# Meeting of the Federal Open Market CommitteeJune 28-29, 2006 Presentation Materials -- Text Version

Presentation Materials (PDF)

Pages 146 to 177 of the Transcript

## Appendix 1: Materials used by Mr. Kos

### Page 1

#### Top panel

Title: MSCI Equity Indices
Series: MSCI Indices for: Latin America, Emerging Europe/Middle East/Africa, All Emerging Markets, Emerging Asia, Japan, U.S., Europe, indexed to 100 on 5/1/2004
Horizon: May 1, 2004 to June 27, 2006
Description: All indices were increasing until a drop-off beginning on May 10, 2006 (labeled with a tripwire).

#### Middle panel

Title: Realized Volatility of MSCI Equity Indices
Series: Rolling 21-day volatility of daily returns on MSCI Indices: Emerging Markets, Europe, Japan, and U.S.
Horizon: January 2, 2006 to June 27, 2006
Description: There was a pickup in volatility starting on May 10, 2006 (labeled with a tripwire).

#### Bottom panelS&P 500: Periods with Greater than 10% Price Declines

(Since January 2, 1942)
Start Date End Date Percentage Decline
9/21/1943 11/29/1943 -10.21
8/13/1946 10/9/1946 -22.55
6/15/1948 6/13/1949 -20.57
6/9/1950 7/17/1950 -13.40
3/17/1953 9/15/1953 -13.03
8/2/1956 2/25/1957 -12.79
7/12/1957 10/21/1957 -20.23
1/5/1960 3/8/1960 -11.46
12/12/1961 5/28/1962 -23.60
2/9/1966 10/7/1966 -22.18
11/29/1968 7/29/1969 -17.43
10/24/1969 1/30/1970 -13.35
3/3/1970 5/26/1970 -23.21
4/28/1971 8/9/1971 -10.73
1/11/1973 8/22/1973 -16.39
3/13/1974 10/3/1974 -37.56
7/15/1975 9/16/1975 -14.14
7/18/1977 2/28/1978 -13.78
9/12/1978 11/15/1978 -13.35
2/13/1980 3/27/1980 -17.07
11/20/1980 9/25/1981 -19.68
11/30/1981 3/17/1982 -13.67
5/7/1982 8/12/1982 -14.27
10/10/1983 7/24/1984 -14.38
8/25/1987 10/19/1987 -33.24
7/16/1990 10/17/1990 -19.02
10/17/1997 10/27/1997 -10.80
7/17/1998 9/10/1998 -17.41
9/1/2000 3/11/2003 -47.35
5/9/2006 6/27/2006 -6.15

### Page 2

#### Top panelSelect International Equity Performance

Percent
January 2, 2006 to May 10, 2006 May 11, 2006 to June 27, 2006
Brazil 24.60 -14.35
India 34.32 -18.37
Mexico 21.51 -15.24
Russia 54.58 -18.97
South Africa 21.39 -7.19
South Korea 4.45 -14.83
Turkey 9.57 -25.72

#### Middle panelSelect Foreign Currency Performance vs. U.S. Dollar

Percent
January 2, 2006 to May 10, 2006 May 11, 2006 to June 27, 2006
Brazil 12.64 -5.96
India 0.34 -2.75
Mexico -2.01 -4.75
Russia 6.35 -0.18
South Africa 4.57 -16.69
South Korea 8.48 -2.42
Turkey -0.53 -16.05

#### Bottom panel

Title: Select Metals Prices
Series: Zinc and copper 3-month futures prices and silver, gold, and platinum spot prices, indexed to 100 on 1/2/2006
Horizon: January 2, 2006 through June 27, 2006
Description: All metals prices were consistently increasing with copper and zinc rising the most until May 10, 2006, when all metals prices started to decline.

### Page 3

#### Top-left panel

Title: Implied Volatility on the S&P 100
Series: VIX Index; average of the VIX Index since January 1990 is also shown (19.26 percent)
Horizon: January 3, 2005 to June 27, 2006
Description: Index started to pick up after May 1, 2006.

#### Top-right panel

Title: Treasury Yield Implied Volatility
Series: Merrill Lynch Move Index; average of the Move Index since January 1990 is also shown (101.01 basis points)
Horizon: January 3, 2005 to June 27, 2006
Description: Index slowly declined after January 3, 2005.

#### Middle-left panel

Horizon: January 3, 2005 to June 27, 2006
Description: Spread started to edge up in May 2006.

#### Middle-right panel

Series: Merrill Lynch High Yield Credit Spread
Horizon: January 3, 2005 to June 27, 2006
Description: Spread started to edge up in May 2006.

#### Bottom panel

Title: EMBI+ Spread to Comparable Treasuries
Horizon: January 3, 2005 to June 27, 2006
Description: EMBI+ spread decreased, for most of the period, until it started to edge up in May 2006.

### Page 4

#### Top panel

Title: Current 3-Month Deposit Rates and Rates Implied by Traded Forward Rate Agreements
Series: U.S. dollar and euro 3-month Libor fixings, 3-month forward, 6-month forward, and 9-month forward rates
Horizon: April 1, 2006 to June 27, 2006
Description: U.S. and euro forward rates rose steadily over the period shown.

#### Middle panel

Title: Bank of Japan Current Account Balances and Overnight Call Rate
Series: Bank of Japan current account balances and uncollateralized yen overnight call rate
Horizon: January 2, 2006 to June 27, 2006
Description: Current account balances decreased in the first part of the year, but began to rise in mid-June. The uncollateralized overnight call rate remained close to zero until jumping up in late-May and mid-June.

#### Bottom panel

Title: Japanese Sovereign Yield Curve
Series: The yield curve, including Japanese 3-month, 6-month, 1-year, 2-year, 5-year, and 10-year yields.
Horizon: There are two curves shown for the dates of 6/28/05 and 6/27/06.
Description: The more recent curve from 6/27/2006 shows that Japanese yields have increased since 6/28/2005.

### Page 5

#### Top panel

Title: 2- and 10-Year Treasury Yields and Target Fed Funds Rate
Series: 10-year Treasury yield, 2-year Treasury yield, and target fed funds
Horizon: April 1, 2006 to June 27, 2006
Description: Short and intermediate Treasury yields rose as the target federal funds rate increased.

#### Middle-left panel

Title: U.S. Breakeven Inflation Rates
Series: 5-year 5-year forward and 10-year breakeven inflation rates
Horizon: January 2, 2006 to June 27, 2006
Description: Both 5-year 5-year forward and 10-year breakeven inflation rates have risen approximately 20 basis points since the beginning of 2006.

#### Middle-right panel

Title: U.S. Breakeven Inflation Rates
Series: 5-year 5-year forward and 10-year breakeven inflation rates
Horizon: January 2, 2002 to June 27, 2006
Description: Both 5-year 5-year forward and 10-year breakeven inflation rates rose approximately 100 basis points between January 2002 and mid-2004, when the tightening cycle began. Since June 2004, breakevens have revolved between 2.2 and 2.6%.

#### Bottom-left panel

Title: U.S. Dollar vs. Euro
Series: Euro currency performance in dollars per euro
Horizon: January 2, 2006 to June 27, 2006
Description: The euro appreciated against the dollar, with the eurodollar exchange rate moving from approximately 1.18 to 1.29 dollars per euro between January and May, before falling back slightly to 1.26 dollars per euro in May and June.

#### Bottom-right panel

Title: U.S. Dollar vs. Yen
Series: Yen currency performance in yen per dollar
Horizon: January 2, 2006 to June 27, 2006
Description: The dollar has appreciated against the yen since mid-May, with the dollar/yen currency pair moving from approximately 110 to 116 yen per dollar.

### Page 6

#### Top panel

Title: Tuesday Float Levels and Forecasts
Series: Monetary Projections forecasts of Federal Reserve float and the actual levels
Horizon: October 2005 to June 2006
Description: The deviations of float forecasts from the actual levels of float are examined.

The Tuesday after a Monday holiday is replaced with Wednesday.

#### Middle panel

Title: Tuesday Float Levels and Forecasts
Series: Monetary Projections forecasts of Federal Reserve float and the actual levels
Horizon: October 2004 to June 2005
Description: The deviations of float forecasts from the actual levels of float are examined.

The Tuesday after a Monday holiday is replaced with Wednesday.

#### Bottom panel

Title: Rate Volatility and Float Forecast Errors on Tuesdays
Series: Forecast errors of Federal Reserve float and the standard deviation of the daily effective fed funds rate (all for two separate time periods).
Horizon: There are two time periods: October 2004 to June 2005 and October 2005 to June 2006
Description: The relationship between float forecast errors and the volatility of trading in the fed funds market is examined.

## Appendix 2: Materials used by Messrs. Slifman, Wilcox, and Kamin

Material for Staff Presentation on the Economic Outlook
June 28, 2006

STRICTLY CONFIDENTIAL (FR) CLASS I-FOMC*
*Downgraded to Class II upon release of the July 2006 Monetary Policy Report.

### Exhibit 1Recent Indicators

#### Top-left panelReal GDP

Percent change, annual rate
Period History May Greenbook Current Forecast
2005:Q3 4.15 ND ND
2005:Q4 1.65 ND ND
2006:Q1 ND 5.28 5.82
2006:Q2 ND 3.66 2.01
2006:Q3 ND 3.17 2.67

#### Top-right panelReal Personal Consumption Expenditures

Series: Real personal consumption expenditures
Horizon: 2003:Q1 to May 2006 (May is a staff estimate based on published retail sales, light motor vehicle sales and CPI data.)
Description: Data are plotted as one curve. Solid dots, representing quarterly average, generally overlay the curve through most of the horizon; a circle, representing staff estimate, is located at May 2006. Units are trillions of 2000 dollars, annual rate. Percent change at an annual rate for specific time periods is 0.9 percent for 2005:Q4, 5.2 percent for 2006:Q1, and 2.2 percent for 2006:Q2(p).

