Economic Outlook and Forecast Stefano Eusepi Research & Statistics Group January 2017 All views expressed are those of the author only and not necessarily those of the Federal Reserve Bank of New York or the Federal Reserve System.
Mandate, Instruments, and Decisions Fed s dual mandate Maximum employment Price stability Instruments In normal times: Federal Funds Rate Unusual circumstances: asset purchase programs Monetary policy decisions Adjust instruments to meet mandate
The Role of Forecasts in Monetary Policy Because of policy lags, the FOMC needs a sense of: Where the economy stands Where it is likely to go Adjust policy if forecasts point to undesirable outcomes Staff provide forecasts of output, unemployment, inflation Also discuss risks A forecast = set of numbers + narrative + risks What assumptions are behind the forecast? Where is it most likely to go wrong?: alternative scenarios
Your Task Give reasoned views on the current state of the economy Given the state of the economy and policy (both monetary and fiscal), present a reasoned view of where the economy is likely to go Discuss risks to the forecast Then discuss possible changes in policy Benefits and costs of policy options
Assessing Current Economic Conditions Concentrate on GDP GDP = Consumption + Investment + Gov t Spending + Exports Imports Why GDP? Rapid real GDP growth is usually connected with job growth and declining unemployment. A high level of real GDP relative to potential GDP (large output gap) is usually associated with higher inflation. Recall dual mandate!
Assessing GDP GDP estimates take time and are subject to revision Need to look at monthly indicators Two approaches: 1. Production-side indicators Hours worked, business activity measures, industrial production 2. Expenditure-side indicators Data for each expenditure category Examples: Retail sales, shipments of capital goods, trade Use judgment in reconciling the two approaches
Assessing GDP: Production Side Labor hours useful for assessing GDP GDP = hours worked * output per hour (labor productivity) Hours information: much comes from monthly labor market report (Bureau of Labor Statistics) Using hours is limited by volatility of productivity growth Least helpful at turning points of the business cycle
GDP Growth and Hours Worked 4 Quarter % Change 4 Quarter % Change 10 8 6 4 2 0-2 -4-6 -8 GDP > Hours Worked = Higher Productivity GDP < Hours Worked = Lower Productivity -10 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: Bureau of Labor Statistics and Bureau of Economic Analysis Hours Worked GDP Growth 10 8 6 4 2 0-2 -4-6 -8-10
ISM Business Activity Survey Measures Index, 50+ = rising activity 70 65 Index, 50+ = rising activity 70 Nonmanufacturing Index 65 60 55 50 45 40 35 Manufacturing Index 60 55 50 45 40 35 30 30 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: Institute of Supply Management Note: Shading shows NBER recessions.
Assessing GDP: Expenditures Side Assess GDP through monthly indicators of each expenditure component For example: private consumption and investment
Consumption: Real PCE and Personal Savings Rate 12 Month % Change Percent of Disposable Income 12 12 10 8 6 4 2 0 Personal Savings Rate (Right Axis) 10 8 6 4 2 0-2 Real PCE (Left Axis) -4 2000 2002 2004 2006 2008 2010 2012 2014 2016-2 -4 Source: Bureau of Economic Analysis Note: Shading represents NBER recessions;
Investment: Shipments of Capital Goods Ex. Aircraft Billion US $ Billion US $ 75 75 70 70 65 65 60 60 55 55 50 50 45 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: Census Bureau 45 Note: Shading shows NBER recessions.
