The Outlook for the U.S.
Economy
Professors Conference,
Federal Reserve Bank of St. Louis
St. Louis, Missouri
February 21, 2008
Kevin L. Kliesen
Economist
Not an official document
February 21, 2008
Kevin L. Kliesen
1
Outline of Talk
1. The Fed’s Operating Strategy
2. The Big Picture and Current Developments
3. What Do the Recession Indicators Say?
4. The Near-Term Consensus Forecast
5. Risks to the Outlook
February 21, 2008
Kevin L. Kliesen
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Disclaimer
February 21, 2008
Kevin L. Kliesen
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Release Date: January 30, 2008
For immediate release
The Federal Open Market Committee decided today to lower its target for the
federal funds rate 50 basis points to 3 percent.
Financial markets remain under considerable stress, and credit has tightened
further for some businesses and households. Moreover, recent information
indicates a deepening of the housing contraction as well as some softening in
labor markets.
The Committee expects inflation to moderate in coming quarters, but it will
be necessary to continue to monitor inflation developments carefully.
Today’s policy action, combined with those taken earlier, should help to
promote moderate growth over time and to mitigate the risks to economic
activity. However, downside risks to growth remain. The Committee will
continue to assess the effects of financial and other developments on
economic prospects and will act in a timely manner as needed to address
those risks.
February 21, 2008
Kevin L. Kliesen
4
The Big Picture
• From the Fed’s perspective, the big
picture is an assessment of where:
1. The economy currently is relative to its
potential; and
2. Current inflation is relative to what is
expected over the near-term and over the
longer-term.
February 21, 2008
Kevin L. Kliesen
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The Big Picture
•
First, the economy relative to its potential:
Real GDP Growth: Actual & Potential
Percent Change at an Annual Rate
6
5
4
3
2
1
0
2006Q1
2006Q2
2006Q3
2006Q4
2007Q1
2007Q2
2007Q3
2007Q4
NOTE: Potential GDP measured by the Congressional Budget Office.
February 21, 2008
Kevin L. Kliesen
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The Big Picture
•
Second, inflation relative to expectations.
The FOMC's Preferred Inflation Range for 2010 and the Overall and
Core PCE Inflation Rate
Inflation Measured as 12-Month Percent Changes
3.5
3.0
NOTE: Shaded
area is the
FOMC’s central
tendency forecast
for PCE and core
PCE inflation in
2010.
2.5
2.0
1.5
Overall PCE Inflation
Core PCE Inflation
1.0
0.5
0.0
Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08
February 21, 2008
Kevin L. Kliesen
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Risk Management
• The Fed operates in a data dependency
framework. Also called “risk management.”
• Two key aspects of this approach to
policymaking are worth noting:
– Policymakers give higher weight to low-probability damaging
outcomes, than to lower probability, less damaging outcomes.
(Bayesian)
– Continual updating of “best guess” scenario for the economy as
more information becomes available.
February 21, 2008
Kevin L. Kliesen
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Recent Economic Developments.
1. The U.S. labor markets deteriorated sharply, and
unexpectedly, in January.
2. A key measure of economic activity in the
nonmanufacturing sector fell sharply in January.
3. Factory orders and shipments were unexpectedly strong
in December. Exports a source of strength.
4. Auto sales weakened in January; non-auto retail sales
rose unexpectedly, but . . .
5. Housing sales, construction and prices appear
uniformly weak.