The series starts at about 7.2 in 2003:Q1 and generally rises to about 7.9 in 2005:Q2. The series falls to a little more than 7.8 in 2005:Q3, remains at about that level until 2005:Q4, and then generally rises to end at a little less than 8.1 in May 2006.

#### Middle-left panelSingle-Family Housing Starts

Horizon: 2003 to May 2006
Description: Data are plotted as two curves. Units are millions of units, annual rate.

For starts, the series begins in early 2003 at a little more than 1.5 and falls to about 1.3 later in the period. From that point, the series generally rises to about 1.7 in late 2003 and falls to about 1.6 by the end of that year. The series then falls to about 1.5 in early 2004. The series fluctuates between that point and about 1.7 for the remainder of the year. The series rises to nearly 1.8 in early 2005, falls to almost 1.5 later in the period, and fluctuates between that point and about 1.8 until early 2006. The series then falls to a little more than 1.5 later in the period and rises to end at a little less than 1.6 in May 2006.

For adjusted permits, the series begins in 2003 at a little less than 1.5 and generally rises to a little more than 1.6 in early 2004. The series then falls to nearly 1.6 later in the period, generally rises to a little more than 1.8 in mid-2005, and generally falls to a little more than 1.6 by the end of that year. The series rises to nearly 1.7 in early 2006, and then falls to end at a little less than 1.5 in May 2006.

Both series generally overlap each other throughout the horizon (except for 2006).

#### Middle-right panelOrders and Shipments of Nondefense Capital Goods*

Series: Orders and shipments
Horizon: 2003 to May 2006
Description: Data are plotted as two curves. Data are three-month moving averages. Units are billions of dollars.

For orders, the series starts at about 50 in early 2003, generally rises to about 50 in midyear, falls to a little less than 50 in late 2003, and then rises to nearly 52.5 in year-end. The series then falls to a little less than 50 in early 2004, generally rises to nearly 52.5 in late 2004, falls to almost 52 toward year-end 2004, and then generally rises to end at about 62 in May 2006.

For shipments, the series starts at about 52 in early 2003, generally falls to about 50 later in the period, remains at about that level until late 2003, rises to about 51 toward year-end 2003, and then falls to a little less than 50 in early 2004. The series then generally rises to end at about 61 in May 2006.

Both series overlap in 2003, 2004, and early 2005.

#### Bottom-left panelInitial Claims for Unemployment Insurance

Series: Initial claims for unemployment insurance
Horizon: 2003 to June 17, 2006
Description: Data are plotted as one curve. Data are four-week moving average. Units are thousands.

#### Bottom-right panelNew Orders Indexes

Series: ISM, Empire State, and Philadelphia
Horizon: For ISM, 2003 to May 2006 and, for Empire State and Philadelphia, 2003 to June 2006
Description: Data are plotted as three curves. Units are diffusion index. There is a horizontal line at 50.

The ISM series starts a little below 60 in early 2003, falls to about 45 later in the period, and generally rises to just above 70 by the end of the year. The series then generally falls to about 55 in late 2004 and then rises to about 65 by the end of the year. The series generally falls to about 52 in mid-2005 and fluctuates between that point and about 62 until early 2006. The series then generally falls to end at about 54 in May 2006.

All of the series generally overlap through the horizon.

### Exhibit 2Longer-Run Projection and Key Background Factors

#### Top-left panelReal GDP

Percent change*
Period History May Greenbook Current Forecast
2003-2005 3.67 ND ND
2006:H1 ND 4.47 3.90
2006:H2 ND 3.11 2.67
2007 ND 2.99 2.66

* Annual figures are Q4/Q4. Half-year figures are Q4/Q2 or Q2/Q4. Return to table

#### Top-right panelChange in Wage and Salary Disbursements

Percent change, annual rate
Period Percent Change May GB Forecast May GB Forecast
2005:Q1 4.91 4.91 ND ND
2005:Q2 3.05 3.05 ND ND
2005:Q3 6.50 6.50 ND ND
2005:Q4 1.55 4.79 ND ND
2006:Q1 5.61 5.99 ND ND
2006:Q2 ND ND 5.80 5.42
2006:Q3 ND ND 5.11 6.06
2006:Q4 ND ND 5.10 5.72
2007:Q1 ND ND 5.41 5.97
2007:Q2 ND ND 4.84 5.31
2007:Q3 ND ND 4.73 5.25
2007:Q4 ND ND 4.64 5.21

#### Middle-left panelFederal Funds Rate

Quarterly average
Percent
Period Federal Funds Rate May GB Forecast May GB Forecast
2002:Q4 1.44 ND ND ND
2003:Q1 1.25 ND ND ND
2003:Q2 1.23 ND ND ND
2003:Q3 1.00 ND ND ND
2003:Q4 1.00 ND ND ND
2004:Q1 1.00 ND ND ND
2004:Q2 1.00 ND ND ND
2004:Q3 1.42 ND ND ND
2004:Q4 1.94 ND ND ND
2005:Q1 2.44 ND ND ND
2005:Q2 2.91 ND ND ND
2005:Q3 3.43 ND ND ND
2005:Q4 3.97 ND ND ND
2006:Q1 4.42 4.42 ND ND
2006:Q2 4.90 4.90 ND ND
2006:Q3 ND ND 5.25 5.00
2006:Q4 ND ND 5.25 5.00
2007:Q1 ND ND 5.25 5.00
2007:Q2 ND ND 5.25 5.00
2007:Q3 ND ND 5.25 5.00
2007:Q4 ND ND 5.25 5.00

#### Middle-right panelWilshire 5000

Index, ratio scale
Period Index May GB Forecast May GB Forecast
2003:Q1 8051.86 ND ND ND
2003:Q2 9342.95 ND ND ND
2003:Q3 9649.68 ND ND ND
2003:Q4 10799.63 ND ND ND
2004:Q1 11039.42 ND ND ND
2004:Q2 11138.91 ND ND ND
2004:Q3 10895.48 ND ND ND
2004:Q4 11971.14 ND ND ND
2005:Q1 11638.27 ND ND ND
2005:Q2 11876.74 ND ND ND
2005:Q3 12289.26 ND ND ND
2005:Q4 12517.69 ND ND ND
2006:Q1 13155.44 13155.00 ND ND
2006:Q2 12480.00 13440.00 ND ND
2006:Q3 ND ND 12680.00 13655.00
2006:Q4 ND ND 12880.00 13870.00
2007:Q1 ND ND 13085.00 14090.00
2007:Q2 ND ND 13290.00 14315.00
2007:Q3 ND ND 13500.00 14540.00
2007:Q4 ND ND 13715.00 14770.00

#### Bottom-left panelHouse Prices

Four-quarter percent change
Period OFHEO House Price Index* Forecast
2002:Q4 7.42 ND
2003:Q1 7.11 ND
2003:Q2 6.46 ND
2003:Q3 5.98 ND
2003:Q4 7.85 ND
2004:Q1 8.24 ND
2004:Q2 9.86 ND
2004:Q3 12.94 ND
2004:Q4 11.99 ND
2005:Q1 13.15 ND
2005:Q2 14.14 ND
2005:Q3 12.71 ND
2005:Q4 13.33 ND
2006:Q1 12.53 ND
2006:Q2 ND 10.02
2006:Q3 ND 7.76
2006:Q4 ND 5.45
2007:Q1 ND 4.06
2007:Q2 ND 3.31
2007:Q3 ND 2.75
2007:Q4 ND 2.37

#### Bottom-right panelCrude Oil Prices

Quarterly average
Dollars per barrel
Period West Texas Intermediate May GB Forecast May GB Forecast
2002:Q4 28.27 ND ND ND
2003:Q1 34.12 ND ND ND
2003:Q2 29.04 ND ND ND
2003:Q3 30.22 ND ND ND
2003:Q4 31.18 ND ND ND
2004:Q1 35.25 ND ND ND
2004:Q2 38.34 ND ND ND
2004:Q3 43.89 ND ND ND
2004:Q4 48.31 ND ND ND
2005:Q1 49.68 ND ND ND
2005:Q2 53.09 ND ND ND
2005:Q3 63.08 ND ND ND
2005:Q4 60.03 ND ND ND
2006:Q1 63.34 63.34 ND ND
2006:Q2 70.18 72.36 ND ND
2006:Q3 ND ND 69.60 75.85
2006:Q4 ND ND 71.28 76.87
2007:Q1 ND ND 72.16 76.96
2007:Q2 ND ND 72.36 76.68
2007:Q3 ND ND 72.11 76.19
2007:Q4 ND ND 71.70 75.65

#### Top-left panelE&S Spending excluding Transportation

Series: High tech (contribution), other (contribution)
Horizon: 2003 to 2007. Data are projected for 2006 and 2007.
Description: Data are plotted as stacked bars. There are five bars. Units are percent change, Q4/Q4.

The bars for each period indicate the following:

• For 2003, high tech is about 6; plus other, total is about 9.
• For 2004, high tech is just below 6; plus other, total is just below 12.
• For 2005, high tech is about 8; plus other, total is just above 9.
• For 2006, the forecast shows high tech at just above 6; plus other, total is about 8.
• For 2007, the forecast shows high tech at about 6; plus other, total is about 7.

