Lockhart Discusses Economic Situation, Need to Remain Especially Vigilant on Inflation

For immediate release: July 1, 2008

WASHINGTON, D.C. — Dennis P. Lockhart, president and chief executive officer of the Federal Reserve Bank of Atlanta, said the U.S. economy is challenged by weakness, continuing threats to financial stability, and uncomfortable levels of inflation.

While first quarter gross domestic product (GDP) growth recently was revised up to 1 percent and second quarter GDP is expected to come in substantially above that number, Lockhart described a U.S. economy that is showing weakness in areas including employment and residential real estate. In his prepared remarks at a panel discussion at the Georgetown University Library, Lockhart noted that consumer activity has held up better than expected and that recent numbers suggest tax rebate checks associated with the fiscal stimulus package are having some effect. Strong export growth also has helped compensate for deteriorating unemployment and ongoing house price declines.

Commenting on credit conditions, Lockhart described "widespread anecdotal and hard evidence of a credit contraction in both bank lending markets and credit capital markets. Investment-grade corporate credit markets seem to be functioning, but other credit markets (mortgage-backed securities, leveraged loans, other consumer credit structured securities and municipal finance) remain fragile and vulnerable. Very importantly, interbank credit markets continue to be stressed, reflecting concern over exposure to still volatile and declining asset values. The banking system now exhibits some signs of stress at all levels—large financial institutions, regional banks, and community banks."

Looking ahead, Lockhart described his forecast for stronger-than-expected growth of 1 to 2 percent in the first half of 2008 without much pickup in the second half. "The drag of high energy costs, continuing financial market stress and a still-declining housing sector may continue for a while with gradual improvement of growth in 2009."

Lockhart noted that energy and food prices have pushed up measures of overall inflation, but he added, "so far, there is little indication that higher actual inflation or inflation expectations have factored into wages and salaries."

He closed his remarks noting that he takes recent inflationary pressures very seriously. "A path to recovery involving stronger growth but with higher and persistent inflation would fit the old adage about winning the battle but losing the war. For that reason, in my view, the current set of circumstances calls for being especially vigilant and attentive to public and business psychology as regards costs and prices. Policy needs to react decisively against signs of the onset of formal compensating practices, including contracts, that treat inflation as a persistent reality—in other words, something that must be lived with. Such signs are not apparent, and I don't expect them to materialize."

The Federal Reserve Bank of Atlanta serves the Sixth Federal Reserve District, which encompasses Alabama, Florida, Georgia and parts of Louisiana, Mississippi and Tennessee. As part of the nation's central banking system, the Atlanta Fed participates in setting national monetary policy, supervises numerous commercial banks and provides a variety of financial services to depository institutions and the U.S. government.

Contact: Jean Tate 404-498-8035