6. Banks still lending, but tightening standards and terms.
7. Financial market strains improve in some areas.
8. Fiscal stimulus package passes, but how important?
9. Recession probabilities on the rise.
February 21, 2008
Kevin L. Kliesen
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Recent Economic Developments
February 21, 2008
Kevin L. Kliesen
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Recent Economic Developments
Tracking Data Releases Relative to Expectations
The FOMC's Intended Federal Funds Target Rate and
the Real Net Tracking Indicator, July 2007-Present
8
5.50
4
5.00
0
-4
4.50
Fed Funds
-8
4.00
-12
Indicator
-16
3.50
-20
3.00
-24
-28
7/1/07
The FOMC's Intended Federal Funds Target Rate and
the Real Net Tracking Indicator for 2008:Q1 Data
2.50
9/2/07
11/4/07
1/6/08
3/9/08
8
4
0
-4
-8
-12
-16
-20
-24
-28
1/9/08 1/23/08 2/6/08 2/20/08 3/5/08 3/19/08
4.50
4.25
4.00
3.75
3.50
3.25
3.00
2.75
2.50
Correlation coefficient: 0.85
February 21, 2008
Kevin L. Kliesen
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Recession Probability in the Next 12 Months
According to WSJ Forecasters
60%
Feb. 2008
50%
40%
30%
20%
10%
0%
Sep- Dec- Mar- Jun- Sep- Dec- Mar- Jun- Sep- Dec- Mar- Jun05
05
06
06
06
06
07
07
07
07
08
08
February 21, 2008
Kevin L. Kliesen
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What are the Recession
Indicators Telling Us?
February 21, 2008
Kevin L. Kliesen
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Probability of Recession from Markov-Switching Model with
Employment Data
1
0.8
Payroll
0.6
Household
0.4
21%
0.2
0
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
Last Observation: Jan. 2008
Source: Haver/BLS, author's calculations.
February 21, 2008
Kevin L. Kliesen
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Probability of Recession from Markov-Switching Model with Leading &
Coincident Indexes
1
0.8
0.6
53%
0.4
0.2
11%
0
1955
1960
1965
1970
Last Observation: Dec. 2007.
Source: Haver/Conference Board, author's calculations.
February 21, 2008
1975
1980
1985
Recession
Kevin L. Kliesen
1990
1995
Coincident
2000
2005
Leading
15
Hamilton's Markov-Switching Recession Probability Estimate
1.00
0.75
0.50
0.25
18%
0.00
-0.25
1942 1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007
February 21, 2008
Kevin L. Kliesen
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Results from a Forward-Looking Probit Model
(i.e., estimating the probability of a recession
over the following four quarters)
The model uses the term structure (3-mo Treasury-bill less
the 10-year Treasury note) and the nominal federal funds
rate.
•
Estimates from March 2007 (using data through 2007:Q1);
probability of the economy being in a recession in 2008:Q1:
 58%
•
Estimates from February 2008 (using data through 2007:Q4);
probability of the economy being in a recession in 2008:Q4:
 9%
February 21, 2008
Kevin L. Kliesen
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Single-Family Housing Starts
Inventory to Sales Ratio: New and Existing
Single-Family Homes
Thousands of units, SAAR
2000
12.0
Dec.
1700
10.0
New
Existing
Dec.
8.0
1400
6.0
1100
4.0
800
Dec. 2007
2.0
1999
2001
2003
2005
2007
500
1985
1988
1991
Actual
SOURCES: U.S. Bureau of the Census and the National Association of Realtors.
1994
1997
2000
Average, 1985-2006
2003
2006
Average, 1997-2006
Case-Shiller/S&P 10-City Composite
House Price Changes
Percent change from 12 months earlier
25
20
15
10
5
0
-5
-10
1988 1991 1994 1997 2000
2003
2006
Data are through November 2007.
February 21, 2008
Kevin L. Kliesen
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2008 Forecasts for Nominal Corporate Profit Growth
Percent
7
6
5
4
3
2
1
0
-1
Jan-07
Mar-07
May-07
Jul-07
Sep-07
Nov-07
Jan-08
Forecast Month
SOURCE: Blue Chip Consensus Forecast
February 21, 2008
Kevin L. Kliesen
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Recent Price and Wage Developments.
1. Inflation in 2007 was 3.5%, the highest in 17 years!
2. Ex food and energy, though, inflation was about the
same as last year (about 2.25%).
3. Nonpetroleum import prices rise 3% in 2007, largest
increase in three years.
4. Commodity prices surging. $12 per bushel
soybeans, $10/bushel wheat and nearly $5 per
bushel corn!
5. Crude oil prices still remain high and fairly volatile.
6. A bright spot: Productivity and unit labor costs
improved markedly in 2007 (vs. 2006).
7. Inflation expectations—a mixed bag.
February 21, 2008
Kevin L. Kliesen
20
Chairman Bernanke’s View
At present, my baseline outlook involves a period of
sluggish growth, followed by a somewhat stronger
pace of growth starting later this year as the effects
of monetary and fiscal stimulus begin to be felt.
