The Outlook for the U.S.
Economy
“Turmoil vs. Stability: The Fed’s Response”
Conference for College Teaching Faculty
Federal Reserve Bank of St. Louis
St. Louis, MO
November 6, 2008
Kevin L. Kliesen
Economist
Federal Reserve Bank of St. Louis
Outline of Talk
Analyzing the Economy -- The Basics
The Big Picture and Current Developments
The Fed’s Strategy . . . And Dilemma
The Near-Term Forecast
Risks to the Outlook
November 6, 2008
Kevin L. Kliesen
DISCLAIMER
November 6, 2008
Kevin L. Kliesen
The Basics
Analyzing current U.S. macroeconomic
conditions requires some “model.” Here’s a
simple one:
1. Over time the economy grows at its trend, as
determined by real factors.
2. Shocks cause the economy to fluctuate around the
trend. Shocks are temporary, but can have
permanent effects.
3. Inflation is ultimately determined by Fed actions and
expectations; some use NK models.
November 6, 2008
Kevin L. Kliesen
The Basics of Fed Policy
The Fed operates under a “risk management”
framework.
1. The evolving flow of data inform near-term risks to the
economic outlook and, if necessary, policy responses.
Two key aspects of this “probabilistic”
approach:
1. Policymakers worry a lot about the potential for damaging
economic outcomes.
2. Continual updating of “best guess” scenario for the
economy as more information becomes available.
November 6, 2008
Kevin L. Kliesen
The Basics of Fed Policy
FOMC Federal Funds Rate
Percent
6.00
5.00
4.00
3.00
2.00
1.00
0.00
11/1/07
November 6, 2008
2/1/08
5/1/08
Kevin L. Kliesen
8/1/08
11/1/08
The Basics of Fed Policy
Central Bank Policy Rates
Percent
6.00
5.00
4.00
3.00
2.00
1.00
0.00
11/1/07
U.S.
November 6, 2008
2/1/08
5/1/08
Canada
Kevin L. Kliesen
8/1/08
ECB
11/1/08
UK
The Big Picture
November 6, 2008
Kevin L. Kliesen
The Big Picture
•
Dramatic interventions by U.S. and
European central banks and governments.
•
Financial market volatility has been
extremely high.
•
Inflation seems to be moderating . . .
helped along by several factors.
•
Near-term economic growth will be
extremely weak in most major economies.
November 6, 2008
Kevin L. Kliesen
Current Developments
Prices and Inflation
Expectations
November 6, 2008
Kevin L. Kliesen
Current Developments
Headline inflation has retreated markedly
over the past two months.
 Energy and commodity prices stage a retreat.

November 6, 2008
But for how long?
Kevin L. Kliesen
Crude Oil Prices
CRB Commodity Price Indexes
($/barrel)
(Index, 1967 = 100)
150.0
500
140.0
475
130.0
450
120.0
110.0
425
100.0
400
90.0
375
80.0
70.0
350
60.0
325
1/2/08
3/2/08
5/2/08
7/2/08
9/2/08
11/2/08
7/2/07
Percent change in Prices since Peak:
Oil Prices:
-56.0%
Commodity Prices:
-28.7%
November 6, 2008
Kevin L. Kliesen
10/2/07
1/2/08
4/2/08
7/2/08
10/2/08
Current Developments
Headline inflation has retreated markedly
over the past two months.
 Energy and commodity prices stage a retreat.
 Also helping matters . . . Inflation expectations, a
stronger dollar, and a slowing in global growth (more
on this later).
November 6, 2008
Kevin L. Kliesen
Current Developments
CPI Inflation, Sept. 2007 to Present
Percent change for period indicated
16
14
12
10
8
6
4
2
0
-2
-4
Sept. 2007
November 6, 2008
1-Month
Dec. 2007
12-Month
Mar. 2008
Kevin L. Kliesen
Jun. 2008
Sept. 2008
Current Developments
Inflation (CPI): Actual, Forecasted, and Long-Run Expectations
Percent change at an annual rate
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
Actual
Expectations
Forecast
2006-Q1 2006-Q3 2007-Q1 2007-Q3 2008-Q1 2008-Q3 2009-Q1 2009-Q3
NOTE: Inflation expectations measured by the Survey of Professional Forecasters.
