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.

Given the likely drawn-out nature of the prospective adjustments in housing and financial markets, I see the most probable scenario as one in which the performance of the economy remains subpar well into next year and then gradually improves in late 2009 and 2010. As credit restraint abates, the low level of policy interest rates will begin to show through into more accommodative financial conditions. This improvement in financial conditions, together with the gradual stabilization of housing markets and the stimulative effects of lower oil and commodity prices, should lead to a pickup in jobs and income, contributing to a broad recovery in the U.S. economy.

At the same time, inflation seems likely to move onto a downward track. If sustained, the recent declines in commodity prices should soon lead to a sharp reduction in headline inflation. In addition, I expect core inflation to slow from current levels as lower commodity prices and greater economic slack moderate upward pressures on costs. Similar reductions in inflation abroad, as well as the recent appreciation of the dollar, should restrain increases in the prices of imported goods.

I would caution, however, that the uncertainty around my forecast is substantial. The path of the economy will depend critically on how quickly the current stresses in financial markets abate. But these events have few if any precedents, and thus we can have even less confidence than usual in our economic forecasts.

Over the last year, Fed policymakers have acted to address both the escalating financial crisis and rising unemployment. But inflation has also been an important concern, since it has been running at unacceptably high levels. In recent months, however, the outlook for inflation has noticeably changed. Commodity prices, including the price of oil, have plunged. And I expect this development, along with a further increase in slack in labor and product markets, to push inflation down to, and possibly even below, rates that I consider consistent with price stability.

My sense is that the pace of growth in the U.S. economy over the second half of the year will be positive but slower than its pace over the first half of the year. Although recent developments suggest that headline inflation may moderate from its current levels, price pressures are elevated and several measures of inflation expectations are inconsistent with the medium-term projections of FOMC participants. A key challenge in the current environment is to navigate through substantial financial market turmoil without creating a new and difficult-to-solve inflation problem in its wake.
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Going forward, falling oil prices, if sustained, should help households and businesses cope with existing strains. In fact, given that the recent decline in oil prices has probably exceeded the near-term assumptions of most forecasters, it is conceivable that economic growth over the second half of the year may turn out to be moderately stronger than the consensus expects.

Real gross domestic product is likely to expand at a pace appreciably below its potential rate in the second half of this year and then to gradually pick up as financial markets return to more-normal functioning and the housing contraction runs its course.  Given the extraordinary circumstances, greater-than-normal uncertainty surrounds any forecast of the pace of activity.  In particular, the intensification of financial stress in recent weeks, which will make lenders still more cautious about extending credit to households and business, could prove a significant further drag on growth.  The downside risks to the outlook thus remain a significant concern.
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If not reversed, these developments {the retreat in energy prices}, together with a pace of growth that is likely to fall short of potential for a time, should lead inflation to moderate later this year and next year.  Nevertheless, the inflation outlook remains highly uncertain.  Indeed, the fluctuations in oil prices in the past few days illustrate the difficulty of predicting the future course of commodity prices.  Consequently, the upside risks to inflation remain a significant concern as well.

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.

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.

"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.

[T]he recent decline in commodity prices, as well as the increased stability of the dollar, has been encouraging. If not reversed, these developments, together with a pace of growth that is likely to fall short of potential for a time, should lead inflation to moderate later this year and next year. Nevertheless, the inflation outlook remains highly uncertain, not least because of the difficulty of predicting the future course of commodity prices, and we will continue to monitor inflation and inflation expectations closely. The FOMC is committed to achieving medium-term price stability and will act as necessary to attain that objective.

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.

My guess is, it's going to pay to be patient at this point, especially with the developments we've seen on the energy side, where, at least from my perception, some of the concerns about inflation and some inflation expectations seem to have diminished.

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I think it will be some time before we see growth at or above trend in this economy.