Regional President Speech

Economic Outlook Cathy E. Minehan President and CEO Federal Reserve Bank of Boston Presented to The Boston Security Analysts Society, Inc. December 6, 2004 A Turbulent Ride, But a Soft-Landing? • The long awaited soft-landing - where output grows at potential and the economy is at full-employment appears to be within our grasp. • Certainly, GDP growth over the past two years looks like a recovery. • But the slow employment growth prevented any talk of a soft-landing. • The recent employment data, along with most forecasts of economic growth, suggest we may very well be on course for a three-point landing. For the past 2 years, GDP has grown at, or above, potential - a recovery. Percent Annualized Change 8 Real Gross Domestic Product 7 6 5 Potential Growth 4 + 3 2 1 0 2002:02 2002:04 2003:02 2003:04 2004:02 2002:03 2003:01 2003:03 2004:01 2004:03 &)urce: Bureau of Economic Analysis. And the consensus forecast calls for more of the same - a soft-landing. Percent Annualized Change Percent Annualized Change 3.55 -.--------------------------------------, 1.7 3.5 1.6 3.45 Real GDP Forecast 1.5 3.4 1.4 3.35 Potential GDP Growth Employment Forecast - 1.3 3.3 + 1.2 3.25 - - - - - - - - - - - 1.1 3.2 - 3.15 -1--------------------------------------' 1 2004:Q4 2005:Q1 2005:Q2 2005:Q3 2005:Q4 2006:Q1 2006:Q2 - Forecast of Real GDP - Forecast of Payroll Employment &>urce: Consensus Forecasts. But we have seen this forecast for the past two years, and it was only half right. GDP and Employment: Forecast and Actuals (2003 and 2004) Percent Annualized Change ■ 7 Forecast of Real GDP Real GDP 6 - 5 - 4 - 3 2 1 - 0 2003:01 and 02 2003:03 and 04 2004:01 and 02 2004:03 2004.04 Monthly Change, Thousands ■ 1500 Forecast of Total Nonfarm Payrolls Actual Total Nonfarm Payrolls 1000 - 500 - 0 -500 - -1000 2003:01 and 02 2003:03 and 04 2004:01 and 02 2004:03 2004:04 Source: Global Insight. Bureau of Economic Analysis. The lack of employment growth has been a puzzle; given actual expansion in GDP we would have expected much more job creation. Monthly Change, Thousands Nonfarm Payroll Employment · 400 ~-------------------------~ ■ ■ Fitted Values Actual Values for Monthly Change in Payroll Employment 300 200 - 100 0 -100 2003:01 2003:02 2003:03 2003:04 2004:01 2004:02 2004:03 However, the recent employment numbers suggest this puzzle may be at an end. Monthly Change, Thousands 400 300 - 200 - 100 0 Jun-04 Jul-04 Aug-04 Sep-04 Oct-04 ■ ■ Total Nonfarm Payroll Employment Before Revision Total Nonfarm Payroll Employment After Revision Source: Bureau of Labor Statistics. Although employment has sent us false signals before. Monthly Change, Thousands 400 300 200 100 0 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04 Sep-04 ■ Total Nonfarm Payroll Employment Before Revisions &>urce: Bureau of Labor S:atistics. ,----------~- When will the employment puzzle disappear? • Which was the false signal, the low employment growth of the summer, or the higher growth of the fall? • Although employment has failed to grow as GDP growth would have expected, it is still our best bet that the two will move together in the future. • Thus, job creation will be strong if GDP growth is robust. But how sure are we that the economy will continue to expand as it has over the past two years? We've progressed from a policy-supporled to a privately-supporled recovery o~------------------------------. -After-tax rea income - Before-tax rea income 5 Earlier, tax cuts provided m 4 most of income CJ) C cu gains ..c (.) ?ft. 3 Now a 0 E I smaller N ..