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Economic Outlookand Current Topics
Christopher J. NeelyAssistant Vice President Federal Reserve Bank of St LouisAssistant Vice President, Federal Reserve Bank of St. Louis
The Cash Management ForumgFour Seasons Hotel, St. Louis, MO
August 23, 2011
The opinions expressed are my own and notnecessarily those of the Federal Reserve Bank ofSaint Louis or the Federal Reserve System.
I thank Brett Fawley for his able assistance inconstructing this presentationconstructing this presentation.
2
Who Am I?Who Am I? I am a research economist, not a forecaster, not a business
economisteconomist. o My research is primarily on exchange rates.
E i t h b tt h th t h d Economists are much better on why the past happened. o Economic events should be difficult to forecast for the same reason
that financial markets are hard to forecast.
Economics has recently become much more controversial.
I try to be as objective as possible. I try to be as objective as possible.
3
Today’s TopicsTh C t O tl kThe Current Outlook
o GDP, employment, manufacturing, housing, i fl ti fi i l k tinflation, financial markets
o Fiscal policy and inflation
Additional topics?o Fed Policy & Quantitative Easing
4
The Current OutlookThe Current Outlook
GDP The Labor market Industry/manufacturing Construction /housing Construction /housing Credit/delinquency The Global outlook
5
The Current Outlook: GDP
4
6 Real Gross Domestic ProductActual and Forecasted, percent change from previous quarter at annual rate
0
2
-2
0
About 1% over the first half
-6
-4
Real GDP Growth
of 2011.
10
-8
-102007 2008 2009 2010 2011 2012 2013
Source: Bureau of Economic Analysis/Macroeconomic Advisers 6
The Current Outlook: Real GDP FForecasts
Economic projections from the July 2011 Monetary Policy Report to Congress
7
The Current Outlook: Industrial Production
702Percent Change from Previous Percent Change from Previous Index
50
60
0
1
40-1Weak ISM index.
20
30
-3
-2 Industrial Production (Left Axis)ISM Manufacturing (Right Axis)
10-4
Axis)
8
0-52007 2008 2009 2010 2011
Source: Federal Reserve Board/Institute of Supply ManagementSource: Federal Reserve Board/Institute of Supply Management
The Current Outlook: Capacity Utilization and New Ordersand New Orders
90500,000Mil.$, SA % Capacity, SA
70
80
400,000
450,000
50
60300,000
350,000
Not bad.
30
40
150 000
200,000
250,000
Value of Manufacturers' New Orders (left axis)
10
20
50,000
100,000
150,000Capacity Utilization: Manufacturing (right axis)
9
002000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Federal Reserve Board and Census Bureau
The Current Outlook: Vehicle Sales80000Mi.$, SA Cash-for-clunkers = broken windows fallacy
70000
75000
Cash for
60000
65000Clunkers
55000
60000
45000
50000
10
400002000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Census Bureau
The Current Outlook: Industrial activityy
GDP has increased very modestly – at about 1% i h b i i f 2011per annum– since the beginning of 2011.
Forecasts for GDP growth in the next 2 years range from 2% to 4%.
Industrial production is not strong but an area of relative strength.
Vehicle sales are weak.
11
The Current Outlook: Civilian Unemployment14700
Unemployment Rate (SA, Right Axis)
Thousands Percent
10
12
500
600
Initial Claims for Unemployment Insurance (Monthly Average, Left Axis)
8400
9.1 % in July
4
6
200
300
2100
1212
002005 2006 2007 2008 2009 2010 2011
Source: Bureau of Labor Statistics/Department of Labor
The Current Outlook: U l t F tUnemployment Forecasts
Unemployment has fallen slowly over the last several recessions. But it h ll f ll l l b t ½ d 1 t i t
13
it has usually fallen slowly, between ½ and 1 percentage point per year.
The Current Outlook: NFP Employment
Thousands (Change from Previous Month)
117K jobs gained in July, somewhat better than the 90K expected.
400
600
Thousands (Change from Previous Month)
200
0
200
-600
-400
-200
-1000
-800
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11
Source: Bureau of Labor Statistics
1414
The Current Outlook: Long term Unemployment
25
PercentUnemployment is always a lagging indicator. The current rate is very high by historical standards but very low compared to the Great Depression
20
very low compared to the Great Depression.