Assessing GDP: Other Expenditure Indicators Consumption: Auto sales (Bureau of Economic Analysis from motor vehicle manufacturers sales reports) Retail sales (Census Bureau) Investment: Housing starts (Census Bureau) Total business Inventories (Census Bureau) Construction (Census Bureau) Exports and Imports: Monthly trade balance (Bureau of Economic Analysis)
Developing a Forecast Forecasters use both economic models and judgment Based partly on previous business cycle patterns Expenditure components in typical expansions: Inventories lead followed by consumption and homebuilding Business fixed investment spending follows later GDP and productivity growth usually rapid early in the expansion Employment growth typically sluggish at the start Unemployment rate has risen early in recent expansions Financial market signals also may be important
Developing a Forecast: Telling a Story Yet, every business cycle is different! Compare current developments to previous business cycles What is different this time? Why is it different? Consider temporary and long-lasting factors Temporary: effects of very low oil prices Long-lasting: global structural slump
A Very Unusual Occurrence at This Stage of the BC Ratio, 1.0 at Peak 1.35 1.30 1.25 1.20 1.15 1.10 1.05 1.00 0.95 2001 Cycle Level of Real GDP 1973 Cycle 1981 Cycle 1990 Cycle Ratio, 1.0 at Peak 1.35 Current Cycle 0.90-2 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 Quarters Since NBER Peak Source: Bureau of Economic Analysis 1.30 1.25 1.20 1.15 1.10 1.05 1.00 0.95 0.90
Also an Unusual Occurrence Non-farm Payroll Employment Ratio, 1.0 at Peak 1.2 1973 Cycle 1.15 1.1 Ratio, 1.0 at Peak 1.2 1.15 1.1 1.05 1981 Cycle 1990 Cycle 1.05 1 1 0.95 2001 Cycle Current Cycle 0.95 0.9-6 0 6 12 18 24 30 36 42 48 54 60 66 72 78 84 90 96 102 Months Since NBER Peak Source: Bureau of Labor Statistics 0.9
A New Normal? Not so Fast Ratio, 1.0 at Peak 1.25 Output/Hour (Nonfarm Business Sector) Ratio, 1.0 at Peak 1.25 2001 Cycle 1.20 1.20 1.15 1990 Cycle 1.15 1.10 1973 Cycle 1981 Cycle 1.10 1.05 Current Cycle 1.05 1.00 1.00 0.95-2 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 Quarters Since NBER Peak Source: Bureau of Labor Statistics 0.95
A New Normal? Not so Fast Ratio, 1.0 at Peak 1.80 Exports Ratio, 1.0 at Peak 1.80 1.60 1.40 1990 Cycle 1.60 1.40 1.20 Current Cycle 1.20 1.00 0.80 2001 Cycle 1981 Cycle -2 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 1.00 0.80 Quarters Since NBER Peak Source: Bureau of Economic Analysis
Developing a Forecast: Telling a Story Let s look at household spending Consumer expenditures Residential investment (housing)
A Slow Recovery in Consumer Spending Ratio, 1.0 at Peak 1.40 Ratio, 1.0 at Peak 1.40 1.30 1.30 1.20 1981 Cycle 2001 Cycle 1.20 1.10 1.00 1990 Cycle Current Cycle 1.10 1.00 0.90-2 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 0.90 Quarters Since NBER Peak Source: Bureau of Economic Analysis
Residential Investment Still Recovering Ratio, 1.0 at Peak 2.00 Ratio, 1.0 at Peak 2.00 1.75 1.50 1.25 1.00 0.75 1973 Cycle 1981 Cycle 1990 Cycle 2001 Cycle Current Cycle 1.75 1.50 1.25 1.00 0.75 0.50-2 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 0.50 Quarters Since NBER Peak Source: Bureau of Economic Analysis
Household Spending recovering? Wealth Percent of Disposable Income Percent of Disposable Income 700 700 650 650 600 600 550 500 Net Worth / Disposable Income 550 500 450 450 400 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: Federal Reserve Board 400 Note: Shading shows NBER recessions.
and a Lower Burden Percent of Net Worth 32 Percent of Net Worth 32 28 28 24 20 Total Liabilities / Net Worth 24 20 16 16 12 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: Federal Reserve Board 12 Note: Shading shows NBER recessions. Data represent households and nonprofit organizations.
Developing a Forecast: Policy Effects Monetary and fiscal policy will affect the outlook, particularly at turning points Analysts estimate policy influence on the economy Tax cuts should boost demand (more money for consumers, incentives to hire and expand capacity for firms) More government spending may boost demand Monetary policy: lower interest rates encourage consumption and business spending Current issue: how fast should be the pace of policy normalization Challenge: what about the size of the balance sheet?