- contribution ;; 2 j from tax cuts e CJ) ~ 1 0 (.) C cu & 0 -l----,---,-----,---,---,-------,-----,---,--,---,----,---.---r-,--=--,-----,--,-,---------,-7'1,-r-"k--,--:::---r-----T~--.----r-----,---,--r-,----,-----,---,--r--,----,----,-r--,-----,--,---I -1 -'--------------------------------' 2001:Jm 2001 :JJI 2002:Jm 2002:JJI 2003:Jm 2003:JJI 2004:Jm 2004:JJI As tax cuts fade, continued household income growth Source: Real Disposable tJref'errdSaonorsoNd (~toymentugrov,rfttcAnalysis. Difference: Quarter to Percent Annualized Change Quarter, in Thousands 20 Privately 2000 Real Personal lncom e 15 Total N onfarm Payroll Employment driven . 10 1000 income 5 growth 0 0 depends on -5 -1000 employment -10 ..... ..... ..... ..... ..... ..... ..... ..... ..... ..... ..... ..... a aCf) a aCf) a aCf) a aCf) a aCf) a aCf) a aCf) a C a f) a aCf) a Caf) a Caf) a Caf) growth. t 0 -- t .. - .. - . t C - f - ) t -s - t - = t ( - 0 - t r: - - - .: 0 t- ) - 0 0 0 0 N 0 0 Cf 0 ) 0 LO 0 0 (0 0 0 0 0 0 0 0 0 ) 0 ... ) .. 0 N ) 0 "" ) " 0 LO ) 0 r:- ) .: 0 00 ) 0 0 0 ..... C 0 f) "0"" 0....). .0...). 0...).. 0...).. .0...). 0...).. 0...).. 0...).. 0...).. 0....). 0....). 0...).. 0...).. 0...).. 0...).. 0....). 0...).. 0....). 0...).. 0...).. 0 N 0 N 0 N N 0 Difference: Quarter to Percent Annualized C ha n ge Quarter, in Thousands 6 1000 Recently 4 Real Personal Income 500 employmen 2 t 0 0 growth has onfarm Payroll Employment -500 propelled -2 . income. -4 -1000 2002:Q1 2002:03 2003:Q1 2003:Q3 2004:Q1 2004:Q3 2002:Q2 2002:Q4 2003:Q2 2003:Q4 2004:Q2 Source: The Conference Board. Bureau of Labor Statistics. Why might this hiring continue in the future? The increase in productivity could help sustain the private recovery. Percent Chan~, Year-Over-Year 5 4 Nonfarm A-odu vity 3 2 1 0 -1 1960:01 1964:01 1968:01 1972:01 1976:01 1980:01 1984:01 1988:01 1992:01 1996:01 2000:01 2004:01 1962:01 1966:01 1970:01 1974:01 1978:01 1982:01 1986:01 1990:01 1994:01 1998:01 2002:01 - Nonfarm Productivity S:>urce: Nonfarm Business S::ictor: Output per Hour of All Peroons (SA.): Bureau of Leoor Satistics. 4 Strong productivity growth generally precedes employment growth. 10 ~-----.......-----------:---,--------:--:-----_,.-,,._.---------~~ 10 -Nont m employment go h 8 8 -Nont m productivity go 6 6 4-L- ___._.__._.._ ....._,__._ _._ __J_4 1950:Q1 1955:Q1 1960:Q1 1965:Q1 1970:Q1 1975:Q1 1980:Q1 1985:Q1 1990:Q1 1995:Q1 2000:Q1 Although It has only recently begun to increase employment, 6-------------------------------------~ - Nonfa-m productivity, 4-qtr. %chg. 5 -Nonfa-m employment, 4-qtr. %chg. 4 3 2 -1 -2 J___ ___, 1999:03 2000:01 2000:03 2001:01 2001:03 2002:01 2002:03 2003:01 2003:03 2004:01 2004:03 and has yet to increase -Nonfcrm productivity, 4-qtr. %chg. 5 -Rea wa;Ja gowth, 4-qtr. %chg. 4 3 2 Q-L-------~-------.-----------,r----.::!l,L_-----r------------,-____J 1999:Q3 2000:Q1 2000:Q3 2001:Q1 2001:Q3 2002:Q1 2002:Q3 2003:Q1 2003:Q3 2004:Q1 2004:Q3 ... it has made its way into profits. 