Susie Gharib: All right let me just start out with the one question that everybody really wants to have answered. Is the recovery on track?

Charles Evans: Well, I think the economy is beginning to recover. I think that you know for the second half of this year I'm looking for the economy to grow about two and half to three percent. I think it will do that over the next eighteen months. I think, that the contraction is pretty much behind us so I'm looking for growth. I think it will be a little uneven, the way it proceeds. But the difficult thing is that the unemployment rate will you know continue to go up probably for the next six months, would be my guess and it's currently at 9.7 percent and I think it's probably going to peak at just a little bit over 10 percent. So I think the recovery is beginning. I think it's proceeding about as well as we could hope for especially from the stand point of last spring when there were a lot of downside risk that everyone was very concerned about.

Evans: Well, I think there are still a lot of uncertainties and as soon as you start thinking about which elements of the economy will be growing, you always start scratching your head. I think that the consumer's very important for the recovery and obviously there are issues about how high the savings rate might be. That would tend to restrain growth of the consumer a bit. Businesses have already cut back so much on discretionary expenditures and they cut employment dramatically. There continue to be concerns about when the hiring margin will begin to pick up. And so I don't think there will be a double dip, I think the economy will grow two and half to three percent, and I think that fiscal stimulus will initially provide a good part of that. The Cash for Clunkers is going to help out a lot for the third quarter and then by next year when the fiscal stimulus begins to impart less stimulus I think the private sector will be taking over.

Gharib:But can there be real recovery without job growth to go with it?

Evans: So that's going to be the hard part, because we've experienced this before. The most recent 2001 recession when the economy began to grow we still had the jobless recovery. In fact it was called the job-loss recovery, because we had employment losses. That's why we're going to be seeing the unemployment rate continue to go up. I think until the first quarter of next year and it's not going to feel like a recovery because of that. And in fact it's going to stay high, it will be above nine percent next year at the end maybe higher than that still. We'll be waiting for momentum and the decline in the unemployment rate. Then things will feel more like a bonafide recovery. But the economy is beginning a recovery in terms of growth turning policy.

Gharib: When do you see the economy getting to full employment, and by that I mean a jobless rate of around five percent?

Evans: Unfortunately, I think that's a few years away. I would guess that at the end of 2010 the unemployment rates going to be above nine percent and 2011 its going to be uncomfortably high probably in the seven's, so it's going to be beyond that time frame.

Gharib: When you talk to consumers and businesses in your district, what are they telling you? How are they doing in terms of getting loans, getting jobs, making money?

Evans: So, I think everybody is spent. Businesses that I've I talked to have spent a lot of time trying to right size their production activities and in the spring of this year they were contracting employment quite a lot. I think the job destruction aspect of that has about come to an end, but the hiring aspect is quite anemic and that's why joblessness will continue for some time. I think that people are concerned about the availability of credit. I think in part that's because it's more expensive than it used to be. We went through a period where credit risk pricing was very low. We're now going through a period where it's more prudent and also everyone who wants to borrow is somewhat more challenged in their credit worthiness and so it continues to be a challenge for banks to assess the risk properly.

Gharib: So when you're talking to individual people and to businesses, what's the bottom line that their telling you about their situation?

Evans:So, I think consumers are worried about their job prospects and whether or not they'll continue to have a job and that's restraining consumption spending. I think the decline of net worth gives rise to a higher savings motive and so that restrains consumer spending.I think businesses are concerned about shoppers coming in on the retail side I think that they are reasonably content with the size of their operations so they are not going to be spending on capital equipment and expanding their activities. So that will restrain growth to some extent. That's why it's going to be more anemic. That's the kind of thing I'm hearing.

Gharib: So can the economy count on consumers to be the engine of growth as it did in the past?

Evans: I don't think it will be the same as it was in the past. I think, in the last few years we had stronger consumption growth in part because net worth was higher. Equity prices were higher, house prices were higher, now things have turned around so that added stimulus to consumer spending that's not there and in fact they're working against that.

Gharib: So where is growth going to come from?

Evans: Well, at first it's going to come from an inventory adjustment. Businesses have been very careful in paring back their inventories. They didn't want to have to pay for products on the shelves that weren't going to be bought. They were very aggressive in doing that. Now they need to add and restock, that's a normal part of an initial recovery. That'll add to growth, that'll add to production. I think the rest of the world is beginning to do better as well, and so we'll see some export growth. That will add strength as well.

Gharib: But if people aren't spending, companies will be somewhat reluctant to really ramp up for demand.  So where do you see real economic growth coming from?

Evans: So as I say, I think the inventory cycle will be part of it. The fiscal stimulus is also part of it.  And so, you know, the auto sector, which was hit very hard, when auto sales fell below 10 million, they're not right-sized for 10 million, that's a very large drop. Now with the Cash for Clunkers program, they've been up to 14 million and so that's helped out. What I think we're trying to do is get through some of the severe downturn. We'll see a little bit of a bounce back because things have been so curtailed, that'll be the initial part of the growth I think in the rest of this year and then the private sector I think will start snapping back next year.

Gharib: Mr. Evans, you said today, "The U.S. economy may be facing the Great Inflation 2.0." So how serious a danger is inflation?

Evans: Well, as I mentioned in the speech, there are a lot of cross currents in the current inflation environment. So I don't think that inflation is a big problem at the moment or for the foreseeable future. In fact there are disinflationary forces due to large resource gaps with the rising unemployment rate. But it's also the case that the Fed balance sheet has grown tremendously and a lot of people concerned about that with rising inflation expectations. My own view is that inflation expectations are pretty well anchored and we're going to see inflation in the one and-a-half percent range probably over the next year to two.