#### Top-right panelU.S. Personal Computer and Server Sales

Series: PCs, servers
Horizon: 1999 to 2006:Q1
Description: Data are plotted as two curves. Data are expressed as millions of units.

The series for PCs begins in 1999 at about 11, rises through mid-2000 to a little above 13, then falls to about 11 by the middle of 2001. The series then continues generally upward through 2006:Q1 to end around 16.

The series for servers starts in 1999 at just above 0.3 and then drops to about 0.3 by the end of the year. The series rises to about 0.5 in mid-2000, then dips to about 0.4 at the beginning of 2001. The series then increases through 2006:Q1 to end just above 0.8.

The curves overlap in 2001, 2002, 2004, late 2005, and 2006:Q1.

Source: Gartner. FRB Seasonals.

#### Middle-left panelComputer Projection

• Servers
• -- New generations: faster computing and lower electricity consumption.
• -- Sources of demand: financial services companies; internet content providers
• PCs
• -- New Intel chip design will increase performance and reduce power consumption.
• -- Prices on old chips plummeting.

#### Middle-right panelReal Nonresidential Structures

Percent change, Q4/Q4
2005 2006p 2007p
1. Total Nonres. 1.5 10.3 4.6
2. Drilling and mining 16.7 11.7 7.4
3. Nonres ex. drilling and mining -2.8 9.5 3.3

#### Bottom-left panelDrilling Rigs in Operation

Series: Drilling rigs in operation
Horizon: 1998 to 2006:Q2
Description: Data are plotted as a curve. Units are number of rigs.

At the start of 1998, the series begins at approximately 1,000. The series then drops to about 500 in early 1999, increases to about 1,300 by mid-2001, then falls to about 800 at the start of 2002. The series then increases through 2006:Q2 to end at about 1,600.

Source: Baker Hughes Tool Company.

#### Bottom-right panelOffice Vacancy Rate and Rent per Square Foot

Series: Office vacancy rate, rent per square foot
Horizon: 1998 to 2006:Q2
Description: Data are plotted as two curves and are quarterly. Units are percent for vacancy rate and dollars for rent per square foot.

In 1998, the series for vacancy rate starts at nearly 9, then generally decreases through mid-2000 to about 7. The series then rises to reach about 14.5 by early 2004, then decreases to end at about 12 in 2006:Q2.

The series for rent per square foot starts in 1998 at about 21.5, increases through 1999 to about 24, then dips to about 23.5 by early 2000. The series rises to about 26 at the start of 2001, then falls to about 22 through 2004; the series then increases to end at about 24 in 2006:Q2.

The curves overlap in 1998 and 2001.

Source: CoStar. Data for 2006:Q2 are preliminary.

### Exhibit 4Household Sector

#### Top-left panelReal PCE and DPI

Percent change*
Period DPI* PCE DPI Forecast PCE Forecast
2005 1.53 2.94 ND ND
2006:H1 ND ND 2.27 3.70
2006:H2 ND ND 5.02 3.00
2007 ND ND 4.13 2.96

* Excluding December 2004 Microsoft Dividend. Annual figures are Q4/Q4. Half-year figures are Q4/Q2 or Q2/Q4. Return to table

#### Top-right panelSaving Rate and Wealth-to-Income Ratio

Period Personal Saving Rate (percent) Wealth-to-Income Ratio Personal Saving Rate Forecast Wealth-to-Income Ratio Forecast
2003:Q1 1.93 4.90 ND ND
2003:Q2 2.10 5.06 ND ND
2003:Q3 2.48 5.06 ND ND
2003:Q4 1.95 5.30 ND ND
2004:Q1 1.84 5.28 ND ND
2004:Q2 1.65 5.31 ND ND
2004:Q3 1.21 5.33 ND ND
2004:Q4 1.20 5.47 ND ND
2005:Q1 0.53 5.47 ND ND
2005:Q2 -0.24 5.55 ND ND
2005:Q3 -1.59 5.67 ND ND
2005:Q4 -0.55 5.68 ND ND
2006:Q1 -1.32 5.77 ND ND
2006:Q2 ND ND -1.27 5.64
2006:Q3 ND ND -0.76 5.61
2006:Q4 ND ND -0.30 5.58
2007:Q1 ND ND 0.15 5.54
2007:Q2 ND ND 0.39 5.51
2007:Q3 ND ND 0.62 5.48
2007:Q4 ND ND 0.87 5.45

Note: Excluding December 2004 Microsoft dividend.

#### Middle-left panelSales of Single-family Homes

Series: Existing homes, new homes
Horizon: 2003 to May 2006
Description: Data are plotted as two curves and are monthly. Units are millions at an annual rate.

The series for existing homes begins in 2003 at about 5.4, generally increases to about 5.8 in the second half of the year, then fluctuates between about 5.4 and 5.7 until year-end. The series climbs to about 6.2 in mid-2004, then dips to about 5.8 toward the end of the year. The series then generally increases through mid-2005, when it reaches about 6.4, then falls to about 5.7 by year-end. The series increases to a bit above 6.0 at the start of 2006, then decreases to end at about 5.7 in May 2006.

The series for new homes starts in 2003 at about 1.0, dipping slightly to about 0.9 before generally increasing to about 1.2 in mid-2003, then falls to about 1.1 by year-end. The series increases to about 1.3 at the beginning of 2004, then fluctuates between about 1.1 and 1.3 until the end of the year. In 2005, the curve fluctuates between nearly 1.2 and just below 1.4; the series then drops to slightly above 1.0 at the start of 2006 and increases to end at a little more than 1.2 in May 2006.

The curves overlap in mid-2003 and early 2004.

#### Middle-right panelUnsold Homes*

Series: Existing homes, new homes
Horizon: 2003 to May 2006
Description: Data are plotted as two curves. Units are month's supply.

The series for existing homes starts in 2003 just below 5.5, then generally decreases to about 5.0 toward year-end. The series increases to about 5.5 in early 2004 and then falls until mid-2004, when it reaches about 4.5. The series then generally increases to a little below 7.5 in May 2006.

The series for new homes starts in 2003 at about 4.0, drops to about 3.5 by midyear, then increases to about 4.0 through the beginning of 2004. The series dips to just above 3.5 in mid-2004 and increases to a little less than 4.5 toward year-end. The series then generally climbs upward through the beginning of 2006 to about 6.0, then decreases to end a bit above 5.5 in May 2006.

* Inventory of unsold homes relative to 3-month moving average of sales.  Return to text

#### Bottom-left panelReal Residential Investment

Billions of 2000 dollars
Period Real Residential Investment Forecast
2002:Q4 479.40 ND
2003:Q1 484.77 ND
2003:Q2 496.01 ND
2003:Q3 521.23 ND
2003:Q4 535.66 ND
2004:Q1 542.43 ND
2004:Q2 565.07 ND
2004:Q3 568.76 ND
2004:Q4 571.02 ND
2005:Q1 584.08 ND
2005:Q2 599.30 ND
2005:Q3 609.95 ND
2005:Q4 614.20 ND
2006:Q1 616.86 ND
2006:Q2 ND 605.12
2006:Q3 ND 586.76
2006:Q4 ND 582.00
2007:Q1 ND 578.04
2007:Q2 ND 577.26
2007:Q3 ND 575.10
2007:Q4 ND 571.90

#### Bottom-right panelInvestor and Second-Home Mortgage Originations

Series: Investor, second homes
Horizon: Mid-2003 to March 2006
Description: Data are plotted as two curves. Units are percent of total originations.

The series for investor starts in the second half of 2003 at about 3, then generally rises to reach about 8 by the end of the year. The series drops to about 5 at the start of 2004; the series then fluctuates between about 4 and slightly above 6 until mid-2004, then increases to about 8 by year-end. The series falls to about 4 at the start of 2005, generally increases to about 7 by midyear, then fluctuates between just above 5 and a little above 6 through the end of the year. The series increases to about 7 at the start of 2006, then decreases to end a bit above 6 in March 2006.

The series for second homes starts in the second half of 2003 just below 3. The series continues generally upward and fluctuates between a little below 3 and about 5 through mid-2004, then decreases to about 3 by year-end. The series then increases through mid-2005 to about 5, decreases to approximately 4, then increases to about 6 toward the end of the year. The series then generally decreases to end at about 5.9 in March 2006.

Source: LoanPerformance.

### Exhibit 5Household Financial Conditions

#### Top-left panelHomeowners' Financial Obligation Ratio

Series: Homeowners' financial obligation ratio
Horizon: 1980 to 2004:Q4
Description: Data are plotted as a curve. Units are percent of homeowner disposable income.

#### Top-right panelMortgage Payment Resets

Percent*
2006 2007 2008 and
beyond
ARM
1. First rate reset 27 25 48
IOs
2. First rate reset 11 24 65
3. End of IO term 4 10 86

* Percent of mortgages in category experiencing indicated type of payment change relative to all mortgages in the category that have yet to face first payment change.  Return to table

Note: Figures are staff estimates based on LoanPerformance.

#### Middle-left panelDelinquency Rates

Series: Subprime, prime
Horizon: 2003:Q3 to 2006:Q2 (April)
Description: Data are plotted as two curves. Units are percent.

For subprime, the series begins in 2003:Q3 at about 7.4, falls to about 7.3 in 2003:Q4, and rises to about 7.4 later in that period. The series then generally falls to about 6.5 in 2004:Q2, falls to about 6.25 in 2004:Q4, rises to about 6.4 in 2005:Q1, and generally falls to about 5.5 in 2005:Q2. The series generally rises to about 6.75 in early 2006:Q1, falls to about 6.25 later in that period, and rises to end at about 6.5 in 2006:Q2.

