...[R]estraint on credit supplies is likely to persist because intermediaries have some way to go to rebuild their balance sheets.  The process of adjustment to a safer, more resilient financial system is going to take a while.    

Overall, I anticipate that real GDP growth in the second half of this year will come in below the growth of potential output which implies that the unemployment rate will rise. On its own, this obviously is not good news. And its interaction with the housing and financial markets raises the potential for worse news—a deepening of the adverse feedback loop I've been describing: more unemployment causing more people to fall behind on their mortgage payments, leading to further delinquencies and foreclosures, tighter credit conditions and further downward pressure on activity and employment. This kind of process represents a downside risk for the economy, especially if it intensifies the sagging consumer and business confidence we've seen.

I think it is very likely we will suffer anemic growth for the current and perhaps the next couple of quarters. .... Still, I think it likely that our movement through the muck and the flotsam and jetsam of the credit and housing debacle will be sluggish, and it may take some time into 2009 for us to get the economy back up to a snappier cruising speed.  

In Admiral Smith’s parlance, having sailed the economy along for years in a tranquil following sea, we are now navigating Force 10 conditions. To be sure, on the growth front we have managed to make better headway than most everyone expected under the circumstances: To everyone’s surprise, our $14 trillion economy grew at a 3.3 percent annualized rate last quarter, meaning that the American economy produced almost $29 billion more in the second quarter than it did in the first.

That said, looking off the bow, I see nothing on the horizon that would lead me to conclude anything different than what I articulated in Aspen: The data received since then on personal consumption expenditures, real capital expenditures and construction show the third quarter off to a weak start, although yesterday’s manufacturing numbers were a nice surprise on the upside. I think it is very likely we will suffer anemic growth for the current and perhaps the next couple of quarters. But I want to lay down a caveat: What bothers me is that this is a widely held view. I learned over the years as a market operator that the consensus view is almost always wrong. American entrepreneurs and business leaders are ingenious in figuring out how to overcome obstacles that might befall lesser capitalists. Still, I think it likely that our movement through the muck and the flotsam and jetsam of the credit and housing debacle will be sluggish, and it may take some time into 2009 for us to get the economy back up to a snappier cruising speed.

As to the inflation outlook, there appear to me to be even odds that one of two scenarios will obtain.

The first calls for slowing domestic and economic growth to dampen the inflationary surges we have seen of late.
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The other probable scenario assumes that rather than passing through as a “one-off" event, there is some spreading of the inflationary pressures we have been experiencing...After companies have had their margins gutted by dramatic rises in their cost of goods sold, one can envision them being a little skeptical about the durability of recent price retrenchments in the commodities markets and taking advantage of every opportunity to buy protection from being victimized again. Under this scenario, consumer prices prove sticky on the downside.

The jury is still very much out as to which scenario will obtain.

With the economy expected to expand at a rate below its potential in the second half of this year, further increases in the unemployment rate are possible.  It now appears that the national unemployment rate may rise above 6 percent, an increase of more than one and a quarter percentage points – or about 2 million workers – from last August, when the financial problems emerged. 

The 12-month inflation rate through July was measured at 5.6 percent, the highest since 1991. This is a high and worrisome number...No matter how you measure it, the aggregate inflation we are experiencing in the United States at the moment is uncomfortably high.

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I expect the recent decline in oil prices will begin to reverse some of the pressures we have seen on overall inflation in the first half of the year. But the underlying global supply pressures remain tight, and demand pressures remain relatively high. As such, any relief will likely be only partial.

Furthermore, some government estimates suggest little respite from food price hikes in the near term. At this point, it seems quite probable that PCE index inflation this calendar year will clock in at more than 3.5 percent and the CPI somewhere north of 4 percent—an improvement over the first half of the year, and trending in the right direction, but not numbers I would be comfortable with over the longer term.

Although recent measures of inflation are higher than I would like to see, I would say that recent price increases are more likely to be transitory than persistent. I expect that CPI inflation will peak near the July level of 5.6 percent. By comparison, in March 1980 the CPI peaked at 14.8 percent.
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I concur with that view and believe current Fed policy is consistent with an easing in overall inflation given the dynamics of the economy. With weak growth and financial market strains, I believe the most likely outcome is that both headline and core inflation will diminish over the rest of 2008 and into next year as the temporary effects of energy and food price increases abate. Note that my outlook does not require that food and energy prices fall, but simply that their rates of increase moderate.

