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

5. Housing: Prices continue to fall Percentage changes OFHEOCase- Shiller Q2-1.4-2.3 This year-3.0-8.9 Since peak-4.8-18.2

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

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

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

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

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. 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- important a. –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: a Willem Buiter, 2008 THE FED b Especially 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 Sources: Bureau of Labor Statistics Contrary to some analysts’ assertions, inflation always falls during slowdowns

15. The recent trajectory of oil prices, if sustained, will also help … both by: (1)Lowering the “tax” on consumers; and (2)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