For prime, the series begins in 2003:Q3 at about 1 and generally remains at about that level until it ends at about 1 in 2006:Q2.

Note: Ninety-plus days delinquent or in foreclosure.

Source: LoanPerformance.

#### Middle-right panelDelinquency Rates for Subprime Mortgages

Series: Variable rate, fixed rate
Horizon: 2003:Q3 to 2006:Q2 (April)
Description: Data are plotted as two curves. Units are percent.

For variable rate, the series begins in 2003:Q3 at about 8.1, falls to about 7.9 in early 2003:Q4, and rises to a little more than 8 later in that period. The series then generally falls to about 6.3 in 2004:Q3, generally rises to about 6.4 in 2004:Q4, and generally falls to about 6.3 later in that period. The series rises to about 6.5 in 2005:Q1, falls to about 5.9 in 2005:Q2, and generally rises to about 7.7 in 2006:Q1. The series generally falls to about 7.2 later in that period and rises to end at about 7.4 in 2006:Q2.

For fixed rate, the series begins in 2003:Q3 at about 7.3, generally falls to about 6.1 in 2004:Q3, and generally rises to about 6.4 in 2005:Q1. The series generally falls to about 5.8 in 2005:Q2, generally rises to about 6.4 in 2005:Q4, remains at about that level until 2006:Q1, and then generally falls to end at about 5.6 in 2006:Q2.

The curves overlap in 2005:Q1 and 2005:Q2.

Note: Ninety-plus days delinquent or in foreclosure.

Source: LoanPerformance.

#### Bottom-left panelConsumer Sentiment by Income Group

Series: Upper two-thirds, lower third
Horizon: 2002 to May 2006
Description: Data are plotted as two curves. Data are three-month moving averages. Units are index, Jan. 2002 = 100.

For upper two-thirds, the series begins in January 2002 at 100, generally rises to about 109 in mid-2002, and then generally falls to about 93 toward year-end 2002. The series rises to about 96 in early 2003, falls to 91 later in that period, generally rises to about 114 in early 2004, falls to about 107 later in that period, fluctuates between that point and 111 until early 2005, and falls to about 100 later in that period. The series rises to about 108 in mid-2005 and falls to about 89 toward year-end 2005. The series rises to about 105 in early 2006 and then falls to end at about 98 in May 2006.

The curves overlap in 2002 and 2003.

Source: Michigan Survey.

#### Bottom-right panelImplications

• Baseline projection for the household sector incorporates these developments.
• The greater stress among the most financially vulnerable segment of households presents a risk to the forecast.

### Exhibit 6The Outlook for Compensation

#### Top-left panelCompensation Per Hour

Percent change, annual rate
P&C ECI
2005: Q1 5.6 3.8
Q2 1.3 2.5
Q3 5.5 2.9
Q4 -.9 2.8
2006: Q1 5.1 2.4

#### Top-right panelSelected Differences Between the ECI and P&C Comp per Hour

• Measurement objectives: The cost of employing a fixed market-basket of labor versus the current workforce.
• Source data: A survey of firms versus administrative records covering the universe of firms.
• Technical issues: For example, the handling of stock options and pension-related costs.

#### Middle-left panelUnemployment Rate

Percent
Period Unemployment Rate NAIRU Unemployment Rate Forecast NAIRU Forecast
2000:Q1 4.00 5.13 ND ND
2000:Q2 3.90 5.12 ND ND
2000:Q3 4.00 5.12 ND ND
2000:Q4 3.90 5.13 ND ND
2001:Q1 4.20 5.10 ND ND
2001:Q2 4.40 5.09 ND ND
2001:Q3 4.80 5.09 ND ND
2001:Q4 5.50 5.09 ND ND
2002:Q1 5.70 5.08 ND ND
2002:Q2 5.80 5.06 ND ND
2002:Q3 5.70 5.06 ND ND
2002:Q4 5.90 5.06 ND ND
2003:Q1 5.90 5.03 ND ND
2003:Q2 6.10 5.01 ND ND
2003:Q3 6.10 5.01 ND ND
2003:Q4 5.80 5.01 ND ND
2004:Q1 5.70 5.02 ND ND
2004:Q2 5.60 5.02 ND ND
2004:Q3 5.50 5.01 ND ND
2004:Q4 5.40 5.00 ND ND
2005:Q1 5.20 5.01 ND ND
2005:Q2 5.10 5.01 ND ND
2005:Q3 5.00 5.01 ND ND
2005:Q4 5.00 4.99 ND ND
2006:Q1 4.71 4.99 ND ND
2006:Q2 ND ND 4.68 5.00
2006:Q3 ND ND 4.76 5.00
2006:Q4 ND ND 4.86 5.00
2007:Q1 ND ND 4.96 5.00
2007:Q2 ND ND 5.05 5.00
2007:Q3 ND ND 5.13 5.00
2007:Q4 ND ND 5.20 5.00

#### Middle-right panelReal Compensation and Productivity Growth*

Average annual rates of growth
Period Real Compensation Per Hour Productivity Real Compensation Per Hour Forecast Productivity Forecast
1973-1993 1.33 1.55 ND ND
1994-2001** 2.45 2.21 ND ND
2002-2006:Q1** 2.15 3.28 ND ND
2006:Q1-2007:Q4 ND ND 2.88 2.48

* Nonfarm business sector. Compensation is deflated by the price index for NFB output. Return to text

#### Bottom-left panelPrice Markup for the Nonfarm Business Sector

Series: Price markup for the nonfarm business sector
Horizon: Late 1993 to 2007 (data are projected for the period beginning in early 2006 through 2007)
Description: Data are plotted as one curve. Units are index. There is a horizontal line at about 1.57, which represents the average for the period from 1973:Q1 to 2006:Q1. The horizontal line overlays the curve toward year-end 1999, in late 2001, and in early 2002.

The series begins in late 1993 at about 1.59, generally rises to about 1.64 in late 1997, and generally falls to about 1.54 in early 2000. The series rises to about 1.56 in mid-2000, falls to a little more than 1.54 in late 2000, rises to a little less than 1.55 later in that period, and then falls to about 1.53 in early 2001. The series generally rises to about 1.63 in mid-2004, falls to a little less than 1.60 toward year-end 2004, and rises to end at about 1.64 in early 2006. In the projected area, the series begins in early 2006 at about 1.64 and then generally falls to end at a little less than 1.63 toward year-end 2007.

#### Bottom-right panelCompensation per Hour

Percent change from year earlier
Period P&C ECI P&C Forecast ECI Forecast
1994:Q1 2.30 3.30 ND ND
1994:Q2 1.70 3.40 ND ND
1994:Q3 1.20 3.30 ND ND
1994:Q4 1.40 3.10 ND ND
1995:Q1 1.10 2.90 ND ND
1995:Q2 1.90 2.80 ND ND
1995:Q3 2.60 2.60 ND ND
1995:Q4 2.90 2.60 ND ND
1996:Q1 3.10 2.70 ND ND
1996:Q2 3.50 2.90 ND ND
1996:Q3 3.70 2.90 ND ND
1996:Q4 3.20 3.10 ND ND
1997:Q1 2.80 3.00 ND ND
1997:Q2 2.60 2.90 ND ND
1997:Q3 2.80 3.20 ND ND
1997:Q4 4.20 3.40 ND ND
1998:Q1 5.50 3.50 ND ND
1998:Q2 6.10 3.50 ND ND
1998:Q3 6.80 3.80 ND ND
1998:Q4 5.50 3.50 ND ND
1999:Q1 5.50 3.00 ND ND
1999:Q2 4.40 3.30 ND ND
1999:Q3 3.60 3.10 ND ND
1999:Q4 5.20 3.40 ND ND
2000:Q1 6.90 4.60 ND ND
2000:Q2 6.80 4.60 ND ND
2000:Q3 8.00 4.60 ND ND
2000:Q4 6.40 4.40 ND ND
2001:Q1 4.50 4.20 ND ND
2001:Q2 4.80 4.00 ND ND
2001:Q3 3.30 4.00 ND ND
2001:Q4 3.50 4.10 ND ND
2002:Q1 3.40 3.80 ND ND
2002:Q2 3.90 4.00 ND ND
2002:Q3 3.80 3.50 ND ND
2002:Q4 3.10 3.10 ND ND
2003:Q1 3.10 3.60 ND ND
2003:Q2 3.50 3.50 ND ND
2003:Q3 4.30 3.90 ND ND
2003:Q4 5.00 4.00 ND ND
2004:Q1 4.30 3.80 ND ND
2004:Q2 3.80 3.90 ND ND
2004:Q3 4.10 3.80 ND ND
2004:Q4 5.90 3.80 ND ND
2005:Q1 6.40 3.50 ND ND
2005:Q2 5.80 3.10 ND ND
2005:Q3 5.60 2.90 ND ND
2005:Q4 2.80 2.90 ND ND
2006:Q1 2.71 2.60 ND ND
2006:Q2 ND ND 3.58 2.87
2006:Q3 ND ND 3.49 3.03
2006:Q4 ND ND 5.07 3.22
2007:Q1 ND ND 5.12 3.54
2007:Q2 ND ND 5.25 3.62
2007:Q3 ND ND 5.27 3.68
2007:Q4 ND ND 5.22 3.71

### Exhibit 7The Outlook for Price Inflation

#### Top-left panelPCE Prices

Percent change
Total Core Market-Based Core
Jan. .5 .15 .09
Feb. .1 .15 .11
Mar. .4 .34 .32
Apr. .5 .25 .21
May (f) .4 .25 .26
Q1 2.0 2.0 1.6
Q2 (f) 4.3 3.1 2.8

Note: Quarterly figures are at annual rates.