November 6, 2008
Kevin L. Kliesen
Current Developments
Headline inflation has retreated markedly
over the past two months.
 Energy and commodity prices stage a retreat.
 Also helping matters . . . Inflation expectations, a
stronger dollar, and a slowing in global growth (more
on this later).
 Falling energy and commodity prices will provide
some relief to consumers and businesses.
 Don’t expect a 1930s-style deflation!
November 6, 2008
Kevin L. Kliesen
Recent Developments
November 6, 2008
Kevin L. Kliesen
Q3 Real GDP Growth
Percent
8
4
5.9
5.8
6
Q3 Growth was the
weakest in 7 years)
2
0.7
0
-0.3
-2
-1.9
-3.1
-4
-6
-5.6
-8
GDP
Consumption
Investment
Government
Imports
NOTE: Inventory investment expressed as contribution to real GDP growth.
November 6, 2008
Kevin L. Kliesen
Exports
Inventories
Actual & Potential Real GDP Growth
Percent
5
Potential
4
3
2
1
0.05
0
-0.25
-1
2007:Q1
2007:Q2
2007:Q3
2007:Q4
2008:Q1
2008:Q2
NOTE: Inventory investment expressed as contribution to real GDP growth.
November 6, 2008
Kevin L. Kliesen
2008:Q3
Consumers Pull Back
Monthly Changes in Employment
Real Retail Sales and Gasoline Prices
Billions of $
Cents/gallon
Thousands of Jobs
395
4.50
200
390
4.00
150
3.50
385
Oct.
380
100
50
3.00
0
2.50
-50
375
2.00
370
1.50
-100
-150
Jan07
Apr07
Jul07
Oct07
Sales
Jan08
Apr08
Jul08
Oct08
-200
Oct. Forecast
-250
Jan-07 Apr-07
Gasoline
Oil Shock!
November 6, 2008
Kevin L. Kliesen
Jul-07
Oct-07 Jan-08 Apr-08
Jul-08
Oct-08
Business Spending Softening
Growth of Business and Household
Fixed Investment in 2008-Q3 vs.
2008-H1
(Q3)
-1.0
-5.5
-10.6
-50.9
(H1)
2.4
-2.8
-1.4
-32.2
Structures
7.9
13.4
Residential
-19.1
-19.4
Nonresidential
Equip. & Software
Industrial
Transportation
November 6, 2008
Kevin L. Kliesen
Businesses becoming
reluctant spenders.
Profits wane; equity cost
of capital high.
Industrial and office
vacancy rates turning
up.
Industrial Production
Index of Industrial Production
Car & Light Truck Production
52-week totals
2002 = 100
113
17.00
16.50
112
111
16.00
110
15.50
109
15.00
108
14.50
107
14.00
6/1/2007
106
Jan07
Apr07
Jul07
Oct07
Jan08
Apr08
Jul08
Oct08
10/1/2007
2/1/2008
6/1/2008
10/1/2008
Light Veh.
IP fell 2.8% in September. However, without the strike at Boeing and
Hurricanes Gustav and Ike, IP would have been about unchanged in September.
Manufacturing capacity utilization in September (76.4%) was the lowest since
October 2003.
November 6, 2008
Kevin L. Kliesen
Current Developments
European Industrial Production
European Economic Sentiment
115.0
115.0
112.0
105.0
109.0
95.0
106.0
85.0
103.0
2005-Q4 2006-Q2 2006-Q4 2007-Q2 2007-Q4 2008-Q2
75.0
2005-Q4 2006-Q2 2006-Q4 2007-Q2 2007-Q4 2008-Q2
NOTE: Last observation is 2008:Q3
NOTE: Last observation is 2008:Q3
The largest countries in Europe appear to be in recession, or headed there, as
does Japan. Major European central banks cut their interest rate target on the
same day as the Fed did (Oct. 8).
November 6, 2008
Kevin L. Kliesen
And Then There’s Housing!
Housing . . . Looking for the light at the end of
the tunnel.





November 6, 2008
No bottom in house prices yet; economists and housing
analysts say 2009 . . . maybe.
