Domestic Economic Conditions

1. Domestic Economic Conditions Jeff Fuhrer Director of Research Federal Reserve Bank of Boston Presented to the 495/MetroWest Corridor Partnership’s Economic Forum September 4, 2008 Chart assistance provided by Denny Lie

2. Overview • Update on the housing crisis: Still going • Update on financial market stresses: Still going • Outlook and risks for the real economy: Weak second half • Outlook and risks for inflation

3. Housing: A massive construction decline has lowered the stock of houses for sale

4. Housing: Despite the construction decline, inventories remain high relative to sales Source: Census Bureau Source: Census Bureau

5. Housing: Prices continue to fall

6. After improvement earlier this year, conditions have continued to deteriorate Financial market conditions:Continued liquidity pressures Significant improvement in liquidity in markets

7. Financial market conditions:Tightening lending standards, for all markets Credit conditions have tightened in a wide array of markets Senior Loan Officers’ Survey Sources: Federal Reserve Board, Financial Times, The Wall Street Journal

8. Financial market conditions:Mortgage, corporate rates have risen, despite Fed actions

9. …but prime ARMs, while at a lower rate, are now showing a parallel rise in foreclosures Subprime ARMs showed the most dramatic rise in foreclosures… At the heart of this, still: The mortgage/housing/subprime crisis Foreclosures initiated in quarter as a percentage of loans Source: Mortgage Bankers’ Association

10. Fed responses to financial market problems • Liquidity measures (Goal: to restore flow of short-term lending) • Term Auction Facility (TAF) • Take MBS as collateral in bids for short-term funding • Other lending facilities (to “primary dealers,” for longer terms, expand list of collateral, lend to used-car dealers, hot-dog stands, etc.) • Bear-Stearns—we could spend all day on this one • Underlying credit problems: Harder to address • Monetary policy response • Cut three 3-¼ percentage points since August 2007

11. THE FED Lessons learned from financial markets • What have we learned? • We are infinitely capable of getting ourselves in trouble. • That’s probably here to stay. • Regulation is to self-regulation as important is to self-importanta. • A “AAA” rating for a fancy new asset really means “Could be pretty good stuff, who am I to say no?”b • When it comes right down to it, there’s only one institution you can trust: aWillem Buiter, 2008 bEspecially if you’re willing to pay me a very large fee if I call it AAA

12. The Real Economy • Weak second half expected • Consumer supports not good • Wage growth slowing • Wealth declining • Oil prices are “taxing”—some respite lately • Interest rates not particularly low • Housing moribund • Commercial real estate—weakening • Exports—foreign growth stalling • May well muddle through at low growth rates • But weaker outcomes are possible

13. Inflation Risks: Recent data are somewhat worrisome Even for those measures that exclude food and energy prices

14. Inflation risks:Some comfort— A slowing economy will help Contrary to some analysts’ assertions, inflation always falls during slowdowns Sources: Bureau of Labor Statistics

15. The recent trajectory of oil prices, if sustained, will also help • … both by: • Lowering the “tax” on consumers; and • Diminishing the risk of elevated • inflation

16. Summary • The housing slowdown continues • Sales may flatten, but still inventory to work off, and prices continue to decline • Financial markets remain somewhat fragile • Tightened lending standards, liquidity issues • Expecting weak second-half growth, rising unemployment • Inflation a risk • Has been high lately • Largely lagged effects of food, energy prices • Likely to retreat in coming months