The National Bureau of Economic Research (NBER)

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1 NationalEconomicTrends July Using Stock Market Liquidity to Forecast Recessions The National Bureau of Economic Research (NBER) Business Cycle Dating Committee (the committee that dates U.S. recessions) says that the recent recession started in the fourth quarter of 7. But looking back years from now, that time frame might not be when we think problems in the economy actually became apparent. Instead, we might think of the credit crunch that began in August 7 as the first time problems emerged. At that time, the cost of interbank borrowing jumped sharply to levels that ultimately made it difficult for firms to afford the level of borrowing that they had grown accustomed to. Once investors figured this out, they began to pull out of the stock market, thus beginning a worldwide downward trend in stock prices. Given this sequence of events, a reasonable question is whether the decline in the liquidity of debt markets (the credit crunch) or the decline in the liquidity of equity markets (the stock market deterioration) caused the recent economic crisis and subsequent recession. For this discussion we focus on the latter, highlighting recent work by Næs, Skjeltorp, and Ødegaard that shows that changes in the liquidity of the U.S. stock market have been coinciding with changes in the real economy at least since the Second World War. In other words, stock market liquidity is a very good leading indicator of the real economy. There are, however, many different measures of liquidity. The one these authors focus on is one. that measures how much stock prices move in response to each volume unit of trades. A high. estimate indicates high liquidity (low price impact of trades) and a low estimate indicates low liquidity (high price impact of trades). Their preferred. measure is constructed by averaging across the common shares of stocks listed at the New York Stock Exchange. The chart combines a time-series plot of their. preferred measure of stock market liquidity with the NBER recession periods (gray bars), illustrating the temporal relationship between stock. market liquidity and the business cycle. Liquidity tends to fall before the recession and rise as the. recession ends. Of course, preceding a recession and actually causing a recession are two very different things. Stock market liquidity did not dry up without cause. It did so only after U.S. housing prices began to fall and the mortgages associated with residential loans started to become suspect. As this problem became well known, market participants began to rebalance their portfolios in a flight to quality toward less-risky assets (such as bonds) and away from riskier assets (such as stocks). The decline in liquidity itself did not cause the recession; it was simply a signal of something fundamental happening in the economy. That said, it is often very difficult to determine whether fundamental shifts are taking place in an economy. In contrast, measures of stock market liquidity are readily available on a daily basis. So, while financial market liquidity may not cause recessions, keeping track of liquidity as an indicator of the state of the business cycle certainly seems like a good idea. Michael W. McCracken Næs, Randi; Skjeltorp, Johannes A. and Ødegaard, Bernt A. Stock Market Liquidity and the Business Cycle. Forthcoming in Journal of Finance; March version available at Liquidity and the Business Cycle NBER Recessions Liquidity 7 Views expressed do not necessarily reflect official positions of the Federal Reserve System. research.stlouisfed.org

2 Contents Page Economy at a Glance Output and Growth 7 Interest Rates Inflation and Prices Labor Markets Consumer Spending Investment Spending Government Revenues, Spending, and Debt International Trade Productivity and Profits FOMC Economic Projections Quick Reference Tables Notes and Sources Conventions used in this publication:. Except where otherwise noted, solid shading indicates recessions, as determined by the National Bureau of Economic Research. The NBER has not yet determined the end of the recession that began in December 7; however, the hatched shading shows that the recession ended in July. We made this determination based on a statistical model for dating business cycle turning points developed by Marcelle Chauvet and Jeremy Piger ( A Comparison of the Real-Time Performance of Business Cycle Dating Methods, Journal of Business and Economic Statistics,,, -). For more information, see refers to simple percent changes. from year refers to the percent change from the same month or quarter during the previous year. Compounded annual of change shows what the growth would be over an entire year if the same simple percent change continued for four quarters or twelve months. The compounded annual of change of x between the previous quarter t and the current quarter t is: [(x t /x t ) ]. For monthly data replace with.. All data with significant seasonal patterns are adjusted accordingly, unless labeled NSA. We welcome your comments addressed to: Editor, National Economic Trends P.O. Box St. Louis, MO - or to: stlsfred@stls.frb.org National Economic Trends is published by the of the. Visit the s website at research.stlouisfed.org/publications/net to download the current version of this publication or register for notification updates. For more information on data in this publication, please visit research.stlouisfed.org/fred or call () -7.