15
10
5
Source: Bureau of Economic Analysis 15
01929 1939 1949 1959 1969 1979 1989 1999 2009
Source: Bureau of Economic Analysis
The Current Outlook: Long term Unemployment
Mean and median durations of unemployment are at record levels.
16
The Current Outlook: Long term Unemployment
Long-term unemployment has costs.o Reduced attachment to the labor force. o Loss of skills.
L GDP th i th f to Lower GDP growth in the future.
Source: Bureau of Economic Analysis 17
The Current Outlook: Unemployment by EthnicityUnemployment by Ethnicity
Unemployment varies with ethnicity.
18
The Current Outlook: Unemployment by EducationUnemployment by Education
Unemployment is always worse for the less educated.
19
The Current Outlook: Unemployment by Sexp y y
Unemployment varies by sex.Women have lower unemployment in recessions.
20
The Current Outlook: Employment/Population RatioEmployment/Population Ratio
66Civilian Employment/Population Ratio: 16 yr + (SA, %)
64Women and Boomers
t th l b f
60
62enter the labor force.
58
60Boomers watch Daniel Boone.
56People are leaving the labor force at unprecedented rates Demographics? Discouraged workers?
21
541948 1958 1968 1978 1988 1998 2008
rates. Demographics? Discouraged workers?
The Current Outlook: Part Time Employeesp y
28,000
Civilians Employed: Part-time (SA, Thous)Thousands, SA
26 000
27,000
24 000
25,000
26,000
Unusual rise in
23,000
24,000 Unusual rise in part-time employment.
21,000
22,000
22
20,0001999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Bureau of Labor Statistics
U.S. Employment has Fallen Fast C d ith O t tCompared with Output
U.S. firms have shed workers much faster than our peers, compared to the fall in GDP. This is often blamed on U SThis is often blamed on U.S. labor market flexibility.
23
The Current Outlook: Creation vs. Layoffs7000Thousands, SA
5000
6000
4000
Total Job Hirings
2000
3000
Total Layoffs, Discharges and Quits
0
1000
24
02001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Bureau of Labor Statistics
The Current Outlook: Labor market
Unemployment remains stubbornly high. o Usual patterns of unemployment by ethnicity and education remain.
o Unemployment is higher for men than women, as it has been in recessions since the 1970s.recessions since the 1970s.
Unemployment is of unusually long duration.o Unusual extension of unemployment benefits might add 1 percent too Unusual extension of unemployment benefits might add 1 percent to
the measured rate.
Hypotheses about skill mismatches or immobility due to housing prices do not hold up well in the data.
25
The Current Outlook: Existing Home Sales Price
20% Change, Year over
Sales Price
H i
10
15Housing prices have declined again.
0
5
g
-10
-5
-20
-15
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011Source: National Assoication of Realtors
26
The Current Outlook: New Home Sales
1600Thousands
1200
1400
800
1000Very weak new home sales.
400
600 Over construction of new homes. Supply response
0
200
400 pp y pto rise in prices.
27
01999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: National Assoication of Realtors
The Current Outlook: Housing
20000Housing vacancies
g
14000
16000
18000
8000
10000
12000
14000
4000
6000
8000
Total Vacant Housing Units: United States (Thous)
There are a lot of vacant houses.
0
2000
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
Total Vacant Housing Units: United States: Year-round (Thous)
28
The Current Outlook: Housingg
The house price boom was accompanied by over i f h W hconstruction of new houses. We have too many
houses. House prices have begun to fall again. New home sales are very weak.
29
Credit markets
“Neither a borrower nor a lender be.”– Ben Franklin
30
The Current Outlook: Mortgage Delinquencies
4 590 days or more, %
3.5
4
4.5
2.5
3
1
1.5
2Delinquencies are still high and lagging.
0
0.5
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
31
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011Source: Federal Home Loan Mortgage Corporation
The Current Outlook: Commercial Real Estate Loan Delinquency RateEstate Loan Delinquency Rate
9%, SA
7
8
9
4
5
6
2
3
4 Delinquencies are still high and lagging.
0
1
1995 1997 1999 2001 2003 2005 2007 2009 2011
32Source: Federal Reserve Board
The Current Outlook: Loan Delinquency RatesRates
5 All Consumer Banks: C & I Loans
%, SA
4
5All Consumer Banks: C & I Loans
All Consumer Banks: Consumer Loans
3
3
4
2
2
3
1
1Loan delinquencies are returning to normal.
