FOMC participants project that the growth in economic activity should moderate to a pace close to that of the growth of potential both this year and next.  Should that moderation occur as anticipated, it should help to limit inflation pressures over time.

Recently, however, we have seen increasing signs that economic conditions are becoming less favorable.  Continuing high energy costs and rising interest rates appear to be slowing economic growth.  At the same time, inflationary pressures are beginning to emerge.  These developments have been associated with increased volatility in commodity markets and in financial markets around the world.

The sectors of the economy that will support our economic growth this year are expected to be somewhat different from those that prevailed in the past few years. The housing market, after several years of strong expansion, is already showing signs of cooling off this year. Consumer sentiment has been deteriorating, according to the latest survey responses, and recent data show signs that consumer spending is softening from its strong first-quarter performance.

Consumers have sustained their spending during the past several years, in part, by cashing out some of their home-equity dollars. This extra source of financing is likely to slow down in a softening housing market. Fortunately, though, I expect to see enough employment and income growth coming out of the labor market to keep consumer spending advancing at a moderate rate.

On the business side, I look for capital spending to continue to expand at a decent pace again this year. Stronger economic growth abroad will also boost American exports. These two sectors - business spending and exports - are likely to mitigate the effects of a slowdown in the consumer and housing sectors.

As the year progresses, I anticipate that the pace of economic expansion will slow from its rapid rate of growth in the first quarter. Nevertheless, I believe that we are on track to achieve our objective of sustainable economic growth.

I expect a flattening-out of energy prices, a cooling housing market, continued strong productivity growth, and a moderation in the overall pace of economic activity.

It is reasonably clear that the US economy is entering a period of transition. For the past three years or so, economic growth in the United States has been robust, reflecting both the ongoing re-employment of underutilized resources as well as the expansion of the economy's underlying productive potential, as determined by factors such as productivity trends and the growth of the labor force...Real gross domestic product grew rapidly in the first quarter of this year, but the anticipated moderation of economic growth seems now to be under way.

To be sure, most forecasters are expecting the overall pace of economic activity to moderate to a more sustainable pace in coming quarters as housing markets gradually cool and the delayed effects of higher interest rates and energy prices temper domestic demand. However, with economic activity abroad expanding at a solid pace, export sales should provide some support for domestic production.

The outlook for business investment should remain quite favorable even as the pace of overall activity moderates. Against a backdrop of sustained growth in sales, businesses should be well positioned to undertake potentially profitable projects.

We are concerned about prices. We see pricing power creeping upward in the reports we’re getting from the CEOs. As you know, our compass in Dallas is the trimmed mean PCE. It’s running at a rate of about 2.3 percent. At some point in the future, Mr. Chairman, I would like to provide a memo on that particular measure of inflation, which we consider to be a more reliable indicator of future inflation. But the point is that, in all of our soundings among these operators of businesses, they are feeling increasing price pressure, both at the intermediate level and at the consumer level. There are two little indicators that I found interesting. One is that Texas Instruments, which usually has 200 or 300 jobs maximum outstanding and looks for highly trained engineers, is now trying to fill 1,000 of those jobs and having trouble filling them. Second, at the other end of the range, 7-Eleven reports that in Florida, the Great Lakes District, and the Chesapeake Bay area, they cannot find $7- to $8-an-hour sales clerks. They are having to raise their prices.
In short, we view this economy to be something like a 2006 BMW Z4 Roadster—Bluetooth-enabled, by the way. It’s complex, it’s highly integrated, it’s a technically advanced machine that apparently cannot help itself from exceeding the speed limit. [Laughter] Thank you.

Based on the information in hand, it seems reasonable to expect that economic growth will moderate toward a more sustainable pace as the year progresses. In particular, one sector that is showing signs of softening is the residential housing market.

Long-term interest rates have been surprisingly—and inexplicably—low relative to the path of short-term rates expected by the markets. If the relationship were to return swiftly to something closer to the historical norm—that is, if long-term rates were to rise suddenly—economic growth might slow more than my forecast suggests.

My broadbrush view is that the economy is now operating in the vicinity of "full employment." Looking ahead, if the growth rate of economic activity returns to its trend, as seems likely, then labor markets are likely to remain at this level.

Sound underlying economic fundamentals are supporting self-sustaining economic growth. Importantly, the fourth quarter aside, the underlying trends in productivity are quite solid.