The ongoing capital injections under the TARP are continuing to bring stability to the banking system and have reduced some of the pressure on banks to deleverage, two critical first steps toward restarting flows of new credit.  However, overall, credit conditions are still far from normal, with risk spreads remaining very elevated and banks reporting that they continued to tighten lending standards through October.

One of the most obvious observations from the current turmoil is that a crisis can stem from parts of the financial market not covered by traditional safety nets.  In past crises, we have typically been able to direct our efforts toward banks and other depository institutions where we have safety nets and a supervisory and regulatory framework to address institutional problems and restore market confidence.  However, many of the institutions and markets now under stress are not subject to prudential oversight.

Collectively, the information I have been looking at tells me that the economy is now in a recession, although the National Bureau of Economic Research, the referee in such matters, has yet to call one. Nationally, employment has been declining all year, and in last week’s employment report we saw the characteristic monthly employment losses that are associated with a recession.

After a slight contraction in real GDP in the third quarter, I anticipate a somewhat sharper decline in the fourth quarter. This forecast will put real GDP growth for 2008 in the neighborhood of one-half of 1 percent (0.5 percent) (measured on a fourth-quarter-to-fourth-quarter basis). Growth in the first half of 2009 is also likely to be weak, but I expect improvement in the second half of the year. Even so, overall growth for 2009 (fourth-quarter-to-fourth-quarter) is likely to be below 2 percent. With relatively weak performance over the next several quarters, I expect the unemployment rate to rise above 7 percent in 2009 before it begins a gradual decline in the latter half of the year.

The near-term economic outlook is not encouraging. The incoming data in September and October have been worse than expected, and these results pushed my staff and me to revise downward the Atlanta Fed's outlook for the economy.

I foresee substantial weakness at least through the first half of 2009. This weakness will exacerbate the employment picture. In my outlook, unemployment will rise some more.

If there is anything positive in this near-term outlook, it is the trajectory of prices. I expect headline inflation to decline over the coming months and fall into an acceptable range below 2 percent by 2010. Over the longer term, inflation experience is influenced by inflation expectations. Encouragingly, the University of Michigan consumer survey's reading for October shows a moderation in inflation expectations both for the year ahead and for the longer term.

Recent data indicate that the national economy is in recession. Economic activity as measured by real gross domestic product (GDP) declined an estimated 0.3 percent at an annualized rate in the third quarter, according to the advance estimate. Data for October suggest an even steeper decline in GDP for the fourth quarter.

There are some notable signs of improvement. Short-term funding spreads are retreating from extremely elevated levels. Funding maturities are being extended beyond the very near term. Money market funds and commercial paper markets are showing signs of stabilization. And credit default swap spreads of banking institutions are narrowing significantly.

The conventional wisdom is that the credit market disruptions we've seen over the last year or so impede the financial sector's ability and willingness to extend credit to households and business firms, thereby creating an additional drag on spending. But causation can flow in the opposite direction as well. When overall economic activity seems poised to contract, the outlook for household income and business revenues deteriorates as well. This implies that individual households and businesses will become less creditworthy, all else constant.

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My reading of the history of U.S. business cycles is that the direct effect of credit markets on real activity – the so-called "credit channel" – accounts for only a small part of the variation in output over the typical cycle. This judgment may be of limited help in thinking about the rather atypical events we have been experiencing recently, but I think it means we have to give serious consideration to the idea that this episode of credit and financial market turmoil is part of the economy's natural response to the sharp decline in the underlying fundamentals in housing finance. My sense is that the deterioration of economic conditions is playing a more prominent role in the tightening of credit terms right now than the direct effects of financial market turbulence.

Because households tend to base their consumption plans on their income prospects, any improvement in consumer spending growth likely will depend on a shift to a more optimistic assessment of those prospects. Once households are convinced that an end to the deterioration in labor market conditions and the fall in equity and home prices is in view, however, consumer spending growth will be based on improving longer-run income prospects and is likely to pickup substantially.

Many analysts expect the U.S. economy to regain positive momentum sometime in 2009. That strikes me as a reasonable expectation, for several reasons. First, monetary policy is now quite stimulative. The federal funds target rate is 1 percent, below the expected rate of inflation. Second, the major shocks that dampened economic activity this past year have already subsided or are in the process of doing so. Energy prices, thankfully, have reversed most of the earlier run-up; that will free up a portion of consumer budgets for spending on other goods and services. And as I've mentioned, the drag from housing seems likely to lessen in the next year, and in fact, I would be surprised if we don't see a bottom in housing construction around the middle of 2009. This is the third straight year, however, that I've been expecting a bottom in the housing market in the middle of next year, so my outlook is tempered by more than the usual amount of humility.
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The sharp decline in oil prices since they peaked this summer has flattened the overall inflation rate in August and September. Many economists are forecasting a decline in core inflation as well in the months ahead, on the grounds that widening economic slack is generally associated with declining price pressures. While this correlation is detectable in many datasets, I would be cautious about relying on it as a causal relationship.⁴ In particular, this relationship can shift over time as expectations about the conduct of monetary policy evolve. Those expectations will be influenced importantly by the measure of monetary stimulus provided during the downturn and how long that stimulus remains in place. As a recovery begins, the path of least resistance is often to hold the policy rate at a low level until it is completely clear that recuperation is complete. The risk associated with that path is that inflation may not moderate obediently during the downturn, and may firm with the ensuing recovery. It is crucial that we not allow expectations of future inflation to ratchet higher during this recession.