02000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Federal Reserve Board
The Current Outlook: Bank CreditFAS requires banks to take
40% Change, Year over Year, SA
FAS requires banks to take securitized consumer loans back on their books in 2010Q1.
20
30All Commercial Banks: C & I Loans
All Commercial Banks: Consumer Loans
10
20
0
-20
-10
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20112000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011Source: Federal Reserve Board C&I loans recover somewhat faster
than in 2001 recession.
The Current Outlook: Loan Delinquencyq y
Real estate loan delinquencies are still very high b f lli Th l ibut falling. They are lagging.
Other loan delinquencies are high but declining and closer to normal.
35
Inflation “Stop worrying and learn to love inflation.”– Paul Krugman
< http://www.pkarchive.org/theory/LoveInflation.htm>
“The expansion of money, given an increase in the monetary base, is inevitable, and will ultimately result in higher inflation and interest rates. In shorter time frames the expansion of money can also result in higherIn shorter time frames, the expansion of money can also result in higher stock prices, a weaker currency, and increases in commodity prices such as oil and gold.”–Arthur Laffer <http://online.wsj.com/article/SB124458888993599879.html>
36
The Current Outlook: Inflation6
% Change, Year over Inflation has been volatile but about 1.5%, on average, since late 2008.
3
4
5
1
2
3
1
0
1
Headline CPI
3
-2
-1 Headline PCECore CPICore PCE
-32005 2006 2007 2008 2009 2010 2011
Source: Bureaue of Economic Analysis/Bureau of Labor Statistics 37
The Current Outlook: InflationInflation expectations appear to be anchored, for now.
3
4Inflation expectations from TIPS
1
2
10-year TIPS spread5 TIPS d
-1
02005-01-07 2007-01-05 2009-01-02 2010-12-31
5-year TIPS spread
-3
-2
38
The Current Outlook: Inflation
Inflation expectations appear to be anchored, for now.
39
The Current Outlook: Inflation forecasts
40
The Current Outlook: Fiscal Policy and I fl tiInflation
The projected path of U.S. fiscal policy is i blunsustainable.
There are three ways that the situation can be resolved:o Reform of fiscal policy: Some combination of reduced
di d/ i d t t d ll d thspending and/or increased taxes to gradually reduce the debt as a % of GDP.
o Explicit default by the U S government (Very bad )o Explicit default by the U.S. government. (Very bad.)
o Implicit default through inflation. (Even worse, probably.)p y )
41
The Current Outlook: Fiscal Policy and I fl tiInflation
42
The Current Outlook: Fiscal Policy and InflationPolicy and Inflation
The projected path of U.S. fiscal policy is unsustainable.
Source: John Taylor 43
The Current Outlook: Fiscal Policy and Inflation
Medicare is largely h l i i
Policy and Inflation
the culprit in exploding spending.
Private expenditures on medical care have also been rising.
Source: New York Times 44
The Current Outlook: Fiscal Policy and Inflation
• Government defaults are common.
Policy and Inflation
– See Reinhart and Rogoff: “This Time Is Different.”– Explicit vs. implicit (inflation) defaults.
Source: This Time Is Different: A Panoramic View Of Eight Centuries Of Financial Crises, Carmen M. Reinhart, Kenneth S RogoffKenneth S. Rogoff, WP 13882http://www.nber.org/papers/w13882
45
The Current Outlook: Fiscal Policy d I fl iand Inflation
120
U.S. Gross Government Debt as a % of GDP
The U.S. paid down high levels of debt after WWII and lower levels of debt after prior wars.
100
Source: U.S. Treasury and Louis Johnston and Samuel H. Williamson, “What Was the U.S. GDP Then?” Measuring Worth, 2010.
60
80
20
40
0
46
The Current Outlook: Fiscal Policy and I fl tiInflation
How do markets expect the U.S. fiscal situation to beHow do markets expect the U.S. fiscal situation to be resolved?
1 Fiscal reform?1. Fiscal reform? 2. Default? 3 fl i ?3. Inflation?
47
The Current Outlook: Fiscal Policy and I fl tiInflation
• Treasury yields remain low. • CDS rates on U.S. bonds are still low but have
risen substantially, indicating increased expectations of explicit default.