6~-----------------------------~32 27 -Nonfcrm productivity, 4-qtr. %chg. 5 - - Growth in After-Tax A'ofits - 22 17 3 - 12 2 - 7 2 -3 -L---------''------------------------'- -2 -8 1999:03 2000:01 2000:03 2001:01 2001:03 2002:01 2002:03 2003:01 2003:03 2004:01 2004:03 f 1t '!isinesses have not spent profits on investment as e1.pect -cu (.) 0 1 - 1 ~ cu ..c CJ) ~-9 0.9 cu 0 CJ) i+= cu _. 0.8 - 0.8 C CD -E- ~ 0.7 0.7 > - Investment a5 a sha e of cash flow C 0 .6 --l--,----r---r'--r--½--.--,r-1--r-'-.--,-<-,'--r-,......,.---,-,-,-,-,---"r-t--,-,--'-r-,'-,--,-...,..-,----+-"T-"-r--+--,--,--.--,--,,-,---r-1-,.._,_-.--,.......,...-,--,---,--,--.,..---11~~-----,-L O .6 1950:Q 1 1955:Q 1 1960:Q 1 1965:Q 1 1970:Q 1 1975:Q 1 1980:Q 1 1985:Q 1 1990:Q 1 1995:Q 1 2000:Q 1 9ad, high productivity has left businesses sitting on a pile of c 20-,-------------------------------------~10 -- C I D 19 - Sock of cesh/tota assets, ~P 500 CJ) 9 CD :::J CJ) -cu 18 CJ) > -Ca5h flow a5 a sha e of nonfin. corp, business g-oss vaue-alded cu 17 8 -c-u 0 0 ~ 16 cu 7 .::: "55 ~ 15 ..c CJ) ""O 6 CU CU " c "O u 14 (.) CJ) 0 CU 13 5 ~ ~ (.) i+= 12 0 u5 ..c 4 11 CcJu) 0 10 +------,----,-----,-----,---,--------,-- 3 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 Source: Private Nonresidential Investment in Equipment & Software, Gross Value Added for Nonfinancial Corporate Business, (SAAR, Billions $): Bureau of Economic Analysis. Cash and near-cash assets as a share of total assets: Flow i I The most recent data suggest that firms are investing more. Mfrs' Shipments: Nondefense Capital Goods excluding Aircraft Percent Annualized Change 20 15 10 5 0 -5 -10 2002:04 2003:01 2003:02 2003:03 2003:04 2004:01 2004:02 2004:03 Source: Census Bureau. If firms regain their confidence, they have the resources to finance the recovery. • Recent employment and investment data suggest firms have begun to spend. - At some point, they could spend it on labor and capital • To satisfy investors-alternatively, pay more dividends and boost consumption? • To earn a decent return vs. cash (short-term liquid assets) • When they are convinced that the investment will pay off. • The soft-landing looks to be in the works, but there are still imbalances that could upset the applecart. The Savings Imbalance: The federal budget imbalance is large, even when measured as a percent of GDP. Federal Budget Surplus/Deficit Billions of Dollars Percent 300 3 2 200 - - 1 100 Federal Surplus or Deficit 0 0 -1 -100 -2 -3 -200 -4 -300 -5 Federal Surplus or Deficit as a Percentage of GDP -400 -6 -500 -7 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 - Federal Surplus{+} or Deficit{-} (Billions.$) - Federal Surplus{+} or Deficit{-} as a Percentage of GDP Source: U.S. Treasury. Office of Management and Budget. Expectations are that it will improve significantly once the tax cut sunset provisions take place. Federal Budget Surplus Estimates Percent of GDP 0 -1 -2 September 2004 Estimate -3 _j_ __ W or st Case Es,tiil mt~ aateet -4 -5 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 - September 04 Federal Budget Surplus Estimate - Worst Case Federal Budget Surplus Estimate ~-,,.,. __ . r' .,._,....,..:---1 O,.rl--.f. r<tU:-- In the near term, however, the shortfall in public savings is not being made up with private savi•n gs. Personal Savings Rate Percent 15 10 5 0 1960:01 1965:03 1971:01 1976:03 1982:01 1987:03 1993:01 1998:03 2004:01 1962:04 1968:02 1973:04 1979:02 1984:04 1990:02 1995:04 2001 :02 - Personal Savings Rate (SA,%) &>urce: Bureau of Economic Analysis. Which has left foreign savings to take up the slack. Net Exports of Goods and Services Billions of Dollars Percent 100 2 0 Net Exports - 1 -100 0 -200 -1 -300 -2 Net Expor s as a Percentage of GDP -400 -3 -500 -4 ,,,. ./ -600 -5 ,I-- / -700 L-------~ ._ -6 __J ._ _, ...