November 3-4, 2009
FOMC Minutes |
Summary of Economic Projections A joint meeting of the Federal Open Market Committee and the Board of Governors of the Federal Reserve System was held in the offices of the Board of Governors in Washington, D.C., on Tuesday, November 3, 2009, at 2:00 p.m. and continued on Wednesday, November 4, 2009, at 9:00 a.m.
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Staff Economic OutlookIn the forecast prepared for the November FOMC meeting, the staff raised its projection for real GDP growth over the second half of 2009 but left the forecast for output growth in 2010 and 2011 roughly unchanged. The spending and production data received during the intermeeting period suggested that economic activity, especially household spending, was a little stronger in the summer than previously estimated. Also, industrial production increased more than had been anticipated at the September meeting. But with labor market conditions somewhat weaker than anticipated, earlier declines in wealth still weighing on household balance sheets, and measures of consumer sentiment relatively low, the staff did not take much signal from the recent unexpected strength in spending and output. Indeed, the staff boosted its projection for the unemployment rate over the next several years. Still, the staff continued to believe that several factors that were restraining spending would gradually fade. The staff anticipated that the strengthening of the recovery in real output during 2010 and 2011 would be supported by an ongoing improvement in financial conditions and household balance sheets, continued recovery in the housing sector, improved household and business confidence, and accommodative monetary policy even as the impetus to real activity from fiscal policy diminished.
The staff forecast for inflation was little changed from the September meeting. Although oil prices moved higher, likely boosting near-term inflation, the staff also revised up its estimate of the degree of slack in the economy, leaving the forecast for total and core PCE inflation over the next two years little changed. With significant underutilization of resources expected to persist for several years, the staff continued to project that core inflation would slow somewhat further over the next two years.
Participants' Views on Current Conditions and the Economic OutlookIn conjunction with this FOMC meeting, all meeting participants--the five members of the Board of Governors and the presidents of the 12 Federal Reserve Banks--provided projections for economic growth, the unemployment rate, and consumer price inflation for each year from 2009 through 2012 and over a longer horizon. Longer-run projections represent each participant's assessment of the rate to which each variable would be expected to converge over time under appropriate monetary policy and in the absence of further shocks. Participants' forecasts through 2012 and over the longer run are described in the Summary of Economic Projections, which is attached as an addendum to these minutes.
In the meeting participants' discussion of the economic situation and outlook, they agreed that the incoming data and information received from business contacts suggested that economic activity was picking up as anticipated, with output continuing to expand in the fourth quarter. A number of factors were expected to support near-term growth: Business inventories were being brought into better alignment with sales, and the pace of inventory runoff was slowing; activity in the housing sector appeared to be turning up, and house prices seemed to be leveling out or beginning to rise by some measures; consumer spending appeared to be rising even apart from the effects of fiscal incentives to purchase autos; the outlook for growth abroad had improved since earlier in the year, auguring well for U.S. exports; and U.S. and global financial market conditions, while roughly unchanged over the intermeeting period, were substantially better than earlier in the year. Above-trend output growth in the third quarter was a welcome development. Moreover, the upturn in real GDP appeared to reflect stronger final demand and not just a slower pace of inventory decumulation. While these developments were positive, participants noted that it was not clear how much of the recent firming in final demand reflected the effects of temporary fiscal programs to support the auto and housing sectors, and some participants expressed concerns about the ability of the economy to generate a self-sustaining recovery without government support. Nonetheless, participants expected the recovery to continue in subsequent quarters, although at a pace that would be rather slow relative to historical experience, particularly the robust recoveries that followed previous steep downturns. Such a modest pace of expansion would imply only slow improvement in the labor market next year, with unemployment remaining high. Indeed, participants noted that business contacts continued to report plans to be cautious in hiring and capital spending even as demand for their products increased. Nonetheless, economic growth was expected to strengthen during the next two years as housing construction continued to rise and financial conditions improved further, leading to more-substantial increases in resource utilization in product and labor markets.
Most participants now viewed the risks to their growth forecasts as being roughly balanced rather than tilted to the downside, but uncertainty surrounding these forecasts was still viewed as quite elevated. Downside risks to growth included the continued weakness in the labor market and its implications for income growth and consumer confidence, as well as the potential for credit availability to remain relatively tight for consumers and some businesses. In this regard, some participants noted the difficulty that smaller, bank-dependent firms were having in securing financing. The CRE sector was also considered a downside risk to the forecast and a possible source of increased pressure on banks. On the other hand, consumer spending on items other than autos had been stronger than expected, which might be signaling more underlying momentum in the recovery and some chance that the step-up in spending would be sustained going forward. In addition, growth abroad had exceeded expectations for some time, potentially providing more support to U.S. exports and domestic growth than anticipated.
Financial market developments over recent months were generally regarded as supportive of continued economic recovery, with equity prices considerably higher, private credit spreads substantially lower, and financial markets generally performing significantly better than earlier in the year. Participants noted, however, that bank credit remained tight. With rising levels of nonperforming loans expected to continue to be a source of stress, and with many regional and small banks vulnerable to the deteriorating performance of CRE loans, banks continued to tighten lending standards for C&I loans and consumer loans, although the net percentage of banks reporting further tightening in each category had fallen in recent surveys. Bank loans continued to contract sharply in all categories. Participants noted that the dichotomy between significant easing of conditions in capital markets and continuing tight conditions in the banking sector implied that financing conditions differed for large and small firms. Large firms with access to debt and equity markets for financing had relatively little difficulty in obtaining credit and in many cases also had high levels of retained earnings with which to fund their operations and investment. In contrast, smaller firms, which tend to be more dependent on commercial banks for financing, reportedly faced substantial constraints in their access to credit. Limited credit availability, along with weak aggregate demand, was viewed as likely to restrain hiring at small businesses, which are normally a source of employment growth in recoveries.