State and Local Government Expenditures Ratio, 1.0 at Peak Ratio, 1.0 at Peak 1.30 1.30 1981 Cycle 1.20 1.10 1.00 1990 Cycle 1973 Cycle 2001 Cycle Current Cycle 1.20 1.10 1.00 0.90-2 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 Quarters Since NBER Peak Source: Bureau of Economic Analysis 0.90
Federal Government Expenditures Ratio, 1.0 at Peak 1.50 Ratio, 1.0 at Peak 1.50 1.40 1981 Cycle 1.40 1.30 1.30 1.20 2001 Cycle 1.20 1.10 1.00 1973 Cycle Current Cycle 1.10 1.00 0.90 1990 Cycle 0.90 0.80-2 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 Quarters Since NBER Peak Source: Bureau of Economic Analysis 0.80
Developing a Forecast: Unemployment Challenge to forecast unemployment rate Will firms increase hours per worker or number of workers? What will productivity do? Higher productivity implies lower employment for given GDP level How will the labor force participation rate behave? Stronger labor market: more people looking for jobs, which could put upward pressure on the unemployment rate and vice versa
Unemployment is low; So is Participation Percent 11 10 9 8 Participation Rate (Right Axis) Percent 68 67 66 7 6 5 4 Unemployment Rate (Left Axis) 65 64 63 3 62 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: Bureau of Labor Statistics Note: Shading shows NBER recessions.
Developing a Forecast: Inflation Price stability goal: overall inflation Overall inflation can fluctuate considerably Volatile energy and food prices Underlying inflation measures (ex. core inflation) Impact of more persistent factors Example: monetary policy stance Other factors influencing the inflation outlook Supply side: wages and productivity Demand side: output gap Downward pressure on core inflation if GDP < potential GDP But inflation expectations matter (a lot!)
Total and Core PCE Deflator 12 Month % Change 12 Month % Change 4.5 4.5 4 4 3.5 Total PCE 3.5 3 3 2.5 2.5 2 2 1.5 1.5 1 1 0.5 Core PCE 0 0.5-0.5 0-1 -0.5-1.5-1 -2-1.5 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: Bureau of Economic Analysis Note: Shading shows NBER recessions.
Inflation: Compensation and Unit Labor Costs 12 Month % Change Nonfarm Business Sector 12 Month % Change 10 10 8 6 Compensation Per Hour 8 6 4 2 0-2 -4 Unit Labor Cost 4 2 0-2 -4-6 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: Bureau of Labor Statistics -6 Note: Shading shows NBER recessions.
External Factors: Dollar Appreciation USD/Euro 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 USD/Euro 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 0 2002 2004 2006 2008 2010 2012 2014 2016 Source: Federal Reserve Board Note: Shading shows NBER recessions.
External Factors: Oil and Commodity Prices $/Barrel Index (1967=100) 160 600 140 120 100 80 60 40 20 CRB Commodity Price Index (Right Axis) West Texas Intermediate, Cushing (Left Axis) 500 400 300 200 100 0 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: Commodity Research Bureau & CME Note: Shading shows NBER recessions. 0
Inflation Expectations Percent 3 Percent 3 2.5 2 Median threeyear ahead expected inflation rate 2.5 2 1.5 1.5 1 1 0.5 2013 2014 2015 2016 Source: Federal Reserve Bank of New York 0.5
Risks and Alternative Scenarios A central forecast is important but need to evaluate risks Think about why a forecast could be wrong Examples. We had a very long expansion: are we close to a Recession in the US? Global growth, dollar appreciation (Policy Divergence); Commodity and oil prices, China. Upside and downside risks to economic activity and inflation Assess the balance of those risks Consequences for monetary policy: Downside risk to economic growth or risk of deflation may require a more aggressive policy response
Example: Alternative Scenarios Produced using in-house macro-economic models Quarters Quarters
Example: Alternative Interest Rate Paths Quarters
Conclusion Forecasts respond to incoming data Outlook also includes a sense of the risks How likely for growth to be stronger than forecast? Comparison to previous business cycles helps to frame a forecast Important to assess and discuss factors influencing the outlook Example: global weakness as headwind