3 updated through 7// National Economic Trends Real GDP Growth Compounded annual s of change Consumer Price Index Industrial Production Interest Rates Treasury -Month Treasury Change in Nonfarm Payrolls Thousands Unemployment Rate of labor force

4 National Economic Trends updated through 7// Real Gross Domestic Product from year Industrial Production and Institute for Supply Management (ISM) Indexes from year Industrial Production Index ISM Aggregate Private Nonfarm Hours from year Real Change in Private Inventories of GDP

5 updated through 7// Real Final Sales and GDP Compounded annual s of change Final Sales GDP (bar) Real GDP Revisions National Economic Trends Compounded annual s of change Advance Second Third Comprehensive Revision : : : : : Industrial Production and ISM Index - Industrial Production (bar) Index Nominal Gross Domestic Product Compounded annual s of change - - ISM Aggregate Private Nonfarm Hours Average Weekly Private Nonfarm Hours Hours Real Change in Private Inventories Billions of dollars Inventory-Sales Ratio Manufacturing and trade

6 National Economic Trends updated through // Contribution of Components to Real GDP Growth age points at compounded annual s Q Q Q Q Q Q Q Q Consumption Exports Government Imports Inventories Investment Contributions to Real GDP Growth Rate nd rd th st nd rd th st Final Sales Consumption Fixed Investment Nonresidential Residential Government Federal State and Local Net Exports Exports Imports Change in Inventory Residual Real GDP Growth

7 updated through 7// National Economic Trends Interest Rates - Treasury -Month Treasury Treasury Yield Curve..... Jun Week Ending: 7//.... Jun m. y y y 7y y Standard and Poor's Index with Reinvested Dividends from year

8 National Economic Trends updated through 7// NIPA Chain Price Indexes from year GDP Gross Domestic Purchases Consumer Price Index from year Excl. Food and Energy All Items Producer Price Index, Finished Goods from year - Excl. Food and Energy PPI Employment Cost Index and Compensation per Hour from year Comp. per Hour ECI

9 updated through 7// NIPA Chain Price Indexes Compounded annual s of change National Economic Trends Oil & Natural Gas Prices: Spot & Futures Dollars per barrel Dollars per million btu - GDP (bar) Gross Domestic Purchases Spot Oil Oil Futures Consumer Price Index Compounded annual s of change CPI (bar) Excl. Food & Energy Spot Gas Gas Futures 7 7 Note: Futures prices as of //. Consumption Chain Price Index Compounded annual s of change - - PCE (bar) Excl. Food & Energy Producer Price Index, Finished Goods Compounded annual s of change PPI (bar) Unit Labor Cost Compounded annual s of change Manufacturing (bar) Excl. Food & Energy - - Nonfarm Employment Cost Index from year Benefits Wages and Salaries Compensation Compensation per Hour Compounded annual s of change

10 National Economic Trends updated through 7// Employment from year Payroll Survey Household Survey Unemployment, Labor Force Participation, and Employment Rates of labor force Labor Force/Population Employment/Population of population 7 7 Unemployment Rate Duration of Unemployment of labor force....7 Weeks... Unemployed > Weeks Unemployed < Weeks.7. Median

11 updated through 7// National Economic Trends Change in Nonfarm Payrolls Thousands Change in Manufacturing Payrolls Thousands Change in Household Employment Thousands Labor Force and Population from year.. Pop % Confidence.. Labor Force Available Labor Supply and Components of labor force Unemployment Rate & Job Openings Rate Available Labor Supply Unemployed 7 Unemployment Rate Job Openings Rate % Confidence 7 Want to Work

12 National Economic Trends updated through 7// Real Disposable Personal Income from year, quarterly data Real Consumption from year, quarterly data Durables from year, quarterly data Total Retail and Food Services Sales from year, quarterly average *Data from Jan. to the present are on a NAICS basis;data prior to Jan. are on an SIC basis and are not strictly comparable (see End Note). Debt Service Payments and Household Debt Outstanding from year, quarterly data of disposable personal income - Debt Service Payments Household Debt Outstanding

