether expansive fiscal policies can be reversed, and the federal budget can be returned to balance as we move through the expansion phase of the cycle. As an economist, I see the value of fiscal integrity, and this requires a cyclically balanced federal budget.

Going forward, businesses will also help drive the expansion by making a substantial contribution to spending growth...I anticipate that the robust growth in business investment spending we have been experiencing will continue for the foreseeable future.

Increasing the degree of central bank transparency is one reason I and some of my colleagues have spoken in favor of an explicit inflation-targeting program. I believe we have reached a point where institutionalizing inflation targeting simply makes good sense from an economic perspective. In short, it is a reasonable next step in the evolution of U.S. monetary policy, and it would help secure full and lasting benefits from our current stable price environment

Increasingly, then, U.S. firms compete with firms around the world in the markets for raw materials and final goods and services, while U.S. workers compete with workers around the world for positions in a widening array of occupations and industries. From the macroeconomic perspective, this globalization of the marketplace and the increased degree of competition it brings are powerful forces that can alter the wage and price dynamics of the U.S. economy and, indeed, have done so over this cycle, persistently dampening upward price pressures.

The increased productivity experienced in the late 1990s, due to the large investment in information and communication technology, or ICT, allowed the United States economy to produce high levels of output while not experiencing inflationary pressures.

The dynamic at work was that the new, profitable investments being offered in ICT created an increase in productivity, which translated into increased profits, and thus more investing and consuming. At the same time, the increase in productivity growth helped keep down unit labor costs and prices. This led to a period of strong growth and low inflation.

As an economist, I recognize that price pressures are an inevitable part of any business expansion. I think we all recognize that as the economy continues on its path of expansion, price dynamics are prone to shift.

Now, it seems that investors are becoming less willing to channel so much of their savings into additional dollar-denominated instruments going forward. And some have suggested that they are beginning to diversify into other currencies, like the euro. This has caused the dollar to depreciate against other currencies.

Now, the forces are aligned for strong growth in business investment spending. Firms have had time to fully digest their previous acquisitions of capital. Profits have been strong. The economic outlook is positive, and some of the previous risks and uncertainties are dissipating.

Rising real estate prices have created conditions in which building costs are significantly less than going market values. That means it now makes good economic sense to develop, redevelop, and revitalize many neighborhoods that had fallen into decay and disrepair. The key is to leverage this opportunity for the benefit of all – both those attracted to these neighborhoods by new opportunities and those who lived there through tougher times.

If the economy evolves as I anticipate over the next year or so, I expect we will continue to move the federal funds rate toward neutrality at a measured pace. But the precise course the Fed takes very much depends on the precise course the economy takes...If signs emanating from the economy suggest that the economy is veering off its most likely course, we will need to consider altering the pace at which we move toward policy neutrality. At the moment, however, this does not seem to be the case.

The Federal Reserve has been committed to making the transition from an accommodative policy stance to a neutral one, more conducive to sustained noninflationary economic growth. This process began about a year ago and is ongoing. The challenge here is to move the interest rate back to a more neutral level without dampening growth in real output or generating undue negative sentiment.

I believe the US economy is embarked upon a period of sustained expansion…And after a mild scare of another 'soft patch' earlier this year, the economy looks to be expanding at a moderate pace. Looking forward, I expect real GDP to grow at a rate of 3-1/2 to 4 percent through 2005. Earlier this year I would have favored the upper end of this range, but recent events have dampened that forecast somewhat.

If the economy evolves as I anticipate over the next year or so I expect we will continue to move the federal funds rate toward neutrality at a measured pace.

But the precise course the Fed takes very much depends on the precise course the economy takes. If signs emanating from the economy suggest that the economy is veering off its most likely course, we will need to consider altering the pace at which we move toward policy neutrality. At the moment, however, this does not seem to be the case.

I also expect inflation to remain well contained in 2005, both overall and by core measures that exclude food and energy prices. My scenario of solid output growth, at or just slightly above the economy's long-run potential, and steady job gains, which gradually bring the labor market into better balance, is consistent with a relatively stable price environment.

The very continuation of the expansion, now in its fourth year, may lessen the competitive pressure on domestic producers and permit them to exert some pricing power.

Over the past several years, economists have been expecting the decline in the value of the dollar to bring stability to the trade picture. This began in earnest in the second half of last year.

Swings in business investment spending have driven the pattern of this past business cycle…Firms are positioning themselves for greater efficiency and greater productive capacity…However, the last number we received on business investment from the first quarter GDP figures was lower than some expected, though clearly positive. Nonetheless, going forward, I anticipate that robust growth in business investment spending will continue to play a major role in our growth through the remainder of the year.

How much of that domestic demand translates into domestic production depends on what happens to our international trade balance. Indeed, the widening trade deficit of the past decade has sapped growth in demand for domestic production.

New job growth and rising household income have been and will continue to support growth in consumer spending and overall. However, in the current rising interest rate environment; growth in big ticket items--such as cars, houses, and other durables--should stabilize and therefore play a less significant role than in past quarters in consumer spending's contribution to economic growth.

