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In the forecast prepared for the meeting, the staff revised down sharply its outlook for economic activity in 2009 but continued to project a moderate recovery in 2010. Real GDP appeared likely to decline substantially in the fourth quarter of 2008 as conditions in the labor market deteriorated more steeply than previously anticipated; the decline in industrial production intensified; consumer and business spending appeared to weaken; and financial conditions, on balance, continued to tighten. Rising unemployment, the declines in stock market wealth, low levels of consumer sentiment, weakened household balance sheets, and restrictive credit conditions were likely to continue to hinder household spending over the near term. Homebuilding was expected to contract further. Business expenditures were also likely to be held back by a weaker sales outlook and tighter credit conditions. Oil prices, which dropped significantly during the intermeeting period, were assumed to rise over the next two years in line with the path indicated by futures market prices, but to remain below the levels of October 2008. All told, real GDP was expected to fall much more sharply in the first half of 2009 than previously anticipated, before slowly recovering over the remainder of the year as the stimulus from monetary and assumed fiscal policy actions gained traction and the turmoil in the financial system began to recede.
Real GDP was projected to decline for 2009 as a whole and to rise at a pace slightly above the rate of potential growth in 2010. Amid the weaker outlook for economic activity over the next year, the unemployment rate was likely to rise significantly into 2010, to a level higher than projected at the time of the October 28-29 FOMC meeting. The disinflationary effects of increased slack in resource utilization, diminished pressures from energy and materials prices, declines in import prices, and further moderate reductions in inflation expectations caused the staff to reduce its forecast for both core and overall PCE inflation. Core inflation was projected to slow considerably in 2009 and then to edge down further in 2010.

In their discussion of the economic situation and outlook, all meeting participants agreed that the economic downturn had intensified over the fall. Although some financial markets exhibited signs of improved functioning, financial conditions generally remained very strained. Credit conditions continued to tighten for both households and businesses, and ongoing declines in equity prices further reduced household wealth. Conditions in the housing market weakened again and house prices declined further.
Against this backdrop, measures of business and consumer confidence fell to new lows, and private spending continued to contract.
Employment and production indicators weakened further as businesses responded very rapidly to the fall-off in demand. Participants expected economic activity to contract sharply in the fourth quarter of 2008 and in early 2009. Most projected that the economy would begin to recover slowly in the second half of 2009, aided by substantial monetary policy easing and by anticipated fiscal stimulus. Meeting participants generally agreed that the uncertainty surrounding the outlook was considerable and that downside risks to even this weak trajectory for economic activity were a serious concern. Indeed, the severe ongoing financial market strains, the large reductions in household wealth, and the global nature of the economic slowdown were seen by some participants as suggesting the distinct possibility of a prolonged contraction, although that was not judged to be the most likely outcome.
Inflation pressures had diminished appreciably as energy and other commodity prices dropped and economic activity slumped. Looking forward, participants agreed that inflationary pressures looked set to moderate further in coming quarters, reflecting recent declines in commodity prices and rising slack in resource markets, and several saw risks that inflation could drop for a time below rates they viewed as most consistent over time with the Federal Reserve's dual mandate for maximum employment and price stability.

Meeting participants observed that financial strains continued to exert a powerful drag on economic activity and that the adverse feedback loop between financial conditions and economic performance had intensified. Although improvements were evident in some markets, particularly those for highly rated commercial paper and for interbank funds, financial markets generally remained under severe stress. Equity prices continued to drop amid high volatility, further reducing household wealth. Rising risk spreads kept the cost of issuing corporate bonds at a high level--especially for lower-rated firms--even though Treasury yields had declined sharply since the October 28-29 meeting. Securitization markets, which over recent years had been an important channel in credit intermediation, remained largely dysfunctional, with the exception of those for mortgages guaranteed by the GSEs. The sharp drops and unusual volatility in the prices of many financial assets since the beginning of the fourth quarter were likely to cause more losses for financial institutions, and a number of participants noted that loan delinquencies were increasing significantly in the consumer sector, adding to pressures on banks' balance sheets and reinforcing banks' cautious lending stance. As a consequence, credit conditions for both businesses and households had tightened further, with banks generally adopting stricter lending standards and declining to renew or paring back existing credit lines.

Participants observed that the effects of the financial turmoil, increased uncertainty, and drops in confidence and demand were becoming increasingly evident in the business sector. Business contacts across the country expected considerable near-term weakness in sales and declining pricing power. Some meeting participants reported especially sharp drops in new orders in their Districts. Even sectors that had performed relatively well until recently, such as mining and drilling, were experiencing reduced activity, mostly due to the decline in commodity prices.
Agricultural activity was also showing signs of weakness. Business sentiment had deteriorated sharply since September, likely contributing to steep drops in employment and production.
Participants anticipated that, with the deteriorating economic outlook and tightening of credit conditions, capital expenditures were likely to be soft in coming quarters.

Many participants noted that the decline in household wealth resulting from large drops in equity and house prices, together with tighter credit conditions, rapidly increasing unemployment, and deteriorating consumer sentiment, was contributing to a sharp contraction in consumer spending. Some participants pointed out that reduced consumer wealth and concerns about employment could lead to a further increase in saving, which, although desirable in the longer term, could put additional downward pressure on consumer spending in coming quarters. The latest housing data suggested a continued substantial contraction in that sector. The recent decline in mortgage rates had sparked some refinancing and purchase activity, but the extent of the longer-term impact of lower rates on housing demand remained uncertain.

Meeting participants noted that economic conditions had deteriorated substantially in recent months in both advanced and emerging market economies. As a consequence, demand for U.S.
exports had weakened, held back also by the strengthening of the dollar since the summer. Going forward, global demand was expected to remain weak, and thus growth in exports was unlikely to provide much support for U.S. activity. However, the weakness in the global economy was contributing to lower prices of energy and other commodities, which should boost real incomes and provide modest support to household spending.