#### Top-right panelPCE Prices

Four-quarter percent change
Period Total Core Market-based core Total forecast Core forecast Market-based core forecast
2001:Q1 2.22 1.62 1.51 ND ND ND
2001:Q2 2.37 1.82 1.65 ND ND ND
2001:Q3 2.05 1.95 1.75 ND ND ND
2001:Q4 1.74 2.22 1.76 ND ND ND
2002:Q1 1.15 1.84 1.46 ND ND ND
2002:Q2 1.21 1.79 1.53 ND ND ND
2002:Q3 1.52 1.89 1.48 ND ND ND
2002:Q4 1.79 1.55 1.37 ND ND ND
2003:Q1 2.32 1.51 1.34 ND ND ND
2003:Q2 1.77 1.31 1.18 ND ND ND
2003:Q3 1.82 1.23 1.09 ND ND ND
2003:Q4 1.73 1.27 1.02 ND ND ND
2004:Q1 1.94 1.65 1.28 ND ND ND
2004:Q2 2.73 2.01 1.53 ND ND ND
2004:Q3 2.60 1.99 1.45 ND ND ND
2004:Q4 3.06 2.23 1.67 ND ND ND
2005:Q1 2.66 2.16 1.76 ND ND ND
2005:Q2 2.54 1.98 1.64 ND ND ND
2005:Q3 3.10 1.95 1.65 ND ND ND
2005:Q4 3.03 1.96 1.68 ND ND ND
2006:Q1 2.96 1.86 1.53 ND ND ND
2006:Q2 ND ND ND 3.21 2.19 1.85
2006:Q3 ND ND ND 2.74 2.42 2.10
2006:Q4 ND ND ND 2.47 2.37 2.12
2007:Q1 ND ND ND 2.54 2.43 2.20
2007:Q2 ND ND ND 2.01 2.21 1.99
2007:Q3 ND ND ND 2.09 2.19 1.95
2007:Q4 ND ND ND 2.15 2.17 1.93

#### Middle-left panelPCE Energy Prices

Four-quarter percent change
Period PCE energy prices Percent change, annual rate PCE energy prices forecast Percent change, annual rate, forecast
2001:Q1 10.91 10.51 ND ND
2001:Q2 10.34 10.04 ND ND
2001:Q3 1.13 -19.41 ND ND
2001:Q4 -9.94 -32.87 ND ND
2002:Q1 -14.1 -8.622 ND ND
2002:Q2 -10.5 29.534 ND ND
2002:Q3 -4.89 2.98 ND ND
2002:Q4 7.67 10.27 ND ND
2003:Q1 21.03 45.86 ND ND
2003:Q2 10.68 -9.41 ND ND
2003:Q3 11.90 7.60 ND ND
2003:Q4 7.18 -7.17 ND ND
2004:Q1 4.07 29.66 ND ND
2004:Q2 13.37 27.54 ND ND
2004:Q3 10.97 -1.23 ND ND
2004:Q4 17.91 18.32 ND ND
2005:Q1 11.48 3.63 ND ND
2005:Q2 11.71 28.57 ND ND
2005:Q3 24.01 50.00 ND ND
2005:Q4 21.84 10.26 ND ND
2006:Q1 20.69 -0.23 ND ND
2006:Q2 ND ND 21.07 30.23
2006:Q3 ND ND 8.01 -5.01
2006:Q4 ND ND 4.05 -5.02
2007:Q1 ND ND 4.68 2.20
2007:Q2 ND ND -1.53 1.98
2007:Q3 ND ND 0.07 1.30
2007:Q4 ND ND 1.40 0.15

#### Middle-right panelExpected Inflation

Series: Michigan SRC, next twelve months; Michigan SRC, next five-to-ten years; TIPS, five-to-ten years ahead (estimates of inflation compensation based on smoothed nominal and inflation-indexed Treasury yield curves.)
Horizon: For Michigan SRC curves, 2001 to June 2006 (data for June are preliminary) and, for TIPS, 2001 to June 23, 2006
Description: Data are plotted as three curves. Units are percent.

For Michigan SRC, next five-to-ten years, the series begins in early 2001 at about 2.9, rises to about 3.1 later in that period, and then generally falls to about 2.8 toward year-end 2001. The series fluctuates between that point and 3.2 until it ends at about 3 in June 2006.

The curves generally overlap throughout the horizon except for the TIPS curve from early 2001 to mid-2001 and from early 2005 to June 23, 2006.

#### Bottom panelPCE Prices

Percent change, annual rate*
2005 2006:H1 2006:H2 2007
1. PCE price index 3.0 3.1 1.8 2.2
2. (May GB) (3.0) (3.0) (2.1) (2.0)
3. Energy 21.8 14.0 -5.0 1.4
4. (May GB) (21.8) (13.9) (1.3) (1.5)
5. Core PCE 2.0 2.5 2.2 2.2
6. (May GB) (2.0) (2.3) (2.1) (2.0)

* Annual figures are Q4/Q4. Half-yearly figures are Q4/Q2 or Q2/Q4.  Return to table

### Exhibit 8Have Inflation Models Been Moving off Track Recently?

#### Top panelTwo Models Among Many

• A backward-looking model proxies for underlying or expected inflation using lagged inflation only.
• A partly forward-looking model uses a weighted average of lagged inflation and expected inflation as measured in the Survey of Professional Forecasters.
• Neither model has been substantially and consistently surprised by the performance of inflation over the last several years.

#### Middle panelsThe Backward-Looking Model

##### Middle-left panelCore PCE Prices

Series: Actual (figure for 2006:Q2 is a staff forecast) and simulated
Horizon: 1999 to 2006:Q2
Description: Data are plotted as six curves. (The curve for actual core PCE prices is a solid line; the curves for simulated core PCE prices are five dashed lines.) Red dots overlay the curve for core PCE prices. Units are four-quarter percent change.

For actual core PCE prices, the series starts at a little less than 1.5 in 1999 and rises to almost 2 in early 2000. The series drops to about 1.5 in late 2000 and generally rises to a little more than 2 by late 2001. The series then generally falls to about 1.25 in late 2003. The series generally rises to a little more than 2 in late 2004, generally falls to a little less than 2 in early 2006, and rises to end at a little more than 2.25 in 2006:Q2.

For simulated core PCE prices, there are five series. The first series starts at about 1.5 in late 2000, and then rises to a little below 2 by the end of 2001. The series generally falls to nearly 1 in early 2003, remains at about that level until mid-2003, and then generally rises to about 2.25 in 2006:Q2. The second series starts at about 2.25 in late 2001 and generally falls to about 1.25 in early 2003. The series then generally rises to about 2.5 in 2006:Q2. The third series starts at about 1.5 in late 2002, falls to a little less than 1.5 in mid-2003, and then generally rises to end at almost 2.75 in 2006:Q2. The fourth series starts at about 1.25 in late 2003 and generally rises to almost 2.5 in 2006:Q2. The fifth series starts at about 2.25 in late 2004, falls to about 2 in early 2005, and then generally rises to end at almost 2.75 in 2006:Q2.

Both series overlap in 2001, 2002, 2003, and 2004.

##### Middle-right panelKalman Filter Estimates of the NAIRU*

Series: Two-sided estimates and one-sided estimates
Horizon: 1990 to 2006:Q2
Description: The data are plotted as two curves. Units are percent. Vertically, the shaded area is between about 6.0 (top left) and a little less than 5.0 (bottom left) and between almost 5.75 (top right) and almost 4.0 (bottom right). Horizontally (top and bottom of shaded area), the shaded area starts in early 1990 (left side) and ends in early 2006 (right side). Data for 2006:Q2 is represented as a dot and is located at a little less than 5.0.

The two-sided estimates series starts just below 5.5 in 1990, and generally falls to a little less than 5.0 in early 2006.

The one-sided estimates series starts just below 6.0 in 1990 and fluctuates between that point and about 5.75 until late 1995. The series then generally falls to about 5.0 in late 2000 and fluctuates between that point and about 5.2 until early 2006. The series ends at nearly 5.0 in early 2006.

Both series overlap in 2000 and 2006.

* The shaded area denotes the 90 percent confidence region for the two-sided estimates.  Return to text

#### Bottom panelsThe Partly Forward-Looking Model

##### Bottom-left panelCore PCE Prices

Series: Actual (figure for 2006:Q2 is a staff forecast) and simulated
Horizon: 1999 to 2006:Q2
Description: Data are plotted as six curves. (The curve for actual core PCE prices is a solid line; the curves for simulated core PCE prices are five dashed lines.) Red dots overlay the curve for core PCE prices. Units are four-quarter percent change.

The actual core PCE prices series starts at about 1.5 in 1999, generally rises to a little less than 2 in late 1999, and falls to a little less than 1.5 in late 2000. The series generally rises to about 2.25 in late 2001, generally falls to about 1.25 in late 2003, and generally rises to about 2.25 in late 2004. The series generally falls to a little less than 2 in early 2006 and rises to end at about 2.25 in 2006:Q2.

For simulated core PCE prices, there are five series. The first series starts at about 1.5 in late 2000, falls to a little more than 1.25 in early 2001, rises to about 1.5 in late 2001, falls to about 1.25 in late 2003, and rises to end at nearly 2.25 in 2006:Q2. The second series starts at about 2.25 in late 2001, falls to about 1.5 in late 2003, and generally rises to end at almost 2.25 in 2006:Q2. The third series starts at a little more than 1.5 in late 2002, generally falls to a little less than 1.5 in late 2003, and generally rises to end at almost 2.25 in 2006:Q2. The fourth series starts at about 1.25 in late 2003 and generally rises to end at nearly 2.25 in 2006:Q2. The fifth series starts at about 2.25 in late 2004, falls to nearly 2 in early 2005, rises to about 2.25 in late 2005, and remains at about that level until ending at a little more than 2.25 in 2006:Q2.

