(prefaced by interoffice email)

> Key line is the Committee will have to judge whether the outlook
> for the economy or the balance of risks has shifted materially. This
> opens the door for changing the balance of risk at the next FOMC
> meeting (Towards weaker gwth in light of expressed concerns on
> markets). This could mean a cut with a changed bias, or no cut
> and a changed bias (less likely).

Yes, agreed, and the inflation risk has elevated as well.

If they are thinking of a discount rate cut to the fed funds rate they may do it before the meeting to see if it alters the fed funds/libor spread. If they do that and spreads do come in over year end (the current cause of higher short term non tsy rates as mentioned in some of the Fed speeches) that will tilt the balance of risks aways from ‘market functioning’ risks.

Worth looking at the entire speech..

Chairman Ben S. Bernanke
National and regional economic overview
At the presentation of the Citizen of the Carolinas Award, Charlotte
Chamber of Commerce, Charlotte, North Carolina
November 29, 2007

Good evening. I thank the Charlotte Chamber of Commerce for bestowing on me this year’s Citizen of the Carolinas Award. I deeply appreciate the honor, and I am grateful for the opportunity it gives me to speak to you this evening. I am also delighted to be here in Charlotte. My wife Anna and I are looking forward to visiting family and friends during our time here in the Queen City.

The focus of my brief remarks this evening will be the Charlotte region and how the area and the economy have changed since I regularly visited my grandparents here some four-and-a-half decades ago. First, though, I would like to share a few thoughts on the U.S. economy and the considerations that we at the Federal Reserve will be weighing as we prepare for our policy meeting on December 11, less than two weeks from now.

The Federal Open Market Committee (FOMC), the monetary policy making arm of the Federal Reserve System, last met on October 30-31. At that meeting, the Committee cut its target for the federal funds rate, the key policy interest rate, by 25 basis points (1/4 of a percentage point), following a cut of 50 basis points in September. Economic growth in the period leading up to the October meeting had proven quite strong, as confirmed by this morning’s figures on third-quarter gross domestic product (GDP). At its meeting, however, Committee members took the view that tightening credit conditions–the product of ongoing stresses in financial markets–and some intensification of the correction in the housing sector were likely to restrain economic activity going forward.

Potential ‘market functioning’ risk.

Specifically, growth appeared likely to slow significantly in the fourth quarter from its rapid third-quarter rate and to remain sluggish in early 2008. The Committee expected that economic growth would thereafter gradually return to a pace approaching its long-run trend as the drag from housing subsided and financial conditions improved. Inflation was seen as edging down next year, approaching rates consistent with price stability;

Implying it’s too high now.

however, the Committee remained concerned about the possible effects of higher energy costs and the lower foreign exchange value of the dollar, especially the risk that they might lead to an increase in the public’s long-term inflation expectations.

Yes, which led to a dissenting vote and six regional banks not wanting a cut.

How has the economic picture changed in the month since that meeting? As is often the case, the incoming economic data have been mixed.

This is the sum of data – not clearly worse and not clearly worse than forecast. My guess in Q4 is their Q4 forecast has been revised up, and the continual upward revisions of Q3 and now Q4 have to be influencing their view of Q1 forecasts and beyond as well.

In the market for residential real estate, indicators of construction and home sales have continued to be weak. In contrast, the labor market remained solid in October, with some 130,000 new jobs added to private-sector payrolls and the unemployment rate remaining at 4.7 percent. Claims for unemployment insurance have drifted up a bit in recent weeks, although, on average, they have remained at a level consistent with moderate expansion in employment. We will, of course, have the labor market report for November next week, and in the coming days we will continue to draw on anecdotal reports, surveys, and other sources of information about employment and wages. Continued good performance by the labor market is important for maintaining the economic expansion, as growth in earnings helps to underpin household spending.