Nationally, home prices are down about 10% over the past
year; considerable variance across regions, though.
Inventories of unsold homes too high;
Mortgage market not helping;
Some indication that home sales are stabilizing.
Kevin L. Kliesen
Housing Developments
Existing Single-Family Home Sales
Thousands of units
6500
6250
6000
5750
5500
5250
5000
4750
4500
4250
4000
2005
September
2006
2007
SOURCE: U.S. Bureau of the Census.
November 6, 2008
Kevin L. Kliesen
2008
Housing Developments
Real GDP Growth and Housing's Contribution
Percentage Points
November 6, 2008
2006 - Q1
2006 - Q2
2006 - Q3
2006 - Q4
2007 - Q1
2007 - Q2
2007 - Q3
2007 - Q4
2008 - Q1
2008 - Q2
2008 - Q3
Real
GDP
4.82
2.68
0.80
1.50
0.05
4.79
4.76
-0.17
0.87
3.28
-0.25
Housing
-0.23
-1.11
-1.40
-1.18
-0.91
-0.60
-1.06
-1.33
-1.12
-0.62
-0.72
Real
GDP ex
Housing
5.05
3.79
2.20
2.68
0.96
5.39
5.82
1.16
1.99
3.90
0.47
Average
2.10
-0.93
3.04
Kevin L. Kliesen
Current Developments
Recent Financial Market
Developments
November 6, 2008
Kevin L. Kliesen
Current Developments
Peak-to-Trough Declines in Stock Prices During
Recent Episodes
0%
-10%
Current
episode
-20%
-20%
-30%
-27%
-40%
-34%
-50%
-48%
-49%
-46%
2001
2007-2008
-60%
1973-1975 1980-1982
November 6, 2008
1987
1990-1991
Kevin L. Kliesen
Current Developments
November 6, 2008
Kevin L. Kliesen
Current Developments
Volatility in the Stock Market has been
incredible!
Daily Percent Change in Stock Prices and their Average
Volatility Over the Past 10 Years
Percent
15
10
5
0
-5
-10
Last Obs.: Nov. 3, 2008
-15
Jun 1 2007
November 6, 2008
Aug 14
2007
Oct 25
2007
Jan 9 2008
Mar 25
2008
Jun 5 2008
Kevin L. Kliesen
Aug 18
2008
Oct 29
2008
Current Developments
One Problem: Volatility in the Stock Market
has been incredible!
 In the face of extreme volatility, households and
businesses disengage—focusing on the here and now
because planning for the future is very difficult.
 One explanation:
 Uncertainty about the direction of the economy.
 Another explanation:
 Uncertainty about the health of the financial
sector—the “lemons problem.”
November 6, 2008
Kevin L. Kliesen
Current Developments
Another Problem: The Credit Market
Disturbance!
 Liquidity risk and credit risk. Negative feedback loops (Bernanke).
 Bank are tightening lending standards, but
lending is not contracting. More difficulties
in the non-bank lending markets (e.g.,
commercial paper).
November 6, 2008
Kevin L. Kliesen
The Libor-OIS Yield Spread and Key Market Events
Percentage Points
4.0
9/15-16/08
Lehman-AIG
3.5
8/9/07
BNP
Paribas
3.0
9/14/07
Northern
Rock Crisis
3/17/08
Collapse of
Bear Stearns
2.5
2.0
10/13/08
Global Capital
Injections
1.5
1.0
0.5
0.0
Aug
06
Oct
06
November 6, 2008
Dec
06
Feb
07
Apr
07
Jun
07
Aug
07
Oct
07
Dec
07
Kevin L. Kliesen
Feb
08
Apr
08
Jun
08
Aug
08
Oct
08
Growth of Bank Loans
Bank Lending Since January 2008
Index, Jan. 2, 2008 = 1.0
1.11
Y-O-Y
10.8
15.3
10.3
3-Months
31.3
25.1
13.3
1.09
C & I:
Consumer:
Real Estate:
1.07
NOTE: date through Oct. 22, 2008
1.05
1.03
1.01
0.99
1/2/08
3/2/08
5/2/08
C&I Loans (left)
7/2/08
Consumer
9/2/08
Real Estate
A huge increase in bank
lending over the past
three months—or is it?