Both series overlap in 2001, 2003, 2004, 2005, and 2006.

##### Bottom-right panelKalman Filter Estimates of the NAIRU*

Series: Two-sided estimates and one-sided estimates
Horizon: 1990 to 2006:Q2
Description: Data are plotted as two curves. Units are percent. The shaded area is between about 5.5 (top left) and a little more than 4.0 (bottom left) and between a little more than 5.5 (top right) and about 3.75 (bottom right). Horizontally (top and bottom of shaded area), the shaded area starts in early 1990 (left side) and ends in early 2006 (right side). Data for 2006:Q2 is represented as a dot and is located at about 4.75.

The two-sided estimates series starts at a little less than 5.0 in early 1990, generally falls to about 4.75 in late 1997, and remains at about that level through early 2006.

The one-sided estimates series starts at about 5.0 in early 1990 and then fluctuates between about 5.1 and a little less than 5.5 until late 1994. The series generally falls to about 4.5 in late 2000, rises to about 4.75 in late 2001, and remains at about that level until early 2003. The series then falls to about 4.6 in late 2003, rises to about 4.8 in mid-2004, and remains at about that level until ending at about 4.75 in early 2006.

Both series overlap in 1997, 1999, 2000, 2001, 2002, 2003, 2004, and 2006.

* The shaded area denotes the 90 percent confidence region for the two-sided estimates.  Return to text

### Exhibit 9The Pass-Through of Energy Prices

#### Top panelEnergy Prices and a PPI for Energy-Intensive Industries

Series: PPI for energy-intensive industries, PPI for finished energy
Horizon: 1991 to 2006:Q1
Description: Data are plotted as two curves. Units are four-quarter percent change (Vertical axis for PPI for energy-intensive industries, ranging from 15 to negative 15, is on the right side; vertical axis for PPI for finished energy, ranging from 30 to negative 30, is on the left side.) There is a horizontal line at zero.

The curves overlap in 1991, 1992, 1993, 1996, 1997, 1999, 2001, 2002, 2004, and 2005.

Note: The PPI for energy-intensive industries is a staff-calculated aggregation of price indexes for industries having an energy cost share greater than 5 percent, based on the 1997 input-output table.

#### Middle panelEstimated Pass-through into Core PCE price inflation*

Series: Backward-looking model, partly forward-looking model
Horizon: 1981 to early 2006
Description: Data are plotted as two curves. Units are percentage points. There is a horizontal line at zero.

The curves overlap in 1989, 1990, 1992, 1993, 1994, 1995, 1996, 2000, and 2006.

* The vertical axis measures the estimated response of core PCE price inflation after eight quarters to a permanent 10-percent increase in the relative price of energy. The results are based on 15-year rolling estimation periods. Dates on the horizontal axis denote the end of the estimation window.  Return to text

#### Bottom panelJudgmental Assumptions about Energy-Price Pass-Through

• We assume that a permanent ten-percent increase in the relative price of energy would boost core inflation about 0.2 percentage point after eight quarters.
• Models that are forced to assume zero energy-price pass-through have been a little surprised by how high inflation has been in the last few quarters.
• Models that assume a larger pass-through than the one we use judgmentally have been a little surprised by how low inflation has been.

### Exhibit 10Housing Prices in the CPI and PCE Price Index

#### Top panelTwo Approaches to Measuring the Price of Owner-Occupied Housing Services

 • The user-cost approach: (1) Price of housing services = P_{t}(i_{i} + \delta - E_{t}\pi^{h}_{t+1}) = imputed interest expense + depreciation - expected capital gain • The rental-equivalence approach: (2) Price of housing services = Rent • In a perfect world, the two approaches would give the same answer, implying: (3) Rent = P_{t}(i_{i} + \delta - E_{t}\pi^{h}_{t+1}) • OER is a theoretically appropriate element of a cost-of-living index. • Whether the FOMC should define its objectives relative to such an index depends on what costs you are seeking to minimize.

#### Bottom-left panelHousing Affordability and the Rental Vacancy Rate*

Series: Housing affordability, rental vacancy rate
Horizon: 1990 to 2006:Q1
Description: Data are plotted as two curves. Units are percent. (Vertical axis for housing affordability, ranging from 170 to 100, is on the right side; vertical axis for rental vacancy rate, ranging from 11 to 6, is on the left side.)

The curves overlap in 1991 and 2003.

* Housing affordability is defined as the ratio of median family income to the amount required to qualify for a mortgage on the median-priced existing single-family home.  Return to text

#### Bottom-right panelTenants' Rent and OER

Series: OER, tenants' rent
Horizon: 1990 to 2007 (data are projected for the period beginning in early 2006 through 2007)
Description: Data are plotted as two curves. Units are four-quarter percent change.

The curves overlap in 1991, 1997, 1998, 2002, 2003, 2006, and 2007.

### Exhibit 11Outlook for Foreign Growth

Exhibit 11 is comprised of six panels, including graphs on the euro area, Japan, and Mexico, a table on foreign real GDP, and graphs on policy interest rates and on stock prices and EMBI spreads.

#### Top-left panelEuro Area

A line chart plots manufacturing orders, IP, and retail sales for mid-2004 through March or April 2006. The range of the y-axis is [90, 125]; index, July 2004 = 100. All three series begin at 100. IP and retail sales both rise to about 103 by April 2006, and both series track closely throughout the entire period. Manufacturing orders, with some volatility, rise to about 108 by March 2006.

#### Top-center panelJapan

A line chart plots machinery orders and IP for mid-2004 through April 2006. The range of the y-axis is [90, 125]; index, July 2004 = 100. Both series begin at 100. IP rises to about 104 by April 2006. Machinery orders, with some volatility, rise to about 123 by April 2006.

#### Top-right panelMexico

A line chart plots exports and IP for mid-2004 through April or May 2006. The range of the right y-axis, which measures IP, is [90, 125]; index, July 2004 = 100. The range of the left y-axis, which measures exports, is [90, 150]; index, July 2004 = 100. Both series begin at 100. IP rises to about 107 by April 2006. Exports, with some volatility, rise to about 135 by May 2006.

#### Middle panelForeign Real GDP*

Percent change, a.r.**
2005:H2 2006 2007p
Q1 Q2p H2p
1. Total Foreign 4.1 4.5 3.5 3.3 3.3
2. Industrial Countries 2.6 3.1 2.7 2.4 2.4
of which:
3. Japan 2.8 3.1 3.0 2.0 1.8
4. Euro Area 1.9 2.4 2.7 2.0 1.5
5. United Kingdom 2.2 2.3 2.5 2.6 2.7
6. Canada 2.9 3.8 2.5 2.6 2.9
7. Emerging Economies 6.4 6.6 4.6 4.6 4.6
of which:
8. China 10.2 13.3 8.0 7.6 8.1
9. Emerging Asia ex. China 7.2 5.0 4.7 4.8 4.9
10. Mexico 5.5 6.3 3.2 3.4 3.4

** Year is Q4/Q4; half years are Q4/Q2; quarters are percent change from previous quarter.  Return to table

#### Bottom-left panelPolicy Interest Rates

A line chart plots policy interest rates (percent) for the United Kingdom, Canada, the euro area, and Japan for 2004 through mid-2006 (actual) and for mid-2006 through 2007 (forecast). The policy rate for the United Kingdom starts at 4 percent, rises to 4¾ percent in mid-2004, declines to 4½ percent in mid-2005, rises to 4¾ percent in late 2006, and stays there through the end of the period. The policy rate for Canada starts at 2¼ percent, immediately declines to 2 percent, rises to 2½ percent in late 2004, stays at that rate through early 2005, rises to 2¾ percent in late 2005, rises further to 4¼ percent by mid-2006, and stays there through the end of the period. The policy rate for the euro area starts at 2 percent, stays at that rate through mid-2005, rises to 3¼ percent by late 2006, and stays there through the end of the period. The policy rate for Japan starts in the second quarter of 2006 at 0 percent, and rises to ¾ percent by the end of the period.

### Exhibit 12Commodity Prices and Global Growth

Exhibit 12 is a three-by-two array of panels, including graphs on consumer price inflation, primary commodity prices, spot prices, real commodity prices, a table on China's contribution to growth, and a graph on China inflation indicators.

#### Top-left panelConsumer Price Inflation

A line chart of consumer prices for emerging economies and industrial economies for 2004 through 2006:Q1 (actual) and for 2006:Q2 through 2007 (forecast). The range of the y-axis is [0, 6]. The series are quarterly percent changes at an annual rate. Consumer price inflation for emerging economies starts at just over 4 percent, falls to about 2½ percent by 2006:Q1, rises to about 4¼ percent by late 2006, and then eases to about 3¼ percent by the end of the period. Consumer price inflation for industrial economies starts at about 1¾ percent, falls to about ½ percent by early 2005, rises to about 1-1/3 percent by 2006:Q1, rises to about 2½ percent by 2006:Q2, and then eases to about 1-2/3 percent by the end of the period.