Strong emphasis on employment data. It has probably been the most reliable indicator over the last six months. No one could ‘understand’ how employment remained high until after late numbers on exports came in, for example.

With respect to household spending, the data received over the past month have been on the soft side. The Committee will have considerable additional information on consumer purchases and sentiment to digest before its next meeting. I expect household income and spending to continue to grow, but the combination of higher gas prices, the weak housing market, tighter credit conditions, and declines in stock prices seem likely to create some headwinds for the consumer in the months ahead.

And ‘on the soft side’ is no reason to cut – especially with exports growing rapidly and supporting demand at high levels.

Core inflation–that is, inflation excluding the relatively more volatile prices of food and energy–has remained moderate.

But not moderated further.

However, the price of crude oil has continued its rise over the past month, a rise that will be reflected in gasoline and heating oil prices and, of course, in the overall inflation rate in the near term. Moreover, increases in food prices and in the prices of some imported goods have the potential to put additional pressures on inflation and inflation expectations.

He is stating directly the inflation risk has increased since October 31.

The effectiveness of monetary policy depends critically on maintaining the public’s confidence that inflation will be well controlled. We are accordingly monitoring inflation developments closely.

They believe they must have credibility to keep inflation expectations anchored.

The incoming data on economic activity and prices

Both – which includes CPI forecasts available before the December 11 meeting.

will help to shape the Committee’s outlook for the economy; however, the outlook has also been importantly affected over the past month by renewed turbulence in financial markets, which has partially reversed the improvement that occurred in September and October.

Partially. Being in the middle with active trading is perfectly acceptable. The concern is spreads will widen further/rapidly to the point trading ceases and real world lending ceases as a consequence, though the ‘channel’ for this is uncertain, and mainstream economic theory probably would say it’s a natural adjustment process that should be left alone for optimal long term outcomes.

Comments welcome on this point, thanks!

Investors have focused on continued credit losses and write-downs across a number of financial institutions, prompted in many cases by credit-rating agencies’ downgrades of securities backed by residential mortgages. The fresh wave of investor concern has contributed in recent weeks to a decline in equity values, a widening of risk spreads for many credit products (not only those related to housing), and increased short-term funding pressures.

All a repricing of risk.

These developments have resulted in a further tightening in financial conditions, which has the potential to impose additional restraint on activity in housing markets and in other credit-sensitive sectors.

But perhaps to where it ‘should be’ as the fed did not like it when risk was priced at zero. What they are watching closely is ‘market functioning’ and the risk of systemic failure.

Needless to say, the Federal Reserve is following the evolution of financial conditions carefully, with particular attention to the question of how strains in financial markets might affect the broader economy.

As above.

In sum, as I have indicated, we will be receiving a good deal of relevant information in the coming days. In making its policy decision, the Committee will have to judge whether the outlook for the economy or the balance of risks has shifted materially.

Implying so far it has not.

In doing so, we will take full account of the implications for the outlook of both the incoming economic data and the ongoing developments in the financial markets.Economic forecasting is always difficult, but the current stresses in financial markets make the uncertainty surrounding the outlook even greater than usual. We at the Federal Reserve will have to remain exceptionally alert and flexible as we continue to assess how best to promote sustainable economic growth and price stability in the United States.

Perhaps a reference to Kohn’s discount rate discussion where he discusses addressing liquidity vs. addressing the macro economy, a discussion which has gotten into the ‘stigma’ aspect of the discount rate that he felt was an obstacle to liquidity.

Employment Security Commission of North Carolina (2007). “Employment
and Wages by Industry, 1990 to Most Recent,”

Hills, Thomas D. (2007). “The Rise of Southern Banking and the
Disparities among the States following the Southeastern Regional
Banking Compact (225 KB PDF),” Balance Sheet, vol. 11, pp. 57-104,

North Carolina Community College System (2006). “Get the Facts,”
press release, July 3,

U.S. Census Bureau (2006). “2005 American Community Survey,”

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