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Tuesday, June 17, 2008

FRBSF: The Current Economy and the Economic Outlook

Reuven Glick of the SF Fed uses fourteen graphs to illustrate the state of the economy, and to predict where the economy might be headed next:

FedViews, by Reuven Glick, FRBSF (no permalink available): Reuven Glick, group vice president at the Federal Reserve Bank of San Francisco, states his views on the current economy and the outlook:


Labor demand remains weak. In May, payroll employment fell by 49,000, bringing total job losses since January to 324,000. Though not encouraging news, this number of job losses equals about half the average performance during the first five months of previous recessions. Thus, the data are consistent with the view that the economy is not as weak as in prior down cycles. Job losses in May were widespread, occurring in professional and business services as well as in manufacturing and construction.


The unemployment rate rose sharply, from 5.0 to 5.5 percent, largely due to an increase in teenagers entering the labor force who could not find jobs.

Consumption also remains weak. Real consumption spending was flat in April compared to March, and over the last twelve months, it grew only 1.6 percent, much below the 3.0 percent growth during the prior twelve months (April 2006-April 2007). The combination of falling house values, declining payrolls, tighter credit conditions, and higher energy costs continues to dampen consumer spending.


Outside the automotive sector, durable goods showed resilience. Nondefense capital goods excluding aircraft orders, used as an indicator for future business investment, rose 4 percent in April following three months of decline.


Retail sales (excluding autos) showed unexpected strength in May, rising 1.2 percent, following increases of 1.0 percent in April and 0.8 percent in March, both of which were well up from previous estimates. This provides some evidence that the federal government’s fiscal stimulus package is working to increase consumption. However, overall sales were up only 2.5 percent over a year ago.


The merchandise trade balance deficit grew in April because of higher oil costs. However, net exports have been improving in the last year, as slower U.S. growth has discouraged imports, and the weaker dollar and growth abroad have encouraged exports. In fact, improving net exports have been a big contributor to real GDP growth recently, adding an average of 1.1 percentage points to overall GDP growth in each of the past four quarters.


Commodity prices continue to soar. The spot price of West Texas intermediate crude oil is up over 40 percent since January and over 100 percent in the last year, reaching a peak of nearly $139 per barrel in early June. Corn and wheat prices are both up over 60 percent from a year ago.


Demand and supply fundamentals play a large role in the rise of commodity prices. On the demand side, booming economic activity in developing countries has boosted their appetite for commodities. In 2007, these countries accounted for roughly 40 percent of world GDP and 70 percent of world GDP growth (in terms adjusted for purchasing power parity).


Indeed, demand from developing countries accounts for most of the increased world demand in recent years for commodities, such as oil, wheat, and corn.


For example, since 2000, world demand for oil has increased by roughly 11 million barrels per day (mbd), rising from 76 million mbd in 2000 to a (projected) 87 mbd in 2008. China accounts for roughly 30 percent of this increase, and other developing countries account for over 60 percent. Developing countries have generated most of the increase in world demand for other commodities as well.

In the case of corn, however, a substantial amount of increased demand also has been coming from its use in ethanol production. Future demand from developing countries depends on how fast they grow as well as on how much they continue to subsidize the retail price of key commodities. In fact, several countries recently announced cutbacks to the subsidies on oil prices because of the fiscal burden they have created.

On the supply side, there have been constraints. In oil markets, supplies have not kept pace with growing worldwide demand. In addition, spare capacity to supply more oil in the short run has been declining. In crop markets, supply problems have been exacerbated by weather variability.


For example, drought conditions have hampered wheat production in Australia, while excessive rainfall is affecting corn production in the U.S. Midwest region.


Because, in the case of commodities, neither supply nor demand adjusts quickly, large price changes can occur in response to news and other shocks to the market.

The role of speculative trading in commodities markets has risen but remains unclear. Hedge funds, institutional investors, and other traders have increased their positions in commodity markets, typically by investing in commodity index funds. However, the prices of individual commodities that are not in index funds have risen just as fast as those that are. Moreover, if speculators were playing a big role in these markets, and if they expected prices to rise, it would be profitable to take some supply off the market, build up inventories, and sell it in the future when prices are higher. In fact, however, inventories have been declining in most commodity markets.


The preliminary GDP report for the first quarter revised growth up from 0.6 to 0.9 percent, confirming a very soft, but still growing, economy. With greater consumer spending than expected at the time of the May Fedviews, we now anticipate stronger growth in the second and third quarters of the year as the drag from the housing sector lessens. After the fiscal stimulus package ends, we expect some payback with somewhat slower growth in the fourth quarter. For 2009, growth is expected to pick up to around 3 percent at an annual rate, with further improvements in the housing sector and the easing of credit constraints.

The price index for overall personal consumption expenditures (PCE) increased by 0.2 percent in April and was up 3.2 percent from a year earlier. The core PCE price index, which excludes volatile food and energy prices, increased by 0.1 percent in April, with the 12-month increase holding steady at 2.1 percent, the same as in March.


The forecast for headline inflation in the two middle quarters of the year has been raised to reflect recent unexpected commodity price increases. We now expect headline inflation to exceed 4 percent in the second and third quarters, before declining, as commodity price increases level off or recede. We expect core inflation to remain relatively stable, as slack in the economy absorbs additional price pressures.


Recent increases in market interest rates imply monetary policy tightening is expected in the future.

    Posted by on Tuesday, June 17, 2008 at 09:54 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (1)


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