#### Middle-right panelTen-Year Government Bond Yields

A line chart plots ten-year government bond yields on a daily basis for U.S. Treasury bonds and for weighted-average foreign bonds for January through late June 2006. The range of the y-axis is [3.0, 6.0]; unit is percent. Yields for weighted-average foreign bonds are defined as the average of rates for Australia, Canada, the euro area, Japan, Sweden, Switzerland, and the United Kingdom, weighted by trade shares. Yields for U.S. Treasury bonds start at about 4.4 percent and rise to about 5.3 percent by the end of the period. Yields for weighted-average foreign bonds start at about 3.5 percent and rise to about 4.2 percent by the end of the period.

#### Bottom panelU.S. Financial Flows

Billions of dollars, s.a.
2005:Q4 2006:Q1 March April
1. Current account balance -223 -209
2. Official capital, net inflow 77 76 17 21
3. Private capital, net inflow 166 82
Of which:
4. Foreign purchases of U.S. securities 193 181 74 14
5. U.S. purchases of foreign securities -48 -53 -21 -14
6. Net banking flows 56 11 5 87

### Exhibit 15Alternative Scenarios for the Dollar

Exhibit 15 is a four-by-two array of panels, including graphs on the broad real dollar, the nominal trade balance, the contribution of real net exports to U.S. GDP growth, core import prices, core PCE prices, the Federal Funds rate, U.S. real GDP growth, and foreign real GDP growth.

A line chart plots the broad real dollar for 1995 through mid-2006 (actual), along with the Greenbook baseline forecast and an alternative simulation for mid-2006 through 2007. The range of the y-axis is [65, 105]; index, 2003:Q1 = 100. The actual broad real dollar starts at about 84, rises to about 105 by early 2002, and falls to about 90 by mid-2006. The Greenbook baseline forecast declines slightly to about 87 by the end of 2007. The alternative simulation declines to about 74 by the end of 2007.

A line chart plots nominal trade balance for 2004 though mid-2006 (actual), along with the Greenbook baseline forecast and an alternative simulation for mid-2006 through 2007. The range of the y-axis is
[-8, -3]; unit is percent of GDP. The trade balance starts at about -4¾ percent of GDP and falls to about -6 percent of GDP by mid-2006. The Greenbook baseline forecast declines a bit more to about -6¼ percent of GDP by early 2007 and then rises to about -6 percent of GDP by the end of the period. The alternative simulation declines to about -6-1/3 percent of GDP by early 2007 and then rises to about -5¾ percent of GDP by the end of the period.

#### Middle-left top panelContribution of Real Net Exports to U.S. GDP Growth

A line chart plots the contribution of real net exports to U.S. GDP growth for 2004 though mid-2006 (actual), along with the Greenbook baseline forecast and an alternative simulation for mid-2006 through 2007. The range of the y-axis is [-2.0, 2.0]; units are percentage points, a.r. The series starts at about -1.2 percentage points, rises to about 1.1 percentage points by mid-2005, falls to about -1.4 percentage points in late 2005, and rises to about 0.2 percentage point by mid-2006. The Greenbook baseline forecast falls to about -0.6 percentage point by the end of 2007. The alternative simulation rises to about 1 percentage point by mid-2007, and then declines to about 0.4 percentage point by the end of 2007.

#### Middle-right top panelCore Import Prices*

A line chart plots core import prices for 2004 though mid-2006 (actual), along with the Greenbook baseline forecast and an alternative simulation for mid-2006 through 2007. The range of the y-axis is [-2, 8]; unit is percent change, a.r. The series starts at about 5-1/3 percent, falls to just below 0 percent by mid-2005, and rises to about 3¼ percent by mid-2006. The Greenbook baseline forecast rises to about 3¾ percent in late 2006, declines to about 1 percent by mid-2007, and stays at that rate through the end of 2007. The alternative simulation rises to about 6½ percent in late 2006, declines to about 4¼ percent by mid-2007, and stays at that rate through the end of 2007.

#### Middle-left bottom panelCore PCE Prices

A line chart plots core PCE prices for 2004 though mid-2006 (actual), along with the Greenbook baseline forecast and an alternative simulation for mid-2006 through 2007. The range of the y-axis is [0, 4]; unit is percent change, a.r. The series starts at about 2¾ percent, falls to about 1-1/3 percent by mid-2005, and rises to about 3 percent by mid-2006. The Greenbook baseline forecast falls to about 2¼ percent in late 2006, and stays at about that rate through the end of 2007. The alternative simulation falls to about 2½ percent in late 2006, and stays at about that rate through the end of 2007.

#### Middle-right bottom panelFederal Funds Rate

A line chart plots the federal funds rate for 2004 though mid-2006 (actual), along with the Greenbook baseline forecast and an alternative simulation for mid-2006 through 2007. The range of the y-axis is [0, 7]; unit is percent. The federal funds rate starts at 1 percent and rises to about 4¾ percent by mid-2006. The Greenbook baseline forecast rises to about 5¼ percent by late 2006 and stays there throughout the forecast period. The alternative simulation rises to about 6¼ percent by the end of 2007.

#### Bottom-left panelU.S. Real GDP Growth

A line chart plots real U.S. GDP growth for 2004 though mid-2006 (actual), along with the Greenbook baseline forecast and an alternative simulation for mid-2006 through 2007. The range of the y-axis is [0, 8]; unit is percent, a.r. Real U.S. GDP growth starts at about 4¼ percent and fluctuates between about 3¼ percent to 4¼ percent through mid-2005, falls to about 1½ percent by late 2005, spikes to about 5¾ percent in early 2006, and falls to about 2 percent by mid-2006. The Greenbook baseline forecast rises to about 2¾ percent by the end of 2007. The alternative simulation rises to about 3¾ percent by the end of 2007.

#### Bottom-right panelForeign Real GDP Growth

A line chart plots foreign real GDP growth for 2004 though mid-2006 (actual), along with the Greenbook baseline forecast and an alternative simulation for mid-2006 through 2007. The range of the y-axis is [0, 8]; unit is percent, a.r. Foreign real GDP growth starts at about 5¼ percent, falls to about 2½ percent by early 2005, rises to about 4½ percent by early 2006, and falls to about 3-1/3 percent by mid-2006. The Greenbook baseline forecast remains at about 3-1/3 percent through the end of 2007. The alternative simulation edges down to about 3 percent by the end of 2007.

### Exhibit 16 - Last Exhibit

#### Top panelECONOMIC PROJECTIONS FOR 2006

FOMC Staff
Range Central Tendency
Percentage change, Q4 to Q4
Nominal GDP 5½ to 6½ 6 to 6¼ 6.1
February 2006 (5¼ to 6½) (5½ to 6) (6.0)
Real GDP 3 to 3¾ 3¼ to 3½ 3.3
February 2006 (3¼ to 4) (About 3½) (3.7)
Core PCE Prices 2¼ to 3 2¼ to 2½ 2.4
February 2006 (1¾ to 2½) (About 2) (2.2)
Average level, Q4, percent
Unemployment rate 4½ to 5 4¾ to 5 4.9
February 2006 (4½ to 5) (4¾ to 5) (5.0)

Central tendencies calculated by dropping high and low three from ranges.

#### Bottom panelECONOMIC PROJECTIONS FOR 2007

FOMC Staff
Range Central Tendency
Percentage change, Q4 to Q4
Nominal GDP 4¾ to 6 5 to 5½ 5.0
February 2006 (5 to 6) (5 to 5¾) (5.0)
Real GDP 2½ to 3¼ 3 to 3¼ 2.7
February 2006 (3 to 4) (3 to 3½) (3.0)
Core PCE Prices 2 to 2¼ 2 to 2¼ 2.2
February 2006 (1¾ to 2) (1¾ to 2) (1.8)
Average level, Q4, percent
Unemployment rate 4¼ to 5¼ 4¾ to 5 5.2
February 2006 (4½ to 5) (4¾ to 5) (5.1)

## Appendix 3: Materials used by Mr. Reinhart

Material for FOMC Briefing on Monetary Policy Alternatives
Vincent R. Reinhart
June 29, 2006

Class I FOMC - Restricted-Controlled FR

### Exhibit 1:Policy Expectations and Asset Prices

#### Top panelFederal Funds and Eurodollar Futures

A line chart showing an intradaily time series of July 2006 federal funds futures rates and December 2007 Eurodollar futures rates, since just before the May FOMC meeting. Both generally drifted higher over this period. Lines are shown marking the effects of selected events: the May FOMC announcement, the release of April CPI data, the release of the FOMC minutes, the release of nonfarm payrolls data, the Chairman's IMC speech, and the release of May CPI data. Each of these events was followed by a marking up of futures rates, with the sole exception of the nonfarm payrolls releases, which was followed by a decline in futures rates.

Note. 5-minute intervals.

#### Middle-left panelExpected Federal Funds Rates*

A line chart that shows the trajectory of the expected federal funds rate through August 2008, derived from money market futures quotes, as of May 9, 2006, June 22, 2006, and June 28, 2006. The path for monetary policy shifted upwards notably from May 9 to June 22. It rose a little further still from June 22 to June 28.

#### Middle-right panelReasons for Inversion of Futures Curve

• Optimal response to inflation bulge
• Nonlinearity in the housing market
• Policy mistake

#### Bottom-left panelSelected Financial Market Quotes*

June 28, 2006 Change from
May 9, 2006
Change from
June 22, 2006
Nominal -percent- -basis points- -basis points-
1. Two-Year 5.32 32 6
2. Ten-Year 5.32 13 5
Inflation Compensation** -percent- -basis points- -basis points-
3. Five-Year 2.53 -11 -1
4. Ten-Year 2.59 -10 0
Stock Prices -level- -percent- -percent-
5. S&P 500 1246.00 -6 0
6. Russell 2000 688.04 -12 0

* Yields and inflation compensation derived from smoothed yield curves.  Return to text

#### Bottom-right panelChange in Implied One-Year Forward Rates Since the May FOMC

A bar chart that shows changes in real and inflation compensation forward rates since May 9, 2006 (as of June 28, 2006). One-year forward rates ending two-, five-, seven- and ten-years hence are shown. All real forward rates increased, especially at the one-to-two year horizon. Forward rates of inflation compensation declined at all horizons shown.