___ ___J 1975:02 1978:01 1980:04 1983:03 1986:02 1989:01 1991 :04 1994:03 1997:02 2000:01 2002:04 2005:03 - Real Net Exports of Goods and Services (SAAR, Bil.Chn.2000$) - Net Exports as a Percentage of GDP &lurce: Bureau of Economic Analysis. How long this borrowing can continue at this pace is uncerlain. U.S International Investment Position Billions of Dollars 1000 0.2 500 U .S International Investment : Assets - Liabilities 0.1 0 -500 - 0 -1000 -0.1 -1500 U.S. International Investment Relative to GDP -2000 -0.2 -2500 -3000 -0.3 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 - U.S.: International Investment Position: Assets (Bil.US$)- Liabilities (Bil.US$) - (U.S.: International Investment Position: Assets (Bil.US$)- Liabilities (Bil.US$))/ Nominal GDP &>urce: International Monetary Fund/ Haver Analytics. The savings imbalance will be rectified by increased savings one way or the other. 0.84 113 112 0.83 111 110 0.82 109 0.81 108 107 0.8 106 Foreign Exchange Rate Euro/USS on 105 0.79 - November 22, 2004: 0.7665 104 Foreign Exchange Rate Yen/USS o~ November 22, 2004: 103.22 0.78 103 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04 Sep-04 Oct-04 - Foreign Exchange Rate: European Monetary Union (Euro/US$) - Foreign Exchange Rate: Japan (Yen/US$) SJurce: Federal Reserve Board. A Potential Labor Market Imbalance: Some worry about an acceleration in inflation. Core CPI and Unemployment Rate Percent Change, Year-O ver-Year Percent 3 6.5 6 2.5 Unemployment Rate 5.5 2 5 1.5 - Core CPI - 4.5 1-----~-~------------------------------J 1 4 2001 :Q1 2001 :Q3 2002:Q1 2002:Q3 2003:Q1 2003:Q3 2004:Q1 2004:Q3 2001 :Q2 2001 :Q4 2002:Q2 2002:Q4 2003:Q2 2003:Q4 2004:Q2 - CPI-U: All Items Less Food and Energy (SA, 1982-84=100) - Civilian Unemployment Rate: 16 yr+ (SA,%) &:>urce: Bureau of Labor Statistics. But is the unemployment rate too low? Labor Force Participation Rate: Females Percent Percent 79 67 78 66 77 65 Female: 35-44 yrs 76 64 Female: 25-34 yrs 75 63 74 62 73 61 72 1993:01 1994:03 1996:01 1997:03 1999:01 2000:03 2002:01 2003:03 1993:04 1995:02 1996:04 1998:02 1999:04 2001 :02 2002:04 2004:02 - Civilian Participation Rate: 16 yr + - Civilian Labor Force Participation Rate: 35-44 Yrs, Female - Civilian Labor Force Participation Rate: 25-34 Yrs, Female SJurce: Bureau of Labor S:atistics. Most of the acceleration has come from food and energy pri•c es. Oil and Food Prices Price ($/Barrel) Percent Annualized Change 55 6 October 1, 2004: Spot Oil Price $50.12 50 I • 5 45 CPI-Food 4 40 Spot O ii Price 35 3 30 2 25 1 20 L----~~--.....,_ __, 15 0 2001 :01 2001 :03 2002:01 2002:03 2003:01 2003:03 2004:01 2004:03 2001 :02 2001 :04 2002:02 2002:04 2003:02 2003:04 2004:02 - Spot Oil Price: West Texas Intermediate [Prior'82=Posted Price] ($/Barrel) - CPI-U: Food (SA) Source: Wall Street .bur nsl. Bureau of Labor Statistics. Effects of oil prices on inflation: so far, modest and temporary Percent Change, Year-Over-Year 4.8 -12-mo. %chg., Core CA 4.3 - -12-mo. %chg., Core PCE 3.8 - • ~ - - , 12-mo. % chg., Tota CA 3 . 