The business sector and business investment spending have been strengthening as the expectation of further growth has permeated the marketplace. In this environment, the demand for commercial loans has begun to accelerate...My sense is that there is keen competition among banks to make these loans. Under these circumstances in the past, banks tended to underprice risk. It is particularly important to guard against this temptation, particularly because slackening growth in deposit inflows may put upward pressure on funding costs as the expansion progresses.

Interest rate risk can never be ignored.  We all know that the FOMC has moved the fed funds rate upward by 2 percent over the last year in a series of eight quarter-point adjustments. Yet over this same period, long-term interest rates have fallen.  It is incumbent upon management to position its balance sheet so as to protect the institution from the vicissitudes of the long bond market, whether long rates remain low or revert to a more common historical pattern.

I expect [Nonfarm payrolls] to continue increasing at an average rate of 150,000 to 200,000 jobs per month this year…Furthermore, research done at the Federal Reserve Bank of Philadelphia suggests that job growth in high-wage industries will account for a large portion of total job growth going forward.

Risk management itself is not a mature discipline...risk management systems simply have not been in existence long enough to generate reliable results on risk trends and assessments, and so the very newness of the profession itself can be considered a disadvantage.

In all likelihood, this investment cycle will unwind too with the arrival of higher rates. As this occurs the speculation present in some markets will eventually dissipate and prices will stabilize.

Demographers assure us that aging baby boomers, a positive rate of family formation, and continued immigration into the U.S. are at least partially responsible for the relative rise in residential real estate prices. Economists’ best guess is that the underlying fundamentals indicate that housing markets and housing prices should begin to stabilize as the so-called conundrum fades and mortgage interest rates rise.

[Consumers] are capitalizing on low mortgage rates by increasing their mortgage debt, while at the same time reducing other debt obligations...So, all in all, the consumer sector’s financial situation appears to be reasonably sound and should provide a firm base for continued growth in consumer spending as incomes and employment expand.

The Bush administration came into office intending to permanently reduce tax rates as a strategy for fostering stronger economic performance over the long term...Without a doubt, this application of counter-cyclical fiscal policy was extraordinarily well timed and effective.

While the recent inflation numbers have been good, and I share the general view that inflation is unlikely to be a problem in the near term, I believe that we must stay ahead of the curve to ensure that it does not become a problem in the long term.

I expect inflation to remain well contained in 2005, both overall and by core measures.

Nonfarm payrolls have been growing for some time now, and I expect them to continue increasing at an average rate of 150,000 to 200,000 jobs per month this year.

The U.S. economy is embarked upon a period of sustained expansion. Looking forward, I expect real GDP to grow at a rate of 3-1/2 to 4 percent through 2005. Earlier this year I would have favored the upper end of this range, but recent events have dampened that forecast somewhat toward the lower end of this band. Of course, the price of oil is one factor that will play a role in determining the exact magnitude of this number.

Disappointing growth of our trading partners’ economies, the increased world price of oil, and the pattern of exchange rate movements since the beginning of this year, all suggest the deficit may continue to widen.

Consumers will do the bulk of the new spending...Of course, as interest rates rise, growth in the sales of big ticket items — cars, houses, and other durables — should stabilize and return to more normal levels.

Going forward, I anticipate that growth in business investment spending will continue to play a major role through the remainder of the year...Moderate growth in government spending appears to be a reasonable estimate. 

Consumers are like the Energizer bunny: their spending growth goes on and on.

Nonfarm payrolls have been growing for some time now...hiring is up and recruiters have returned to campus. In fact, over the past 12 months, non-farm payroll gains have averaged 185,000 per month, somewhat above the figure that many economists believe is necessary to keep pace with growth in the labor force. As a result, the unemployment rate has slowly drifted down, and now stands at 5 percent, which is relatively low by historical standards.

So the Fed's best strategy is to keep careful watch on economic developments, approach each policy decision with an open mind, and communicate the rationale for its decisions as clearly as possible.

If the economy evolves as I expect, then my sense is that the policy path upon which we embarked just over a year ago — a movement toward neutrality at a measured pace — will continue to be appropriate.  If the economy evolves as I expect, it is likely that we can continue to move the federal funds rate toward neutrality at what we have described as a measured pace, steadily converging to a level of interest rates that supports the current expansion into 2006 and beyond. 

To keep these incipient price pressures well-contained, the Fed will have to continue shifting monetary policy from its current somewhat accommodative stance to a more neutral one.

In the near term, overall inflation will be affected by the substantial increase in energy prices...But this should be a transitory phenomenon.

Thus far over this cycle, inflation has been well-behaved, and inflation expectations have remained well-anchored. I fully expect that this will continue to be the case.

I expect employment growth to continue in the range of 150,000 to 200,000 jobs per month this year, and obviously, this would be a welcome pattern in an economy that had struggled to add jobs in this cycle.

With the unemployment rate at 5 percent, we must also begin to ask how much slack remains in the labor market...By at least one measure, there may not be much...Once a year, we ask the [Survey of Professional Forecasters] participants for their estimate of the economy's “natural rate” of unemployment...In our most recent survey, released this month, the median of the estimates of the natural rate of unemployment was 5 percent. This suggests to me that we may begin seeing some tightness in the labor markets soon, and some upward pressure on wages and prices.