Some have asked why policymakers and others didn’t see all of this coming. A lot of people talked about a bubble in home prices that could eventually collapse and lead to sizable credit losses and significant negative wealth effects.  I think the answer is that a lot of people also did not fully understand how these effects would be magnified by several key features of the financial system—features that have interacted with one another to produce a deep wariness about counterparty risk and a freezing up of credit flows. Each of these features corresponds to one of the three main elements of a balance sheet: assets, capital, and liabilities.

By any measure, September was historic. The events of September contributed substantially to a fundamental restructuring of this country's financial system. It also brought a transition from an incremental approach, including the Federal Reserve's various measures to provide much-needed liquidity to markets, to a comprehensive attack on the diverse elements of the crisis.

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Looking ahead at the U.S. economy, this is a period of vexing uncertainty...With the deterioration in economic conditions and the recent associated falloff in energy and many other commodity prices, I anticipate further dissipation of inflationary pressures. Nevertheless, given high inflation readings during the summer and into the fall, I'll continue to watch developments closely.

We at the Atlanta Fed expect weakness to persist for some time into 2009 as credit markets gradually improve. The thawing of credit markets is a necessary condition for a recovery back to levels of growth consistent with the economy's underlying potential.

Even before the recent intensification of the financial crisis, economic activity had shown considerable signs of weakening...  Incoming data on consumer spending, housing, and business investment have all showed significant slowing over the past few months, and some key determinants of spending have worsened:  Equity and house prices have fallen, foreign economic growth has slowed, and credit conditions have tightened.  One brighter note is that the declines in the prices of oil and other commodities will have favorable implications for the purchasing power of households.  Nonetheless, the pace of economic activity is likely to be below that of its longer-run potential for several quarters.

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The prices of the goods and services purchased by consumers rose rapidly earlier this year, as steep increases in the prices of oil and other commodities led to higher retail prices for fuel and food, and as firms were able to pass through a portion of their higher costs of production.  These effects are now reversing in the wake of the substantial declines in commodity prices since the summer.  Moreover, the prices of imports now appear to be decelerating, and consumer surveys and yields on inflation-indexed Treasury securities suggest that expected inflation has held steady or eased.  If not reversed, these developments, together with the likelihood that economic activity will fall short of potential for a time, should bring inflation down to levels consistent with price stability.

Core inflation for personal consumption expenditures was up to 2.6 percent (year-over-year) in August. In my opinion, this rate has been high...Although some risks to the inflation outlook remain, a forward-looking assessment would put less weight on inflation concerns than earlier this summer.
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The outlook for real economic activity likely will result in production, spending, and labor markets being very sluggish in the second half of this year and well into 2009. I expect that such activity will then pick up as the housing and financial markets gain headway in working through their problems. Such progress would be signaled by stabilization in construction and improvement in credit flows.
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There is, of course, a level of cloudiness in any economic forecast. In the current situation, the substantial stress in the financial markets has led to an unusually high degree of uncertainty. This is because it is extremely difficult to assess how the turmoil will influence markets and how policy responses to address the economic unrest will play out over time...We at the Federal Reserve continuously reevaluate the stance of monetary policy in light of current and forecasted conditions, as well as our assessments of the risks to our long-term objectives of maximum sustainable growth and price stability. Currently, these risk assessments must factor in the substantial uncertainties in the outlooks for growth and inflation that I just described. These uncertainties certainly pose difficult challenges for policymakers.

{E)conomic and financial conditions have deteriorated recently, and while the housing and financial markets are most impacted, there is little doubt that the effects are spilling over to the rest of the economy. However, now with appropriate and determined policy actions underway, I believe much of the spillover can be mitigated and the economy can return to growth that is closer to potential next year.  To that end, I believe that policymakers should maintain a focus on three key areas, which I’ll mention briefly.

First, it is essential that liquidity for companies is maintained, or more accurately, is re-established.  It is really in every citizen’s interest that firms — particularly our most creditworthy ones — not face uncertainty over whether they will be able to continue to finance themselves with short-term debt.

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My second observation is that financial firms need to have the financial strength to continue to lend to creditworthy borrowers. Making sure that banks have sufficient capital to continue to lend is vital, because access to credit is critical for households and businesses.

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My third broad observation for policy focus involves the housing market — it needs to reach bottom and potential homebuyers need to gain the confidence to return to the market. By this I mean that individuals shopping for homes need to be confident that appropriate financing is available for home-ownership.