My belief is that the Fed has undertaken tactically prudent actions to help move the economy through a difficult transition in line with the larger strategic goals of sustainable growth, low and stable inflation over the long term, and financial stability. Also, let me emphasize that I am mindful of today's elevated risks and am prepared at any point to change tactics to ensure inflation expectations do not become unanchored.

"Growth will taper down...to a snail's pace in the second half," and it "may be anemic for a while," Mr. Fisher said, adding that he "could see us approaching" zero growth during the latter half of the year due to the "enormous stress" created by financial markets, which remain strained.
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"The real concern I have as a central banker is whether or not [inflation] begins to affect the...spending patterns by consumers [and] pricing patterns by producers," Mr. Fisher said.

"I don't know the answer to that question," he said, adding that the odds are even whether inflation gains prove a "one-off event" or more persistent. He fears the latter scenario may be more likely.

"I have been most concerned" that expectations of further price increases will become embedded in the economy.

And while the recent pullback in energy and commodity prices is encouraging, Mr. Fisher said "it's too early to take comfort in these reversals."
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Mr. Fisher said he is confident the committee "won't do what is required" to bring price pressures back in line.

I expect U.S. economic growth will decelerate to a snail’s pace, if not completely grind to a halt, in the second half of this year. Indeed, we may see the slowdown extend into 2009 as the excesses that drove the housing markets unwind before the economy can again gear up to cruising speed. Then, as 2009 unfolds, it is quite possible that the economy will resume a more normal growth trajectory.

It's going to depend on your forecast for that. So it's difficult to argue against futures markets that have a certain view built in that energy prices are going to, crude oil, for example, is going to be flatter down from here. But they've been wrong before, and there's a huge band of uncertainty around that central tendency of a forecast. So I think the most likely outcome is moderation in headline inflation over the next half year or year. Core inflation likely to rise to 2.5 percent or so. And I think it will moderate after that.

The current monetary policy environment is even more complicated than usual. If we were using battlefield language to describe our situation, this would be a "three-front conflict." Although real activity is weak, we also are simultaneously experiencing bad news on the inflation front in the form of higher energy and commodity prices. This creates the challenge of facilitating the economy's return toward more favorable growth rates without igniting greater inflationary pressures. The financial turmoil and subsequent tightening of credit conditions add another dimension of difficulty to the problem.

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I think the risks for growth have increased and the risks for inflation remain elevated and a concern....I see real GDP growth returning near potential by 2010—somewhere in the range of 2-1/2 to 3 percent....I think inflation should moderate over the medium term, with PCE headline inflation declining to around 2 percent by 2010.
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Our 325-basis-point cumulative cut in the funds rate was larger than we otherwise might have done in order to insure against the unlikely event of a severe downturn. That said, even though I think the current 2 percent funds rate is accommodative, it is not especially stimulative. This is because the financial market turmoil has meant that our funds rate reductions have led to less credit expansion to households and businesses than typically would be the case.

From my perspective, I like policy where it is.  I view the current situation as reasonably balanced, with a great deal of uncertainty around both the downsides to growth and the upsides to inflation….If the inflation numbers remain high -- which is another way of saying if I'm wrong -- then I may support action earlier.  The outlook for the second half of the year and going into 2009 is we'll see some alleviation of inflation pressures. Having oil and other commodities come down so strongly helps.

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I would characterize today's markets as still showing some stress. Credit spreads have been somewhat rising.  The healing process of the financial sector is going to take some time.  I think it is reasonable to assume there will be some more pain before we really completely see a turn.

I would not rule out any action {on interest rates}.  I think we have to react to circumstances.

I think that today’s circumstances align well, although certainly not perfectly, with the experience of the early 1990s.
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It is important to bear in mind, however, that many “initial conditions” prevailing prior to this financial shock were perceptibly better than in the early 1990s. Unemployment, interest rates, and inflation were all lower at the outset of the latest period of turmoil than in the previous headwinds episode. Equally important, the financial condition of both banking and nonfinancial businesses was healthier at the onset of recent problems.

Overall, while there is considerable uncertainty about the outlook and while the policy environment is challenging to say the least, my view is that the early 1990s headwinds episode remains a valuable guide at this juncture. Specifically, it would imply a continuation of only modest expansion in the economy, the likelihood of further increases in unemployment for a time, and a diminution of inflation, absent a resurgence in energy and other commodity prices.

In considering these prospects, it is worth recalling that, despite early challenges, the 1990s turned out to be an excellent decade for the U.S. economy by almost all metrics. The economy is fundamentally flexible and resilient, and these characteristics should ultimately prevail.