The weakness in labor market conditions remained an important concern to meeting participants, with unemployment expected to remain elevated for some time. Although the pace of job losses was moderating, the unusually large fraction of those who were working part time for economic reasons and the unusually low level of the average workweek pointed to only a gradual decline in the unemployment rate as the economic recovery proceeded. In addition, business contacts reported that they would be cautious in their hiring and would continue to aggressively seek cost savings in the absence of revenue growth. Indeed, participants expected that businesses would be able to meet any increases in demand in the near term by raising their employees' hours and boosting productivity, thus delaying the need to add to their payrolls; this view was supported by aggregate data indicating rapid productivity growth in recent quarters. Moreover, the need to reallocate labor across sectors as the recovery proceeds, as well as losses of skills caused by high levels of long-term unemployment and permanent separations, could limit the pace of gains in employment. Participants discussed the possibility that this recovery could resemble the past two, which were characterized by a slow pace of hiring for a time even after aggregate demand picked up.
The prospect for continued weakness in labor markets remained an important factor in the outlook for consumer spending. Although consumer spending had picked up more than expected in recent months, participants saw that increase as partly reflecting special factors such as the cash-for-clunkers program. Uncertain job prospects, slow income growth, and tight credit, as well as wealth levels that remained relatively low despite the recent rise in equity prices and stabilization in house prices, were seen as weighing on consumer confidence and the growth of consumer spending for some time to come. In such an environment, households' saving behavior was an important source of uncertainty in the outlook. Participants continued to believe that the most likely outcome was for the saving rate to remain near its average level over the past few quarters or to edge up gradually. However, they could not completely discount the possibility of a further substantial rise in the saving rate as households took further steps to repair their balance sheets.
Participants noted that firms seemed to be reducing inventories at a slower pace than earlier in the year and apparently had made substantial progress in reducing stocks toward desired levels. With inventories lower, firms were beginning to raise production to meet at least a portion of increased demand, and this adjustment was expected to make an important contribution to economic recovery in the fourth quarter of the year and, to a lesser extent, in 2010 as well. Investment in E&S appeared to have stabilized in the third quarter, and recent data on new orders continued to point to a pickup next year. However, many participants expressed the view that cautious business sentiment, together with low industrial utilization rates, was likely to keep new capital spending subdued until firms became more confident about the durability of increases in demand.
In the residential real estate sector, home sales and construction increased over recent months from very low levels; moreover, house prices appeared to be stabilizing and in some areas had reportedly moved higher. Generally, the outlook was for these trends to continue. However, some participants still viewed the improvements as quite tentative, pointing to potential sources of softness from the pending termination of the temporary tax credit for first-time homebuyers, the winding down of the Federal Reserve's agency MBS purchase program, and the downward pressure that anticipated further increases in foreclosures would put on house prices. In contrast to developments in the residential sector, CRE activity continued to fall markedly in most Districts as a result of deteriorating fundamentals, including declining occupancy and rental rates and very tight credit conditions.
Stronger foreign economic activity, especially in Asia, as well as the partial reversal this year of the dollar's appreciation during the latter part of 2008, was providing support to U.S. exports. Participants noted that the recent fall in the foreign exchange value of the dollar had been orderly and appeared to reflect an unwinding of safe-haven demand in light of the recovery in financial market conditions this year, but that any tendency for dollar depreciation to intensify or to put significant upward pressure on inflation would bear close watching. Further improvements in foreign economies would likely buoy U.S. exports going forward, but as the recovery took hold in the United States, import growth would also strengthen.
Participants continued to discuss the appropriate weights to place on resource slack, inflation expectations, and other factors in assessing the inflation outlook. In the near term, most participants anticipated that substantial slack in both labor and product markets would likely keep inflation subdued. Indeed, the considerable decelerations in wages and unit labor costs this year were cited as factors putting downward pressure on inflation. However, some participants noted that the recent rise in the prices of oil and other commodities, as well as increases in import prices stemming from the decline in the foreign exchange value of the dollar, could boost inflation pressures. Overall, many participants viewed the risks to their inflation outlooks over the next few quarters as being roughly balanced. Some saw the risks as tilted to the downside in the near term, reflecting the quite elevated level of economic slack and the possibility that inflation expectations could begin to decline in response to the low level of actual inflation. But others felt that risks were tilted to the upside over a longer horizon, because of the possibility that inflation expectations could rise as a result of the public's concerns about extraordinary monetary policy stimulus and large federal budget deficits. Moreover, these participants noted that banks might seek to reduce appreciably their excess reserves as the economy improves by purchasing securities or by easing credit standards and expanding their lending substantially. Such a development, if not offset by Federal Reserve actions, could give additional impetus to spending and, potentially, to actual and expected inflation. To keep inflation expectations anchored, all participants agreed that it was important for policy to be responsive to changes in the economic outlook and for the Federal Reserve to continue to clearly communicate its ability and intent to begin withdrawing monetary policy accommodation at the appropriate time and pace.
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