13 updated through 7// Real Disposable Personal Income Personal Saving Rate National Economic Trends Real Consumption Compounded annual s of change Real Consumption Retail & Food Services Total (bar) Real Durables Consumption & Vehicle Sales Millions of vehicles, annual Durables (bar) Ex. - Autos Autos and Light Trucks Consumer Sentiment (U. of Michigan) Index Real Durables Consumption Compounded annual s of change

14 National Economic Trends updated through // Investment of nominal GDP Total Private Private Fixed Investment from year Nominal Real Real Nonresidential Fixed and Equipment & Software Investment from year Equipment & Software Nonresidential Real Residential Fixed Investment from year

15 updated through 7// National Economic Trends Gross Saving Rates and Balance on Current Account (NIPA) of GDP - - Gross Private Saving Gross Govt. Saving BOCA Real Private Fixed Investment Compounded annual s of change Nondefense Capital Goods Orders from year, excluding aircraft Orders Equipment & Software Investment Real Equipment & Software Investment Compounded annual s of change Real Nonresidential Fixed Investment Compounded annual s of change Real Residential Fixed Investment Compounded annual s of change Housing Starts and New Home Sales Millions, annual Millions, annual New Home Sales Housing Starts

16 National Economic Trends updated through // Govt. Consumption and Investment Billions of dollars 7 Govt. Current Receipts and Expenditures of GDP Total Expenditures Total State & Local 7 Total Receipts Fed. Expenditures Federal Fed. Receipts Government Budgets Billions of dollars National Income Accounts Calendar s Unified Budget Fiscal s Receipts State and Local Federal Federal Expenditures Surplus or Deficit (-) Receipts Expenditures Surplus or Deficit (-) Receipts Outlays Surplus or Deficit (-) Q Q Q Q Q Q Q Q

17 updated through // Federal Debt of GDP 7 Total Held by Public Change in Federal Debt of GDP of GDP Unified Budget National Economic Trends Federal Surplus (+) / Deficit (-) NIPA NIPA: Net government saving. Federal Surplus (+) / Deficit (-), Unified Basis Billions of dollars, fiscal years Excl. interest payments Total Total - - Held by Public - - Federal Government Debt Billions of dollars, end of month or fiscal year Excludes Agency-issued debt Total Public Debt Held by Agencies and Trusts Held by Public Federal Total Reserve Banks Held by Private Investors Foreign and Total International March June September December March June September December March June September December March

18 National Economic Trends updated through 7// Current Account, Trade and Investment Income Balances Billions of dollars, quarterly of GDP Investment Income Current Account Goods and Services Exchange Rates Index, March 7 = Yen/US$ x (Ecu or Euro/US$) 7 Yen Major Currency Index Euro Ecu Goods Export Shares, Goods Import Shares, UK.% Mexico.% UK.% Mexico.% China.% All Other.7% China.% Japan.7% Japan.% Germany.% All Other 7.% Germany.% France.% Other OECD.% Canada.% France.7% Other OECD.7% Canada.%

19 updated through 7// Trade Balance Billions of dollars Goods and Services -7 Goods Goods Trade National Economic Trends from year - Exports - Imports Current Account Balance Billions of dollars - Services Trade from year Exports Imports Real GDP Growth of Major Trading Partners Compounded annual s of change United Kingdom Germany Canada France Japan Mexico

20 National Economic Trends updated through 7// Output per Hour and Capacity Utilization, Manufacturing from year Utilization Rate (level) 7 Output/Hour *Data from 7 to the present are on a NAICS basis;data prior to 7 are on an SIC basis and are not strictly comparable (see End Note). Nonfarm Compensation per Hour from year Nominal Real Output per Hour, Nonfarm Business and Nonfinancial Corporations from year Nonfinancial Corporations Nonfarm Business Sector

21 updated through // National Economic Trends Nonfarm Output per Hour Compounded annual s of change Manufacturing Output per Hour Compounded annual s of change Selected Component Shares of National Income 7 Corpo Profits Proprietors' Income 7 Compensation Corpo Profits of GDP Profits (Before Tax) Profits (After Tax)