3 , I\ ' ., I~ .. --'~ ' # . • . \ •.. .. ' ~ - 2.8 - # # I ' Forecast, 2.3 Core PCE 1.8 ... - ... - - - ... 1.3 0.8 +----,--,--,--,----,--.------.----,----.-----,--,....-,--,---,----,---,--m--,-,--,---,--,----,----,-,,----.-----,--,----,-r--,--,---,---,--,--,-,--,-,--,----,--,--,---,--,----.-----,--r-r---,-,------,-----,-,------,---,-.---,----,---,--,----,,---.------.---,~.,.......,...-1 2000:J:n 2001 :J:n 2002:J:n 2003:J:n 2004:J:n 2005:J:n Oil price pressures on inflation offset by: • Remaining excess capacity - Excess capacity of about 1 .5% • Near-record profit margins • Moderate labor costs - Overall compensation growth is subdued by most measures, especially relative to productivity and inflation. Unit labor costs stable. • We expect inflation to remain moderate, but of course vigilance is required here Another risk to the recovery: Oil prices will affect spending Good news: Energy share of consumptions has halved since 1980. Percentage 10 9 8 7 6 5 4 3 1960:Q1 1965:Q3 1971 :Q1 1976:Q3 1982:Q1 1987:Q3 1993:Q1 1998:Q3 2004:Q1 1962:Q4 1968:Q2 1973:Q4 1979:Q2 1984:Q4 1990:Q2 1995:Q4 2001:Q2 How much of a tax has oil imposed on consumers? Increase over As a percentage of past year (billions disposable personal Spending category . $) income Gasoline, fuel oil $40.2 0.6 Electricity and gas $8.2 0.1 Source: Personal Consumption Expenditures; PCE: Gasoline, Fuel Oil, & Other Energy Goods; PCE: Household Operation Services-- Electricity & Gas, (SAAR, Billions $): Bureau of Economic Analysis. Some good news in this regard: Oil prices have receded recently Wes. Texas Intermediate Crude Oil, A-ice per ba rel 50.000 40.000 30.000 20.000 10.000 0.000 --h-,-~.----r-rr-rr,-r.,...,...,",T"T"T"T---i--rr7rr"T"TTTTT""T"TTTTTTTTTT7""TTT7---.rT""rr,-,--TTTTrm-r-r-rr""l"TT7rTTT7rrrrrrrr.,....,...,,...,..,-,,-.--rr,--r-r--r-rr,--,-T"T"rr"-ri--r-r-,--,--,,".T"T"T"T--.-r-f 1995:..m 1996:..m 1997:..m 1998:..m 1999:..an 2000:J:ri 2001:..m 2002:..m 2003:..m 2004:..m Source: West Texas Intermediate Crude Oil, $/bbl: Haver Analytics And recent data on consumption remain strong Percent Monthly Change 2.5 2 Retail Sales Excluding Motor Vehicles 1.5 1 0.5 0 -0.5 Retail Sales -1 -1.5 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04 Sep-04 Oct-04 - Retail Sales - Retail Sales Exel Motor Vehicles & Parts Dealers Source: Census Bureau. Summary • The outlook is for 3-4% real GDP growth - Which implies gradual absorption of excess capacity • The fundamentals on the consumer and business side are generally encouraging - Some risks, especially to household spending: • Strong employment growth is critical to ongoing income creation-some recent good news here • Low household savings • Further oil price shocks • Inflation remains well controlled - Most likely outcome: about 1-1/2% in 2005

Cathy E. Minehan (2004, December 5). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_20041206_cathy_e_minehan

@misc{wtfs_regional_speeche_20041206_cathy_e_minehan,
  author = {Cathy E. Minehan},
  title = {Regional President Speech},
  year = {2004},
  month = {Dec},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_20041206_cathy_e_minehan},
  note = {Retrieved via When the Fed Speaks corpus}
}