Note. Forward rates are the one-year rates maturing at the end of the year shown on the horizontal axis as implied by smoothed yield curves fitted to nominal and indexed Treasury securities.

### Exhibit 2:The Case for Pausing

#### Top panelCase for Alternative A

• Weak data on spending
• Cumulative tightening that has already occurred may be sufficient, given lags in policy.
• Consistent with a number of policy rules

#### Middle-left panelHousing Market Surveys

A line chart showing monthly data on homebuying attitudes from the Michigan survey and builders' ratings of current new home sales from a survey conducted by the National Association of Home Builders. Data are shown from the start of 2002 through June 2006. Both series have fallen sharply over the last year.

Note. Builders' ratings are seasonally adjusted by Board staff.

Sources: Michigan Survey (Homebuying attitudes); National Association of Home Builders (Builders ratings).

#### Middle-right panelEstimated Policy Rules

A line chart that shows the actual and Greenbook-projected path of the funds rate, and forecast-based and outcome-based estimated policy rules. The graph also shows 70 percent and 90 percent confidence intervals obtained from model simulations. The forecast-based and outcome-based policy rules are very similar, and both slope downwards modestly to a bit below 4-1/2 percent even though the Greenbook-projected path is flat at 5-1/4 percent.

#### Bottom panelsOptimal Policy with 2 Percent Inflation Goal

Optimal policy with a 2 percent inflation goal derived from FRB/US. There are three line charts, showing the implied trajectories of the federal funds rate, the unemployment rate, and core PCE inflation, through 2010.

##### Bottom-left panelFederal Funds Rate

As shown in the chart, the federal funds rate peaks at a bit over 5 percent in 2007 and slopes downwards thereafter.

##### Bottom-center panelUnemployment Rate

As shown in the chart, the unemployment rate peaks at a bit over 5 percent in 2008 and moves back down to 5 percent thereafter.

##### Bottom-right panelCore PCE Inflation

As shown in the chart, core PCE inflation rises to nearly 2-1/2 percent later this year and next year, before moving back down towards the 2 percent goal.

### Exhibit 3:The Case for Tightening

#### Top panelsEvolution of Staff Forecast

##### Top-left panelUnemployment rate

A line chart shows the forecast for the unemployment rate in 2005, 2006 and 2007 in each Greenbook since the start of 2004. There is no trend to these forecasts over the period, but the forecast for the unemployment rate in 2006 and 2007 rose in the most recent Greenbook.

##### Top-right panelChange in Core PCE Prices

A line chart shows the corresponding forecasts for core PCE inflation, which all consistently trended upwards.

#### Middle panelsOptimal Policy Implications of Recent Changes in the Staff Outlook (Inflation Target: 1.5 Percent)

Optimal policy with a 1.5 percent inflation goal derived from FRB/US in January 2006 and in June 2006. There are three line charts, showing the implied trajectories of the federal funds rate, the unemployment rate, and core PCE inflation, through 2010.

##### Middle-left panelFederal Funds Rate

As shown in the chart, in the June 2006 simulations, the federal funds rate peaks at over 5-1/2 percent in 2007, more than 50 basis points above the peak from the previous simulations.

##### Middle-center panelUnemployment Rate

As shown in the chart, the trajectory of the unemployment rate has also moved higher, except that at the very near term, it is down a little.

##### Middle-right panelCore PCE Inflation

As shown in the chart, the trajectory of core PCE inflation has also moved higher.

#### Bottom panelInflation Compensation

A line chart showing a daily time series of five-year and five-to-ten-year forward inflation compensation implied by yields on nominal Treasury securities and TIPS over the period since June 2004. Rates of inflation compensation declined since the last FOMC meeting, but have fluctuated in a narrow range over the last year.

##### Bottom panel inset boxCorrelation between policy expectations and forward inflation compensation
• Far-forward inflation compensation declined and policy expectations firmed following official statements
• Data releases led to increases in policy expectations and inflation compensation

### Exhibit 4:More Tightening to Come?

#### Top panelRange of Estimated Equilibrium Real Rates

A line chart reproduces the Bluebook chart on staff estimates of the equilibrium real interest rate, R*. The 90-percent confidence interval around the staff estimates of R* prepared for the current FOMC meeting ranges from roughly 0 to 6 percent. The 70-percent confidence interval ranges from about 1 to 5 percent. The range of the staff estimates is roughly 2 to 4 percent. The Greenbook-consistent measure of R* is currently about 2-1/2 percent. The actual real federal funds rate is currently about 2-3/4 percent, and would be about 3 percent if the Committee tightened policy by 25 basis points, and 3-1/4 percent if the Committee tightened policy by 50 basis points. Over the period since mid-2004, the actual real federal funds rate has trended higher, moving from about -1 percent to its current value of 2-3/4 percent. The range of estimated values of R* has only moved slightly higher over the same period.

Explanatory notes are provided after Chart 7 of the Bluebook.

#### Middle panelsPlacing Greater Weights on the Inflation Objective (Inflation Target: 1.5 Percent)

Optimal policy with a 1.5 percent inflation goal derived from FRB/US using equal weights on the three stabilization objectives (which are keeping core PCE inflation close to its long run goal, keeping inflation close to the NAIRU, and minimizing fluctuations in the federal funds rate). There are three charts showing the paths for the federal funds rate, the unemployment rate, and core PCE inflation, through 2010. The line charts also show what the optimal policies would be if the weight on the inflation objective were increased.

##### Middle-left panelFederal Funds Rate

As shown in the chart, increasing the weight on the inflation objective would imply a substantially tighter path for policy, with the funds rate peaking over 6 percent.

##### Middle-center panelCivilian Unemployment Rate

As shown in the chart, if greater weight were placed on the inflation objective, the unemployment rate would rise to about 5-3/4 percent, before edging lower in 2009 and 2010.

##### Middle-right panelCore PCE Inflation

As shown in the chart, if greater weight were placed on the inflation objective, core PCE inflation would move down towards its 1-1/2 percent target more rapidly than with equal weights on the objectives. Even still, core PCE inflation would be above 1-1/2 percent in 2010.

#### Bottom-left panelProbabilities of Alternative Policy Paths over June and August FOMC meetings*

A line chart showing the evolution of the probabilities of four alternative paths for policy since just before the May FOMC meeting. Odds of no change at the two meetings, no change in June and a 25 basis point increase in August, a 25 basis point increase in June and no change in August, and a 25 basis point increase at both meetings are shown. These are derived from federal funds futures and options prices. The odds of a 25 basis point increase at both meetings rose consistently, especially following the release of May CPI data.

#### Bottom-right panel

• Markets have become convinced of a quarter-point rate hike today.
• Odds of a further rate hike in August have moved up to about 70 percent.

### Table 1:Alternative Language for the June FOMC Announcement

[Note: In Appendix 3, Table 1, emphasis (italic) has been added to indicate normal red text in the original document. Strong emphasis (bold) has been added to indicate normal blue text in the original document.]
May FOMC Alternative A Alternative B Alternative C
Policy
Decision
1. The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 5 percent. The Federal Open Market Committee decided today to leave its target for the federal funds rate unchanged at 5 percent. The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to percent. The Federal Open Market Committee decided today to raise its target for the federal funds rate by 50 basis points to percent.
Rationale 2. Economic growth has been quite strong so far this year. The Committee sees growth as likely to moderate to a more sustainable pace, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices. Recent indicators suggest that economic growth is moderating noticeably from its quite strong pace earlier this year, partly reflecting a cooling of the housing market and the lagged effects of increases in interest rates and energy prices. Recent indicators suggest that economic growth is moderating from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices. Recent indicators suggest that economic growth is moderating from its quite strong pace earlier this year, but the level of resource utilization remains relatively high.
3. As yet, the run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation, ongoing productivity gains have helped to hold the growth of unit labor costs in check, and inflation expectations remain contained. Still, possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures. The Committee views the pickup in core inflation this spring as unwelcome but likely to be transitory. Ongoing productivity gains, anchored inflation expectations, and moderate economic growth should reduce inflation in coming quarters. Readings on core inflation have been elevated in recent months. Ongoing productivity gains have held down the rise in unit labor costs, and inflation expectations remain contained. However, the high levels of resource utilization and of the prices of energy and other commodities have the potential to sustain inflation pressures. Ongoing productivity gains and contained inflation expectations should restrain inflation going forward. However, recent readings on core inflation have been elevated, which the Committee views as unwelcome.
Assessment
of Risk
4. The Committee judges that some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information. The Committee judges that the risks to the attainment of price stability remain tilted to the upside but recognizes that the moderation in the growth of aggregate demand, along with other forces, should work to contain inflation going forward. While the Committee judges that some further policy firming may yet be needed to address inflation risks, considerable uncertainty attends the outlook, making it prudent to await the accumulation of additional information. Although the moderation in the growth of aggregate demand should help to limit inflation pressures over time, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as determined by incoming information. In order to foster price stability and sustainable economic growth, the Committee seeks a medium-term decline in core inflation from its recent elevated levels. The Committee judges that some further policy firming may yet be needed to accomplish this outcome. The extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information.
5. In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives. [None.] In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives. [None.]

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