22 National Economic Trends updated through 7// June FOMC Projections Change in Real GDP (Q/Q) Actual - 7 Long Run Unemployment Rate (Q) 7 Actual 7 Long Run Change in PCE Price Index (Q/Q) Actual 7 Long Run Change in PCE Price Index Excluding Food and Energy Prices (Q/Q) Actual 7 Long Run

23 updated through 7// National Economic Trends FOMC Quarterly Projections for and : A Timeline Change in Real GDP for.. Change in Real GDP for. Oct..... Oct. 7 June. June. 7. Unemployment Rate for (Q) June Unemployment Rate for (Q) Oct. Oct. 7 June 7 Change in PCE Price Index for Change in PCE Price Index for Oct. 7 June Oct. June 7 Change in PCE Core Price Index for Change in PCE Core Price Index for June Oct. 7 June Oct. 7

24 National Economic Trends updated through // Billions of $ Nominal GDP Billions of $ Real GDP Billions of $ Final Sales Change in Private Inventories Billions of $ Last qtr / Billions of $ Consumption Durables Consumption Billions of $ Private Fixed Investment Billions of $ Nonresidential Fixed Investment Billions of $

25 updated through // National Economic Trends GDP Chain Price Index Employment Cost Index ECI: Wages ECI: Benefits Index Index Index Index Exports Imports Nonfarm Output per Hour Nonfarm Compensation per Hour Billions of $ Billions of $ Index Index

26 National Economic Trends updated through 7// Household Survey Employment Thousands Change Nonfarm Payroll Employment Thousands Change Nonfarm Aggregate Hours Index Monthly Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

27 updated through 7// National Economic Trends Unempl. Rate Retail and Food Services Sales Billions of dollars Monthly/ quarterly Index Industrial Production Monthly/ quarterly Treasury Yields () -mo -yr Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

28 National Economic Trends Index Consumer Price Index Monthly/ quarterly to date Index Consumer Price Index less Food and Energy Monthly/ quarterly to date updated through 7// Producer Price Index Finished Goods Index Monthly/ quarterly Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

