At the National Conference on Public Employee Retirement Systems Annual Conference, New Orleans, Louisiana, Fed Vice-Chair Kohn gave the following outlook this morning.
“The Economic Outlook
Although the current financial and economic situation remains quite difficult, I believe that the most likely scenario over the next year or so is one in which economic activity firms during the second half of this year and then gathers some strength in 2009. In the near term, consumer spending is likely to receive a boost from the rebates that are now flowing to taxpayers. Although the timing and the magnitude of the spending response are uncertain, economic studies of the previous experience suggest that a noticeable proportion of households respond reasonably quickly to temporary cash flows. Of course, the stimulus to domestic production will depend on the extent to which the additional demand is met by a temporary drawdown of inventories or an increase in imports rather than by an expansion in domestic output. But to date, businesses appear to be keeping tight control on inventories, and a reasonable assumption is that we will see a temporary lift to the economy in coming months.
The pace of activity should continue to improve next year, with an important part of the gains coming from the abatement of the forces currently restraining activity. That said, a number of factors suggest that the recovery could be relatively moderate. I’ve already mentioned my expectation that financial market functioning and risk appetites will continue to improve, but that recuperation will require some time. As all that happens, the policy easing the Federal Reserve has put in place over recent months will begin to show through more in reductions in the cost of capital and the greater availability of credit. The demand for housing is not likely to rebound substantially for a while after this episode, but the drag on growth from declining activity and prices in the housing market will ebb as excess inventories are worked off and affordability improves. Consumption should pick up along with the improvement in jobs and income, though a gradual increase in the saving rate would be expected now that households will no longer be counting on increases in the value of their homes to finance retirement or other future spending. With a lag, business investment should turn up as prospects for a sustained expansion of economic activity become clearer. And both households and businesses should benefit from a leveling-off in the prices of energy and other commodities along the path implied by futures markets.”
Inflation
“My expectations for moderating inflation and limited spillover effects from commodity price increases depend critically on the continued stability of inflation expectations. In that regard, year-ahead inflation expectations of households have increased this year in response to the jump in headline inflation. Of greater concern, some measures of longer-term inflation expectations appear to have edged up. If longer-term inflation expectations were to become unmoored–whether because of a protracted period of elevated headline inflation or because the public misinterpreted the recent substantial policy easing as suggesting that monetary policy makers had a greater tolerance for inflation than previously thought–then I believe that we would be facing a more serious situation.”