The bottom line is that the U.S. trade deficit will probably continue to widen over the near term, and somewhat diminish growth of U.S. output.

The aftermath of Hurricane Katrina has accentuated the concerns already in the market place and caused a further escalation in oil prices today. There is little doubt that the weather damage to our oil industry could be substantial and dislocations are likely in the short run.

The events unfolding in Louisiana and Mississippi add more than the usual amount of uncertainty to our economic environment.

With the kind of growth I am projecting — moderately above the economy's long-run potential — we will continue to add new jobs at a healthy pace, without creating undue inflationary pressures. This, in turn, positions us to settle into a prolonged period of sustained expansion.

The value of the dollar declined somewhat last year, but has appreciated thus far this year. It seems that foreigners, including both private investors and central banks, have been more willing to hold dollars than we anticipated.

Thus far, the U.S. economy has proven relatively resilient to the rising oil prices...Our economy has become more fuel-efficient, and as our output shifts from goods to services, it has become less energy-intensive. These trends render the economy better equipped to handle rising oil prices. Thus, while oil price increases have robbed the U.S. economy of some momentum, growth has remained quite healthy.

The effects of Katrina are likely to slow but not stall the forward progress of the national economy. Of course, we must all wait to see the damage that Mother Nature has caused, but for the moment I am hopeful that the damage done to the national economy will be neither substantial nor very long lived.

Most economists expect housing prices to begin to stabilize as long-term interest rates adjust upward. As this occurs, the speculation present in some markets will eventually dissipate and price increases should slow.

As usual, consumers will do the bulk of the new spending that generates this growth. They always do and always will. With the expansion well underway, solid job growth and rising household incomes are supporting steady growth in overall consumer spending now, and will continue to do so into the future. This ought to be true even with the regional disruption associated with this season's hurricanes and even as energy prices rise and the accumulation of home equity begins to moderate.

I expect businesses to continue contributing significantly to the overall increase in spending. With the expansion firmly in place, businesses are investing again in high-tech hardware and software, and in warehouses and machinery as well...Going forward I anticipate that growth in business investment spending overall will continue to play a major role in aggregate economic growth. 

For the past decade, a widening trade deficit has been siphoning off some of the growth in demand for domestic production in the U.S., and funneling it into our trade partners — Europe, Japan, and most notably, China.

I believe the U.S. economy remains on a path of sustained expansion, and I expect real GDP to grow at a rate of 3-1/2 to 4 percent in 2005. From a policymaker's perspective, that would be a good outcome and a good place for the economy to be.

It appears our nation’s pattern of payments is finally evolving — some might say it is experiencing a radical change — from one based on paper checks to one based on electronics.

Changes in the payments structure have had, and will continue to have, profound effects on our physical infrastructure. It is expected that the Fed’s paper processing role will diminish as checks recede in both absolute volume and relative importance in the retail payments system. In the interim, however, the changes taking place in payments patterns are causing us to adapt and adjust to the market’s evolution.

Most experts expect that retail payments will continue moving away from cash and paper checks toward electronic instruments.

It is also clear that monetary policy's capabilities are limited.  We may be able to limit the severity of the cycle, but we cannot eliminate it.  There are too many powerful forces at work in the economy for that.  And as the recent hurricanes remind us, an aggregate demand management tool is not very effective when the economy is hit with a shock from the supply side.

Before the hurricanes struck, the economy was clearly on a sustainable path of expansion.  While the recent disruptions and dislocations in the gulf may slow the rate at which the economy grows for a time, I believe the expansion is strong enough to withstand them.

We must keep in mind that with expansions inevitably come increasing inflationary pressures.  In the near term, overall inflation will be affected by the substantial increase in energy prices.  To keep cyclical price pressures and any transitory spike in energy prices from permanently disrupting the price environment, the Fed will have to continue shifting monetary policy from its current somewhat accommodative stance to a more neutral one.

To the extent that the future course of monetary policy becomes less obvious, forthrightly communicating not only the actions we take but the reasons we take them will be essential to maintaining our credibility.

Putting all these factors together — slower population growth, an aging baby boom generation, the plateauing of women joining the workforce, young people’s delayed entry, and the capping of immigrant inflows — growth in our nation’s labor force will almost surely drop below 1 percent in the decade ahead, perhaps significantly so.

With the IT revolution continuing and a flexible U.S. economy operating in a more global marketplace, I expect labor productivity to grow by around 2-1/4 percent per year. These estimates imply a potential for output growth of about 3 percent per year on a sustained basis.

Some may see the trend toward output growth of 3 percent as a failure of policy. But if the estimates [of labor productivity] above are correct, it is not. The economy must be allowed to move along its path of potential growth if we are to achieve monetary policy’s dual mandate of sustainable growth and price stability. Attempts to maintain consistently higher growth than this will only produce inflationary pressures and erode the price stability that is monetary policy’s most important contribution to macroeconomic stability.