29 National Economic Trends Notes Pages, : Final Sales is gross domestic product (GDP) minus change in private inventories. Advance, Second, and Third GDP Growth Rates are released during the first, second, and third months of the following quarter. Changes result from incorporation of more complete information. Real GDP is measured in dollars. The ISM (formerly Purchasing Managers ) Index is a weighted average of diffusion indexes for new orders, production, supplier deliveries, inventories, and employment. Aggregate and Average Weekly Hours are paid hours of production and nonsupervisory employees. The Inventory-Sales Ratio uses nominal (current-dollar) inventory and sales data. Page : For information on how to calculate the Contribution of a component to the overall GDP growth, see the October issue of the Survey of Current Business, p.. The sign is changed for Imports. Page 7: Ten-year Treasury Yields are adjusted to constant maturity; threemonth yields are secondary market averages. All s used in the yield curves are adjusted to constant maturity. Standard and Poor s Index with Reinvested Dividends shows the total return: capital gains plus dividends. Pages, : Oil (West Texas intermediate) and Natural Gas (Henry Hub) spot and futures prices are listed in the Wall Street Journal. Spot prices are monthly averages of daily prices; futures prices are usually taken from the last trading day of the month. Consumer Price Index is for all urban consumers. The Consumption Chain Price Index is the index associated with the personal consumption expenditures component of GDP. The Employment Cost Index (ECI) covers private nonfarm employers. ECI Compensation refers to a fixed sample of jobs, while Compensation per Hour covers all workers in the nonfarm business sector in a given quarter. In both cases, compensation is wages and salaries plus benefits. Pages, : Effective with the January Employment Situation, the establishment survey data for employment, hours, and earnings have been converted from the NAICS system to the 7 NAICS system. For more information see Nonfarm Payroll Employment is counted in a survey of about, establishments (Current Employment Statistics). It excludes self-employed individuals and workers in private households, but double-counts individuals with more than one job. The Household Survey (Current Population Survey) of about, households provides estimates of civilian employment, unemployment, labor force participation, and employment-population ratio. Population is civilian, noninstitutional, years and over. The percent confidence intervals for the unemployment (±. percentage points) and change in household survey employment (±,) measure uncertainty due to sample size. Because the household survey was changed in January, data prior to this date are not strictly comparable. The Bureau of Labor Statistics announced several revisions to the Household Survey on Feb. 7,, with the release of the January data. For more information, see < The Job Openings is the number of job openings on the last business day of the month as a percent of total employment plus job openings. Page : The Michigan Consumer Sentiment Index shows changes in a summary measure of consumers answers to five questions about their current and expected financial situation, expectations about future economic conditions, and attitudes about making large purchases. The survey is based on a representative sample of U.S. households. Page : Gross Private Saving is the sum of personal saving, undistributed corpo profits with IVA and CCAdj (see notes for pp. -), and private wage accruals less disbursements. Gross Government Saving is net government saving (surplus/deficit) plus consumption of fixed capital. Balance on Current Account (NIPA) is net capital transfer payments to the rest of the world plus net lending or net borrowing (international trade and income flows). Pages, 7: Government Consumption and Investment is current expenditures on goods and services, including capital consumption (depreciation) and gross investment, as reported in the NIPAs. The Unified Federal Budget Surplus/Deficit differs from NIPA Basis in four main ways: () NIPA excludes transactions involving existing assets; () NIPA outlays exclude government investment and include consumption of government capital, while unified budget outlays do the reverse; () NIPA accounts exclude Puerto Rico and U.S. territories; and () various timing issues are handled differently. Outlays and Receipts are from the NIPAs, except as noted. Since 77, the federal Fiscal starts on October. Excluded agency debt was. percent of federal debt at the end of fiscal 7. Federal Debt Held by the Public includes holdings of the Federal Reserve System and excludes holdings of the social security and other federal trust funds. Federal grants in aid to state and local governments appear in both state and local receipts and federal outlays. Pages, : The Trade Balance (shown on a balance of payments basis) is the difference between exports and imports of goods (merchandise) and services. It is nearly identical in concept to the Net Exports component of GDP, but differs slightly in accounting details. The Investment Income Balance equals income received from U.S.-owned assets in other countries minus income paid on foreign-owned assets in the U.S. The investment income balance is nearly identical in concept to the difference between gross national product and gross domestic product, but differs in accounting details. The Current Account Balance is the trade balance plus the balance on investment income plus net unilateral transfers to the U.S. from other countries. Pages, : Output per Hour (Y/H), Unit Labor Cost (C/Y), and Compensation per Hour (C/H) are indexes which approximately obey the following relationship: %(Y/H) + %(C/Y) = %(C/H) with %() meaning percent changes. Unit labor cost is shown on page. Real Compensation per Hour uses the CPI to adjust for the effects of inflation. Nonfarm business accounted for about 77 percent of the value of GDP in, while nonfinancial corporations accounted for about percent. Inventory Valuation Adjustments (IVA) remove the effect of changes in the value of existing inventories from corpo profits and proprietors income. (This change in value does not correspond to current production and therefore is not part of GDP). Capital Consumption Adjustments (CCAdj) increase profits and proprietors income by the difference between estimates of economic depreciation and depreciation allowed by the tax code. Components of national income not shown are rental income of persons and net interest. Pages, : The economic projections of the Federal Open Market Committee (FOMC) are published four times a year. Except for the unemployment, the projections for the current and following years are on a Q/Q horizon. The shaded area represents the range of the economic projections of the FOMC members, and the dot signifies the mid-point of the ranges. The projections of the changes in the total PCE price index and the core PCE price index (excluding food and energy prices) are presumed to converge over time. Sources Bureau of Economic Analysis (BEA), U.S. Dept. of Commerce National income and product accounts, international trade and investment data (except by country), auto and light truck sales. Census Bureau, U.S. Dept. of Commerce Inventory-sales ratios, retail sales, capital goods orders, housing starts, exports and imports by country. Bureau of Labor Statistics (BLS), U.S. Dept. of Labor All employment-related data, employment cost index, consumer and producer price indexes, unit labor cost, output per hour, compensation per hour, multifactor productivity. United States Department of Treasury Unified budget receipts, outlays, deficit, debt. Federal Reserve Board Index of industrial production, treasury yields, exchange s, capacity utilization, household debt. The Survey Research Center, The University of Michigan Consumer sentiment index. Organization for Economic Cooperation and Development (OECD) GDP for major trading partners (not available on FRED).