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Economic Outlook and Current Topics Christopher J. Neely Assistant Vice President Federal Reserve Bank of St Louis Assistant Vice President, Federal Reserve Bank of St. Louis The Cash Management Forum Four Seasons Hotel, St. Louis, MO August 23, 2011

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Page 1: Economic Outlook and Current Topics

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

Page 2: Economic Outlook and Current Topics

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

Page 3: Economic Outlook and Current Topics

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

Page 4: Economic Outlook and Current Topics

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

Page 5: Economic Outlook and Current Topics

The Current OutlookThe Current Outlook

GDP The Labor market Industry/manufacturing Construction /housing Construction /housing Credit/delinquency The Global outlook

5

Page 6: Economic Outlook and Current Topics

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

Page 7: Economic Outlook and Current Topics

The Current Outlook: Real GDP FForecasts

Economic projections from the July 2011 Monetary Policy Report to Congress

7

Page 8: Economic Outlook and Current Topics

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

Page 9: Economic Outlook and Current Topics

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

Page 10: Economic Outlook and Current Topics

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

Page 11: Economic Outlook and Current Topics

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

Page 12: Economic Outlook and Current Topics

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

Page 13: Economic Outlook and Current Topics

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.

Page 14: Economic Outlook and Current Topics

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

Page 15: Economic Outlook and Current Topics

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

Page 16: Economic Outlook and Current Topics

The Current Outlook: Long term Unemployment

Mean and median durations of unemployment are at record levels.

16

Page 17: Economic Outlook and Current Topics

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

Page 18: Economic Outlook and Current Topics

The Current Outlook: Unemployment by EthnicityUnemployment by Ethnicity

Unemployment varies with ethnicity.

18

Page 19: Economic Outlook and Current Topics

The Current Outlook: Unemployment by EducationUnemployment by Education

Unemployment is always worse for the less educated.

19

Page 20: Economic Outlook and Current Topics

The Current Outlook: Unemployment by Sexp y y

Unemployment varies by sex.Women have lower unemployment in recessions.

20

Page 21: Economic Outlook and Current Topics

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?

Page 22: Economic Outlook and Current Topics

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

Page 23: Economic Outlook and Current Topics

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

Page 24: Economic Outlook and Current Topics

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

Page 25: Economic Outlook and Current Topics

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

Page 26: Economic Outlook and Current Topics

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

Page 27: Economic Outlook and Current Topics

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

Page 28: Economic Outlook and Current Topics

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

Page 29: Economic Outlook and Current Topics

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

Page 30: Economic Outlook and Current Topics

Credit markets

“Neither a borrower nor a lender be.”– Ben Franklin

30

Page 31: Economic Outlook and Current Topics

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

Page 32: Economic Outlook and Current Topics

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

Page 33: Economic Outlook and Current Topics

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

Page 34: Economic Outlook and Current Topics

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.

Page 35: Economic Outlook and Current Topics

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

Page 36: Economic Outlook and Current Topics

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

Page 37: Economic Outlook and Current Topics

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

Page 38: Economic Outlook and Current Topics

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

Page 39: Economic Outlook and Current Topics

The Current Outlook: Inflation

Inflation expectations appear to be anchored, for now.

39

Page 40: Economic Outlook and Current Topics

The Current Outlook: Inflation forecasts

40

Page 41: Economic Outlook and Current Topics

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

Page 42: Economic Outlook and Current Topics

The Current Outlook: Fiscal Policy and I fl tiInflation

42

Page 43: Economic Outlook and Current Topics

The Current Outlook: Fiscal Policy and InflationPolicy and Inflation

The projected path of U.S. fiscal policy is unsustainable.

Source: John Taylor 43

Page 44: Economic Outlook and Current Topics

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

Page 45: Economic Outlook and Current Topics

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

Page 46: Economic Outlook and Current Topics

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

Page 47: Economic Outlook and Current Topics

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

Page 48: Economic Outlook and Current Topics

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

Page 49: Economic Outlook and Current Topics

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

Page 50: Economic Outlook and Current Topics

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

Page 51: Economic Outlook and Current Topics

The Current Outlook: Financial Markets

51

Page 52: Economic Outlook and Current Topics

The Current Outlook: Financial Markets

52

Page 53: Economic Outlook and Current Topics

The Current Outlook: Financial Markets

53

Page 54: Economic Outlook and Current Topics

The Current Outlook: Financial Markets

54

Page 55: Economic Outlook and Current Topics

The Current Outlook: Financial Marketshttp://research.stlouisfed.org/publications/net/NETJan2010Appendix.pdf

Recent volatility

Very low risk premia

55

Page 56: Economic Outlook and Current Topics

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

Page 57: Economic Outlook and Current Topics

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

Page 58: Economic Outlook and Current Topics

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

Page 59: Economic Outlook and Current Topics

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

Page 60: Economic Outlook and Current Topics

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

Page 61: Economic Outlook and Current Topics

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

Page 62: Economic Outlook and Current Topics

Th E dThe End

62

Page 63: Economic Outlook and Current Topics

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

%

Page 64: Economic Outlook and Current Topics

Spending on medical care

64