At the same time, overall consumer price inflation
should moderate from its recent rates, and the
public's longer-term inflation expectations should
remain reasonably well anchored.
February 21, 2008
Kevin L. Kliesen
21
5-Yr, 5-Yr Forward Breakeven Inflation
Rates
3.20
3.00
2.80
2.60
2.40
2.20
2.00
2/1/07
5/1/07
8/1/07
Board
February 21, 2008
11/1/07
2/1/08
Constant Maturity
Kevin L. Kliesen
22
Actual CPI Inflation and Short- and Long-Term
Inflation Expectations: Survey of Professional
Forecasters
Percent
4.5
4.0
1-Yr Forecast
10-Yr Forecast
3.5
3.0
2.5
2.0
2008:Q1
1.5
1.0
1991
February 21, 2008
1993
1995
1997
1999
Kevin L. Kliesen
2001
2003
2005
2007
23
Mean Probability Attached to Core PCE Inflation:
Survey of Professional Forecasters
Percent
60
50
40
30
20
10
0
Less than 2%
07Q4 TO 08Q4
February 21, 2008
Kevin L. Kliesen
More than 2%
08Q4 TO 09Q4
24
The Near-Term Outlook
1.
Economic growth looks to be fairly weak over the first
half of the year—well below trend growth.
2. As far as a recession goes . . . It’s a coin toss.
3. Price pressures may moderate if growth remains weak
for a few quarters, but no guarantees (Plosser).
4. Further declines in the dollar, continued strength in
commodity prices, a seasonal upturn in oil prices, and
an over aggressive easing all have the potential to keep
inflation above the Fed’s preferred range.
February 21, 2008
Kevin L. Kliesen
25
The Near-Term Outlook
Real GDP Growth Forecasts, 2008-2009
6
5
4.9
4
3
2
1
0.6
0
-1
2007:Q3 2007:Q4 2008:Q1 2008:Q2 2008:Q3 2008:Q4 2009:Q1 2009:Q2 2009:Q3 2009:Q4
Global Insight
February 21, 2008
SPF
Kevin L. Kliesen
Blue Chip
Potential (CBO)
26
The Near-Term Outlook
CPI Inflation Forecasts, 2008-2009
5.0
4.5
4.3
4.0
3.5
3.0
2.5
2.0
1.5
1.9
1.0
0.5
0.0
2007:Q3 2007:Q4 2008:Q1 2008:Q2 2008:Q3 2008:Q4 2009:Q1 2009:Q2 2009:Q3 2009:Q4
Global Insight
February 21, 2008
SPF
Kevin L. Kliesen
Blue Chip
27
The Near-Term Outlook
Table 1: Economic Projections of Federal Reserve Governors and Reserve Bank Presidents 1
2007
2008
2009
2010
Central Tendencies
Real GDP Growth
Oct. 2007 Projections
June 2007 Projections
2.4 to 2.5
2¼ to 2½
1.8 to 2.5
2½ to 2¾
2.3 to 2.7
2.5 to 2.6
Unemployment Rate
Oct. 2007 Projections
June 2007 Projections
4.7 to 4.8
4½ to 4¾
4.8 to 4.9
about 4¾
4.8 to 4.9
4.7 to 4.9
PCE Inflation
Oct. 2007 Projections
Core PCE Inflation
Oct. 2007 Projections
June 2007 Projections
February 21, 2008
?
?
?
2.9 to 3.0
1.8 to 2.1
1.7 to 2.0
1.6 to 1.9
?
1.8 to 1.9
2 to 2¼
1.7 to 1.9
1¾ to 2
1.7 to 1.9
Kevin L. Kliesen
1.6 to 1.9
28
Risks to the Outlook
1.
Spillovers from the housing downturn spread to the
consumer and deepen.
2. Consensus forecasts does not assume a recession.
3. Fiscal and monetary stimulus boost economic growth
by more than expected, boosting long-run inflation
expectations even higher.
4. Foreign economic growth weakens.
February 21, 2008
Kevin L. Kliesen
29
Questions?
February 21, 2008
Kevin L. Kliesen
30