According to the Board of Governors, large domestically chartered commercial banks
acquired $259.2 billion in assets and liabilities of nonbank institutions in the week
ending October 1, 2008.
November 6, 2008
Kevin L. Kliesen
Current Developments
How Did We Get Into This Mess?
 Public policies—Bi-partisan goal of increasing home
ownership; low-cost of credit.
 Securitization—willing lenders, borrowers, and
investors (the search for high yield in an
environment of unusually low risk premiums).
 Wrong assumptions about house prices.
 Bad timing—an oil shock and the housing bust.
November 6, 2008
Kevin L. Kliesen
The Fed’s Strategy
November 6, 2008
Kevin L. Kliesen
The Fed’s Response
1. Reduce the FOMC’s interest rate target .
. . It is currently at 1.5% (as of Tuesday,
Oct. 28)
2. Increase funds available to banks and
financial institution to support
borrowing and intermediation?
November 6, 2008
Kevin L. Kliesen
Summary of Fed Lending Facilities
November 6, 2008
Kevin L. Kliesen
The Fed’s Response
High-Powered Money: The Adjusted Monetary Base
Billions of Dollars
1200
1100
1000
900
800
700
1/5/05
10/5/05
7/5/06
4/5/07
1/5/08
Growth:
Jan. 5, 2005, to Sept. 10, 2008: 11.5%
Sept. 10, 2008 to Oct. 22, 2008: 35.6%
November 6, 2008
Kevin L. Kliesen
10/5/08
The Fed’s Response
November 6, 2008
Kevin L. Kliesen
The Near-Term
Forecast
November 6, 2008
Kevin L. Kliesen
Forecast
Are We in a Recession? If it walks like a
duck, and quacks like a duck . . .
A 90% Recession Probability in the Next 12
Months According to WSJ Forecasters!
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Sep05
November 6, 2008
Jan- May- Sep- Jan- May- Sep06
06
06
07
07
07
Kevin L. Kliesen
Jan- May- Sep08
08
08
Forecast
An “Average” Profile of the Past Four
Recessions.
Real GDP Around Business Cycle Peaks,
1973-75 to Present
Over the past four
recessions, the
average decline in
real GDP is about
0.75%.
104
102
100
The average
decline lasts about
2 quarters.
98
96
-6
-5
-4
-3
-2
-1
0
1
2
3
Avg.
November 6, 2008
4
Peak
Kevin L. Kliesen
5
6
Forecast
The Consensus forecast: A short, shallow
recession.
Real GDP Around Business Cycle Peaks,
1973-75 to Present
104
102
100
98
96
-6
-5
Avg.
November 6, 2008
-4
-3
-2
-1
0
1
Current (Consensus)
Kevin L. Kliesen
2
3
4
5
Peak
6
Forecast
The Optimistic forecast: No recession.
Real GDP Around Business Cycle Peaks,
1973-75 to Present
104
102
100
98
96
-6
-5
Avg.
November 6, 2008
-4
-3
-2
-1
0
1
Current (Optimistic)
Kevin L. Kliesen
2
3
4
5
Peak
6
Forecast
The Pessimists’ forecast: A deeper, longer
recession than normal.
Real GDP Around Business Cycle Peaks,
1973-75 to Present
104
102
100
98
96
-6
-5
Avg.
November 6, 2008
-4
-3
-2
-1
0
1
Current (Pessimistic)
Kevin L. Kliesen
2
3
4
5
Peak
6
Real GDP
Growth
Residential
Fixed Inv.
Growth
Short-term
Real Interest
Rates
House
Prices
November 6, 2008
Kevin L. Kliesen
SOURCE: OECD,
August 2008
Forecast
What are Some Key Risks to the Outlook?
 Difficult to forecast in an environment of
uncertainty.
 If equity prices continue to decline, the outlook for
consumer and business spending will worsen.
 By contrast, a rapid V-shaped recovery with a lot of
monetary stimulus in the pipeline is worrisome.
 FY 2009 budget deficit may exceed $1 Trillion!
November 6, 2008
Kevin L. Kliesen
QUESTIONS?
November 6, 2008
Kevin L. Kliesen