Yet, as near as we in Boston can tell, the best baseline forecast is that U.S. growth will moderate from its average of around 4 percent in the first half of 2006 to something slightly below its potential of a bit less than 3 percent over the next year or so.

Globally, growth is solid as well. U.S. exports have increased and trade is at least for now marginally supportive of growth. 

To summarize — I see growth for the next year or so in the high 2’s, approximately full employment, and core inflation subsiding.  Not a bad picture, particularly given the challenges I mentioned a moment ago.

The next obvious question concerns risks — where are they and how likely are they to materialize?  In my view, risks have grown over the summer on both sides of this forecast.  Growth could be slower or inflation could be higher and more persistent -- or both.  I take both of these risks seriously.

[T]he so-called “wealth effect” that links increases and decreases in house prices with rises and falls in consumer spending may not be as strong as some analysts suggest.  In our estimation, the run-up in housing values over the past several years did not spur much of a bigger-than-expected increase in consumer spending — if anything, the response was a bit on the low side compared to the historical average. So we wonder about how large a spending effect one should expect to accompany a fall in housing prices, if that were to occur. Clearly mortgage equity withdrawals have been sizable during the housing “boom,” but many of these withdrawals were used to reduce other forms of consumer debt and to make one-time improvements in the housing stock.  Indeed, as a result, overall household balance sheets today continue to look fairly strong.

The Bank’s baseline forecast assumes that if energy prices stabilize as indicated in the futures market, core inflation will gradually subside.  That is my best guess at this point and, based on inflation expectations measured in a variety of ways, private-sector individuals, businesses, and financial markets appear to agree.  But, as others have said repeatedly, monetary policy is about risk management.  A key risk is that inflation will continue to rise or persist at high levels and embed itself in consumer and business plans.  Managing that risk is clearly important, and a matter about which central banks need to be quite vigilant – as I believe the FOMC has been and will continue to be.

On the risk of the Fed losing credibility:  Of course there's always a risk. But we watch pretty carefully and we don't want to see that risk materialize. Certainly as long as I have anything to do with this process I will be pushing hard for a policy that is as tight as it has to be, as disciplined as it has to be, to keep long-run inflation within bounds. And that would be lower than today's inflation.

{Our response} depends on what we know about why {inflation is} hanging high, if that's the hypothesis we're exploring. We need to look at why and we need to look at the various lags in this system.

If we believe that we're headed off in the right direction then we can be patient. We can be patient and sit there and not create a disturbance in the economy. 

[T]he wealth effect is total household wealth. Remember, we've also got equities and bond-market wealth in there. So housing is not the total at all. And the stock market has generally been doing pretty good. 

The wealth effect has also spread out over time. It doesn't produce an instantaneous impact. So it's clearly something we're watching. And we would anticipate that consumption might soften a little.   But I think that's all within the realm of what's anticipated.

I think inflation is well controlled. Actually inflation expectations have come down a little bit in recent weeks as the long bond has come down as well.

So to me the inflation environment, although it has a bit of an edge to it and inflation over the last 12 months is certainly higher than I would like, I believe that basically that situation is pretty well controlled.

...I've said before that I am perfectly pleased with a rate that would average in the one to two percent range on the PCE core. And we're a little above that now. I'd rather see it lower. And I think it's going to work its way down.  But not next month but over a period of some months and maybe even some quarters I think it'll work its way down.

Rising disposable incomes should enable household spending to expand at a moderate pace and provide continued support for the overall economic expansion.

I expect second-quarter GDP growth to be revised upward to closer to 3 percent. And my best guess one month and two weeks into the third quarter is that the speed at which we are now proceeding is roughly of that magnitude. From my vantage point, despite what you hear from some of the Eeyores in the analytical community, a recession is not visible on the horizon.

The U.S. economy appears to be in a period of transition... [I]t is clear that, after several years of above-trend growth, slack in resource utilization has been substantially reduced.  As a consequence, a sustainable, non-inflationary expansion is likely to involve a modest reduction in the growth of economic activity from the rapid pace of the past three years to a pace more consistent with the rate of increase in the nation's underlying productive capacity.

The US economy appears to be in a period of transition.  For the past three years or so, economic growth in the United States has been robust.  This growth has reflected both the ongoing re-employment of underutilized resources, as the economy recovered from the weakness of earlier in the decade, and the expansion of the economy's underlying productive potential, as determined by such factors as productivity trends and growth of the labor force.  Although the rates of resource utilization that the economy can sustain cannot be known with any precision, it is clear that, after several years of above-trend growth, slack in resource utilization has been substantially reduced.  As a consequence, a sustainable, non-inflationary expansion is likely to involve a modest reduction in the growth of economic activity from the rapid pace of the past three years to a pace more consistent with the rate of increase in the nation's underlying productive capacity.

As I have noted, the anticipated moderation in economic growth now seems to be under way, although the recent erratic growth pattern complicates this assessment.

Growth of the global economy will help support US economic activity by continuing to stimulate demand for our exports of goods and services.

[In response to the question, What do you see as the single biggest threat to the continuation of that expansion?]
One would be that we would have an inflationary problem which is greater than we now expect.  And the other would be energy prices coming from geopolitical  concerns or other sources.