by Calculated Risk on 2/09/2007 01:25:00 PM

Cleveland Fed President Sandra Pianalto spoke today: A Policymaker's Perspective on Monetary Policy and the Economy

First, an excerpt on the long view:

"Let's consider the long-term growth factors first. Generally speaking, two main factors - labor force growth and productivity - determine our nation's long-term potential for economic growth. When the workforce grows, so too does our economic output. Likewise, when our workforce is more productive, we can generate more goods and services."

This is why I'm very positive for the longer term, especially because I believe innovation (productivity gains) will almost certainly continue.

On the short term:

"... we also know that unexpected events can temporarily push the economy off its longer-term path...

By far, the most pronounced economic shock of the past year was a contraction in the nation's housing market. The downturn in this sector has clearly pulled economic growth below its long-term potential.

Some observers think that the worst of the national housing contraction is behind us. That view may be premature, but the recent data are encouraging. Home sales no longer seem to be falling, and inventories of unsold homes have dropped a bit. And even though new homes under construction fell sharply last year following several years of strong growth, most economists expect further declines to become less steep. Some industries, such as construction and home building supplies, have clearly felt the brunt of the housing market contraction, but by and large, we have seen little spillover to other sectors of the economy."

This view is probably "premature" and any spillover is ahead of us, not behind us.

For those hoping for a rate cut, Pianalto argues the Fed will not cut rates to support the housing market:

"Unfortunately, the FOMC can do very little to directly soften the housing contraction. The supply and demand for housing must eventually come into balance on its own."

In fact, Pianalto believes "some additional policy firming may be needed":

"The national inflation picture has been clouded in the past few years by large swings in energy, commodity, and housing prices. As these markets normalize, and as we gain a clearer picture of the underlying inflation trend, we may see that some inflation risks remain. In that case, some additional policy firming may be needed - depending, of course, on the outlook for both inflation and economic growth."