• Expected inflation is still stable. o http://research.stlouisfed.org/publications/mt/20110301/cover.pdf
48
The Current Outlook: Fiscal Policy and I fl tiInflation
It th t k t till l hi h• It appears that markets still place a very high probability on some sort of U.S. fiscal reform. P itti tl hi h l l f d bt h• Permitting a permanently high level of debt has costs. Debt crowds out private investment and reduces growthreduces growth.
49
The Current Outlook: Inflation
Inflation has been very volatile since 2008 but has d b 1 5 2% hi h i i i haveraged about 1.5 – 2%, which is consistent with
stated FOMC goals and the Congressional mandatemandate.
Commodity prices have been very volatile as political factors (e g the Libyan situation) andpolitical factors (e.g., the Libyan situation) and expectations of future real activity fluctuate.
Inflation expectations appear to be anchoredInflation expectations appear to be anchored.
50
The Current Outlook: Financial Markets
51
The Current Outlook: Financial Markets
52
The Current Outlook: Financial Markets
53
The Current Outlook: Financial Markets
54
The Current Outlook: Financial Marketshttp://research.stlouisfed.org/publications/net/NETJan2010Appendix.pdf
Recent volatility
Very low risk premia
55
The Current Outlook: Financial Markets
Financial markets were supportive of growth in the first half of 2011half of 2011.
But stock and bond markets have mirrored the pessimism f th l t f kof the last few weeks.
The St. Louis Fed’s “Financial Stress Index” has risen very sharply lately.
56
The Current Outlook: A summary y
GDP: Growth has slowed. Industry/manufacturing: Relative strengthRelative strength
Employment: Lagging
Construction /housing: Weakness
I fl ti R t l tilit b t t ti i Inflation: Recent volatility but expectations remain anchored, for now.
Credit/delinquency: Lagging
Financial markets: Turmoil for the past few weeks.
57
Why is the recession so protracted?
• Recessions precipitated by financial crises tend to be severesevere.
• Financial firms are crucial for all sorts of economic activityactivity.
• Activity will increase as balance sheets improve.
• Consumers’ net worth has also taken some big hits. Negative wealth effects and uncertainty reduce consumptionconsumption.
• There might be significant mismatches in skills and geography but studies cast doubt on thisgeography but studies cast doubt on this.
58
Why didn’t economists predict it?Why didn t economists predict it?
Some economists recognized the housing bubble Some economists recognized the housing bubble.o The housing bubble wasn’t obvious in real time.
o Changes in long-term real rates appeared to justify higher house prices. g g pp j y g p
o U.S. house prices had not fallen, year-over-year, nationally from 1967-2006.
o How was one to “prick” it?
What if it was a bubble? o House price would fall; borrowers would default; bondholders p ; ;
would lose.
o Interconnectedness, derivatives/leverage greatly magnified the problemproblem.
59
Conclusions• There are renewed fears of a double dip recession;
forecasters have recently estimated the probability y p yat about 26%. (That is quite high.)
• The recovery will not be strong or quick• The recovery will not be strong or quick.
• Some potential trouble spots:
o The European fiscal situation.
o The U.S. fiscal situation.
o U.S. commercial real estate.
o Chinese banking balance sheets.
60
Conclusions• A retrospective on the financial crisis of 2008:
o The recent subprime crisis was actually sort of a classic banking crisis.
B bbl i i i hi d i h d i d lo Bubbles are easier to recognize in hindsight and easier to deal with on paper.
o Financial crises tend to take a long time to resolve due to theiro Financial crises tend to take a long time to resolve due to their effect on financial firms’ and consumer balance sheets.
o We had overbuilt residential housing and this will take a longo We had overbuilt residential housing and this will take a long time to fix.
61
Th E dThe End
62
QE’s impact on financial markets Q p3
Long Term Bonds
res
Pric
es
US
Canada
Germany
10 15 20 25 30
0
1
2
%
10-Y
ear B
ond
Futu
r
Japan
UK
10 15 20 25 3003-18-2009
-1
0
hang
e R
ates
Foreign Exchange Rates
10 15 20 25 30
-4
-3
-2
03-18-2009
%
Fore
ign
Exc
AUD/USD
CAD/USD
EUR/USDJPY/USD
GBP/USD
2
4
6
8
P
rice
S&P 500 and NY Light Crude
S&P 500
NY Light Crude
6310 15 20 25 30
-2
0
03-18-2009
%
Spending on medical care
64