San Antonio Business and Economics Society October 27, 2004 The U.S. Economic Outlook: Soft Patch, Sink Hole, or Springboard? Kevin L. Kliesen Economist, Federal Reserve Bank of St. Louis Not an official Document
Outline of Talk Current Conditions (are we past the soft patch?) The Consensus Forecast Risks to the Consensus Forecast
Current Conditions Economic conditions firm in the third quarter, following the second-quarter soft patch Economic activity hit a soft patch in late spring after having grown briskly in the second half of 2003 and the first part of 2004... That softness in activity no doubt is related, in large measure, to this year's steep increase in energy prices. Chairman Greenspan, Congressional Testimony, September 18, 2004
Tracking Forecast: 2004/Q3 Real GDP Growth Percent 6 5 4 4.1 4.2 4.3 3.6 3.6 3.5 4 5 4 Baseline Baseline Baseline Baseline 3 Current Qtr Forecast Current Qtr Forecast Current Qtr Forecast 2 1 0 6/29/2004 7/2/2004 7/13/2004 7/15/2004 7/28/2004 8/3/2004 8/12/2004 8/17/2004 8/25/2004 9/1/2004 9/8/2004 9/14/2004 9/21/2004 10/1/2004 10/4/2004 10/14/2004 10/15/2004 10/25/2004 Source: Macroeconomic Advisers
Current Conditions Economic conditions firm in the third quarter, following the second-quarter soft patch Payroll employment growth weakened in 2004:Q3, but hours growth accelerated at fastest rate in more than 7 years
Payroll Employment During the Current & Average Business Cycle 6 5 4 3 2 1 0-1 -2-3 Percentage Difference from Peak Value Average Business Cycle 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Quarters After Peak NOTE: Average excludes the 1980 peak; post-ww II period. Current Business Cycle
Real GDP Growth and the Hours Growth Gap Real GDP 6 5 4 3 2 1 0 Percent change, four quarters earlier 1994 1996 1998 2000 2002 2004 Hours 2 1.5 1 0.5 0-0.5-1 -1.5-2 -2.5 Hours Gap Real GDP Growth NOTE: Hours gap is the four-quarter growth of nonfarm hours less the four-quarter growth of aggregate nonfarm employment.
Current Conditions Economic conditions firm in the third quarter, following the second-quarter soft patch Payroll employment growth remains relatively weak, but hours growth accelerates Monetary policy remains accommodative; FOMC moving in a measured pace toward neutrality Oil prices move past $50/bbl, but inflation expectations remain stable
Financial Market Inflation Expectations Percent 4 Weekly Data 3 2 1 1999 2000 2001 2002 2003 2004 10-Year 30-Year NOTE: Yield spreads between nominal and inflation-indexed U.S. Treasury securities.
Consensus Forecast Key assumptions
Consensus Forecast Key assumptions Continued strong structural productivity growth boosts real incomes, spending, and holds down growth of unit labor costs and prices
Four- and 40-Quarter Growth Rates of Nonfarm Labor Productivity Percent 8 6 4 2 0-2 -4 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 4-Qtr 40-Qtr
Consensus Forecast Key assumptions Continued strong structural productivity growth boosts real incomes, spending, and holds down growth of unit labor costs and prices Robust profits, low cost of capital keeps business capital spending growing briskly Weaker foreign growth in 2005
U.S. & Foreign Economic Growth Rates Percent Change 4.5 4 3.5 3 2.5 2 1.5 1 0.5 0-0.5 2002 2003 2004 (F) 2005 (F) U.S.A. Canada Mexico Japan Euroland SOURCE: Blue Chip Economic Indicators (October 10, 2004)
Forecasts for 2004 and 2005
Forecasts of Major GDP Components 6 5 4 3 2 1 0 Consumer Spending 4.4 3.6 3.4 3.5 3.2 2.6 1.6 2004:Q2 2004:Q4 2005:Q2 2005:Q4 18 15 12 9 6 3 0-3 -6-9 Fixed Investment 13.4 11.4 12.4 10.3 9.0 5.7 2.9 2.7-4.9-5 -6.1-7 2004:Q2 2004:Q4 2005:Q2 2005:Q4 Business Residential Govt. Spending Net Exports 3-500 2 1 2.2 1.7 1.5 1.7 2.0 1.9 1.9-520 -540-560 -580-600 -580.3-584.0-585.6-569.9-553.3-534.7-520.6 0 2004:Q2 2004:Q4 2005:Q2 2005:Q4 2004:Q2 2004:Q4 2005:Q2 2005:Q4 Source: Macroeconomic Advisers
Risks to the Forecast Oil prices continue to rise, weakening consumer spending and heightening business uncertainty
Cumulative 12-Month Percent Changes in Real WTI Prices During Oil Shock Episodes (Zero Otherwise) Percent 2000 1800 1600 1400 1200 n = 26 n = 21 n = 22 1000 800 600 n = 26 400 200 n = 15 n = 16 0 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004
Percent change, annualized 5.00 Effects of $50/Bbl Oil on Real GDP Growth (Hamilton's methodology) 4.00 3.67 4.08 4.26 4.48 4.46 4.40 3.00 2.59 2.00 1.85 2.19 1.25 1.00 0.72 1.01 0.00 2004:Q3 2004:Q4 2005:Q1 2005:Q2 2005:Q3 2005:Q4 Real GDP Growth (Baseline) Real GDP Growth (Adjusted for Change in Oil Prices) NOTE: Calculations based on methodology formulated by Hamilton (2003). Assumes spot price of WTI averages $50 per barrel from 2004:Q4 through 2005:Q4.
Increased Energy Efficiency: Partial Offset to Higher Prices SOURCE: U.S. Energy Information Administration
Simulating the Effects of Higher Oil Prices Using a Structural Forecasting Model SOURCE: Macroeconomic Advisers (October 2004)
Risks to the Forecast Oil prices continue to rise, weakening consumer spending and heightening business uncertainty Low real interest rates cause demand growth to increase faster than expected inflationary effects from tighter labor and product markets offset Output gap not as large as consensus forecast suggests; in actuality monetary policy too accommodative
Percent 12 Hypothetical Neutral Federal Funds Target Rates 10 8 6 4 2 Gap 0 1988 1992 1996 2000 2004 Neutral, 1% Inflation Target Actual Fed Funds Target Rate Neutral, 2% Inflation Target NOTE: Hypothetical fed funds target rate is the sum of the 40-quarter annualized growth rates of labor productivity and labor force growth, plus an assumed inflation target of either 1 or 2 percent.
Year-to-date Core PCE inflation rates and the FOMC s inflation projection for 2004 made in July 2004 Percent 3 2 FOMC Central Tendency (1.75 to 2.0%) 1 Core inflation, Jan. Aug. 1.4 0 Jan Mar May Jul Sep Nov 2004
Questions?