The ongoing housing correction and the volatility and uncertainty in the credit markets are significant near-term drags on the economy and I expect growth in the first half of the year to be quite weak, around 1 percent. As conditions in the housing and financial markets begin to stabilize, I expect growth to improve in the second half of the year and to move back to trend, which I estimate is around 2.7 percent, in 2009. Overall, I am now anticipating economic growth in 2008 of near 2 percent.  

Given the slowdown in economic growth this year, payroll employment will rise more slowly than last year and will remain below trend for much of the year before picking up in 2009. Slower job growth will also lead to an unemployment rate near 5-1/4 percent in 2008, after fluctuating between 4‑1/2 and 5 percent in 2007.  

The FOMC’s reductions in the federal funds rate have been proactive in responding to evolving economic conditions that led to the deterioration in the outlook for economic growth. My inclination to alter monetary policy depends on whether the accumulation of evidence based on the data between now and our next meeting causes me to revise my forecast further.

Although the economy’s resilience to past shocks makes me cautious about making changes to my outlook based on just one or two pieces of economic news, the string of weaker than anticipated numbers released in late December and in January had a cumulative effect on my own assessment of the 2008 outlook. While I would not be very surprised if the economy bounces back more quickly than many forecasters are now projecting, I am now, nevertheless, anticipating a weaker first half of 2008 than I did in October. This downward revision to the economic outlook is what led me to conclude that a substantially lower level of interest rates was needed to support the process of returning the economy to its trend rate of growth. Consequently, I believe the recent reductions in the federal funds rate were a necessary and appropriate recognition of this changed outlook.

It looks like we're going to get growth of 0.5% perhaps in the first half of the year and then later in the year growth firming, and increasing and after about a couple of years back to our long-run trend (2%-3%). That's what I think is most likely.

From conversation with students and faculty as reported by Market News International.

In my view, the prominence of downside risks means that further easing ultimately may be warranted. My expectation that growth is likely to be sluggish this year figured prominently in my thinking about policy last month, however, so if incoming data is not weaker than expected over the next several months, it's not clear further rate cuts would be warranted.

As I said, my sense is that the most likely path is sluggish growth in the near term. But I can also see the possibility of a mild recession, similar to the last two we have experienced — in other words, shallow and with a slow recovery. What I don't expect is a more severe recession, like those we saw in 1982 or 1974. Keep in mind that monetary policy has moved aggressively in recent months, and that inflation-adjusted interest rates are now very low by historical standards. That by itself won't solve all our problems, but it will help support activity enough to at least avoid the worst outcomes, and possibly avoid a recession altogether.

There is a fair amount of month-to-month volatility in the employment numbers, so it is quite possible that the underlying trend is stronger than the January reading by itself would suggest. If job growth is positive in the months ahead, and if wages can stay ahead of inflation, then income growth should be sufficient to support consumer spending gains and allow us to skirt the boundary of recession.

Exports are likely to remain a source of strength next year, however, as a weaker dollar and continuing growth abroad support demand for U.S. goods and services. Accordingly, I expect the trade deficit to continue to narrow, providing modest support to real GDP growth.

The housing sector has been and will continue to be affected by the tightening we've seen in lending standards. New home sales have fallen 64 percent from their peak in October, 2005. Home construction is unlikely to bottom out this year, and I expect housing investment to continue to be a drag on growth through at least year-end.

The economic outlook for 2008 has worsened in response to the developments of the last six months, and the recent flow of data has heightened the downside risks.

VICE CHAIRMAN GEITHNER. I really couldn’t tell, President Lacker, what inference you were going to draw from that. But I would just reinforce the point that, if you are more worried and uncertain now about the magnitude of the headwinds and the duration, I think it has to mean that you err on the side of going lower sooner. But the main point is that we just don’t know much about it, and I think it is worth a lot of humility. I mean, think how surprised we have been by so much over this period, even with all our thinking through three years ago about alternative paths for housing. So I would just vote for humility. But the basic point is that we have to err on the side of being worried about reducing the risk that you end up with 75 mile an hour headwinds rather than 25 for a long period of time.

….

PRESIDENT LACKER. Our Vice Chairman urges humility. I strongly support that. I agree with President Evans that it’s not obvious that the greater one’s humility, the greater one should favor ease. I think we should be humble about the path of inflation going forward, whether it’s likely to fall on its own. I think we should be humble about our understanding of the output gap. I think we should be humble about whether that’s even a sensible way to think about how real and monetary phenomena interact. The Phillips curve itself embodies a relationship. It is uncertain, but it embodies expectations of our future behavior. I think we should be humble about what those expectations are in the present circumstance. Times in the past when we’ve gotten in trouble on inflation have often been when we were over-solicitous about weak economic growth, and I think we should be humble about whether we’ve completely gotten past those inflation dynamics or not. I think we should be humble about the willingness of our future selves to reverse course, and a lot has been said about that. For some it seems to counsel greater ease now, but I think the opposite argument can be made that the extent to which we think we may be hindered or feel impeded in raising rates, even if we think it’s warranted in the future, should cause us to be more cautious about lowering rates now. It always seems in recoveries that there’s always something that looks fragile, that looks likely to threaten economic growth. You know, one month it will be the commercial paper market and CDO writedowns, and this month it’s monolines. There will be headwinds. I predict we’ll be talking about headwinds a fair amount in the next couple of years. But if those are genuinely going to impede us, we need to be realistic about that, and I think we need to take it on board now. I agree with President Poole. We need to be humble about our ability to prevent a recession. I think we should also be humble about the extent to which what we see in terms of both growth and financial markets is presumptively inefficient and needs remedial action on our part. You spoke several meetings ago, I think a year or two ago, Mr. Chairman, about our need to retain a concern about inflation but not be seen as inflation nutters. I think we need to care about financial fragility but not be fragility nutters.

Inflation expectations seem to be fairly contained right now. The upward movement we see does not at this point seem to be likely to result in runaway inflation.

From press Q&A, as reported  by Market News International

A slowing economy requires a lower real interest rate because it means softer relative demand for resources now compared to the future. And the current downside risks mean that further slowing, and thus further easing, is quite possible. But inflation also presents risks. Throughout the period since 2005, when inflation rose, eased off, then rose again, longer-term inflation expectations have remained fairly stable. If energy and food prices continue to push overall inflation above core inflation, then this higher overall trend could work its way into expectations, further complicating monetary policy in 2008.

Putting it all together, I expect growth to be very weak for several more months, but to improve toward the end of this year. Clearly, the most cogent risks to the growth outlook are on the downside. With the strains in housing persisting, a substantial slowdown in business spending could raise the odds of a recession. This risk would be heightened if December's job market weakness proved persistent, pulling down prospects for personal income and household spending. Nevertheless, I believe the most likely outcome is for growth to continue and to improve. I should note that my baseline outlook does not depend on an overly sanguine view of financial market conditions, which are, after all, a significant source of uncertainty right now.

Recently, negative information has been exceeding expectations. I think these circumstances call for policymakers to be prepared to respond pragmatically. In my view, pragmatism in the face of growing weakness in the general economy may very well require additional moves to lower the federal funds rate.