Gharib: So what is the Federal Reserve going to do to make sure that inflation doesn't do damage to the economic recovery?

Evans: Well, we're going to be keeping our eye on inflation. We're going to be looking at inflation indicators and also expectations. And if inflation pressures were to begin to rise prematurely, before we think they will, much later in the economic recovery, we would respond aggressively as needed. But at the moment, I think that it's going to take time for the recovery to truly take hold, for the roots of growth to embed themselves firmly and for the unemployment to start coming down later in 2010. It's hard for me to imagine strong inflationary pressures before those things happen.

Gharib: So how much longer do you think the Federal Reserve will stand by its zero interest rate policy?

Evans: So I think the markers for that will be when the recovery takes hold, when unemployment starts coming down when it's firmly embedded in the outlook, when businesses are truly forward-looking. They're forward looking at the moment, but they've recently been looking to make sure that they're viable, then they'll be looking for growth and be forward looking. Consumers, their savings will be to the point where they're more comfortable with their financial system. I think that that's most likely to be towards the end of 2010-2011, that things will be more firmly embedded, that's a time that when you'd begin to expect inflationary pressures to be emerging.

Gharib: So at that time, as the Federal Reserve begins to navigate away from zero interest rates, how will you know if you're moving too fast or too slow?

Evans: We'll be looking for the pace of the recovery. We'll be looking for inflationary expectations and markers of inflationary pressures. I think that financial markets will be improving at a time when we're thinking about removing the accommodation. Credit spreads will be lower. It'll be more vibrant. I think that it will just sort of feel more natural that we need less accommodation as at that point we begin to increase interest rates, get our balance sheet in order to continue to sustain that. But I think that's some time from now.

Gharib: But timing… figuring out the timing of how to calibrate against inflation is tricky. And the Federal Reserve has had issues with this in the past. So looking now at this experience how will the central bankers know if they're getting it right? Raising rates gradually or more aggressively?  How will you know?

Evans:So, I'm not sure we'll exactly know the answer to that. There are always a lot of uncertainties. And looking back on the period from 2004 to 2006, I think that the increase in interest rates was perhaps a little too measured... not at the beginning but towards the end. So I think we will be looking at that period and responding a bit more aggressively than we did at that time. I think we will have to make a very hard judgment about whether or not the recovery is firmly on hold and how much inflationary pressures might be rising above the point that's consistent with our price stability objective. And you know we'll be having to look at everything.

Gharib: Mr. Evans we're coming up on the one year anniversary of the financial crisis. And the general consensus is that both the government and the Federal Reserve averted a major catastrophe. But looking now, what do you see as the most serious threat to the economy?/p>

Evans: Well the most serious threat to the economy is the labor market situation. The fact that people are concerned about their job prospects and how that might inhibit consumer spending. I think that businesses looking at their expansion, that's also a concern. They're waiting for everybody to feel more confident about the recovery. I think in terms of the financial situation I think it will be very important for us to keep our eye on financial institutions, to improve our supervisory process. I think that we have learned an awful lot from the most recent supervisory capital program, capital assessment program the stress test... the 19 largest banks. I think that we'll continue to look at lessons that we learned there to help supervise banks.  Beyond the 19, I think that for a lot of those banks commercial real estate will be an issue for them that there are losses coming on those portfolios. And we will be looking to make sure that they have enough capital in place in order to sustain those losses without impairing their ability to make loans.

Gharib: But what do you see as the most dangerous threat to the economy... if you had to single out your biggest worry?

Evans: My biggest worry is the labor market. But it's also the case that financial markets have gone through a very challenging period. They're improving. Credit spreads are improving. But there are a lot of risks associated with commercial real estate loans, CMBS securitization and it will be important for all of the financial institutions associated with those to work their way through those losses that are coming. The most recent stress test worked very hard to make sure that there was enough capital in place over the next two to three years at those largest institutions. And I think that will be important for maintaining lending capacity.

Gharib: Everyone is so worried about whether there is another shoe to drop. What do you think that could be?

Evans: I think that we've sustained a tremendous number of shocks already. I think that the economy in the U.S. and in the world is on their way to improvement. Something could happen but frankly, if it did happen it would be quite a surprise. I think that rising energy prices would have a slightly restrictive implication for growth. But I think that rising energy prices would likely be associated with greater worldwide growth and that would also have a beneficial effect for our exports.

Gharib: The Treasury's regulatory proposals give greater powers to the Federal Reserve. If that happens will the Fed be able to prevent financial crises like this one in the future?

Evans:Well, the Administration's proposal has suggested that there be a systemic risk regulator and they have identified the Federal Reserve as that regulator. The Federal Reserve already is charged with umbrella supervision responsibilities under the Graham-Leach-Bliley Act. I think that this additional authority would help, that we would be able to go in and look at a variety of institutions in a horizontal fashion. I think it would improve maters quite a lot. But improved supervision is an important part of what we need in order to sustain financial stability as well as appropriate monetary policy.

Gharib: How would you describe the health of the economy, right now?

Evans: So I think that the economy has weathered a tremendous shot earlier this year. I think that in the spring of this year we were very concerned about downside risks. And so we seem to have overcome that and at the moment it doesn't feel as if the economy is growing very strongly.  We've been looking for the economy to stabilize and it looks like it has stabilized, at a low level though. From here we're looking for growth to be 2 1/2 to 3 percent. That's a pretty low growth rate considering that the economy has contracted as much as it has. So we're looking for what a lot of people would describe as a "U" shaped recovery. It's not going to be a strong expansion coming out of this and that's going to be associated with the rise in unemployment. So it doesn't feel like a strong economy and it's not a strong economy. But it's an improving economy and that's a very important part of what we need to go through in order to have an ultimately very healthy economy.