Economic Update Boston 2011

1

ECONOMIC DEVELOPMENTS FOR THE U.S. AND N.E.

REVIEW OF MONETARY POLICY ACTIONS

PRESIDENTS’ FORUMTHE ENTREPRENEURSHIP INSTITUTE

JEFF FUHRER, EVP AND SENIOR POLICY ADVISORFEDERAL RESERVE BANK OF BOSTON

OCTOBER 6, 2011

2

First, my apologies

2012

FED ECONOMIST

Jeff

3

Economic Developments: Challenges Ahead

The outlook Tepid growth likely

Recent data suggest growth of 2-2.5% in second half

High unemployment for a while—Structural? Housing likely to be weak for some time Elevated inflation (how to interpret recent rises?) Concern over developments in Europe

Some recent positive signs Initial claims down, capital goodsorders up, ISM up a bit Suggests continued slow growth 0

75001500022500300003750045000525006000067500

0

100

200

300

400

500

Cap. Goods ordersInitial ClaimsISM index

4

…but nothing as bad as this!

(cats and dogs living together—a sign

of the Apocalypse)

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The recovery has lost steam

2009:Q3

2009:Q4

2010:Q1

2010:Q2

2010:Q3

2010:Q4

2011:Q1

2011:Q2

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

GDP growthLong-run sus-tainable growth

Sources: Bureau of Economic Analysis, Haver Analytics

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The labor market:Slowing job growth, rising unemployment

-1000

-800

-600

-400

-200

0

200

400

4

5

6

7

8

9

10

11Labor markets

3-mo. Avg. change, total em-ployment

3-mo. Avg. change, private employment3

-mon

th a

vera

ge c

han

ge i

n

em

plo

ym

en

t

Civ

ilia

n u

nem

plo

ym

en

t ra

te, %

of

lab

or

forc

e

Employment growth

Total Private

August 0 17

June-Aug avg

35 83

Sources: Bureau of Labor Statistics (employment, initial claims), Haver Analytics

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Structural unemployment?

ConstructionManufacturing

Wholesale tradeRetail trade

MVTransportation

InformationFinancial

Prof. and Bus. ServicesEduc. And Health

Leisure and hospitalityGovernment

-30 -25 -20 -15 -10 -5 0 5 10

Peak-to-trough employment declines during the recession were large and widespread,

across almost all sectors

PercentSources: Bureau of Labor Statistics, Haver Analytics

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Structural unemployment? Wages have decelerated noticeably over

the past two years Despite rather strong productivity growth

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

Avg. hourly earnings

Sources: Bureau of Labor Statistics , Haver Analytics

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Structural unemployment

Likely some increase in structural unemployment

But most of the rise has been due to very weak demand

However, a prolonged state of weak demand could turn cyclical unemployment into structural unemployment

This is a risk to monitor

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Weak housing continues

I know you were expecting me to huff and puff and all that. But it is the 21st century, so I’m just going

to foreclose on you. And then roast you with a nice honey glaze.

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Weak housing continues

200

200

200

200

200

200

200

200

200

200

200

200

201

201

201

201

201

0

200

400

600

800

1000

1200

1400

1600

1800

-25

-20

-15

-10

-5

0

5

10

15

20HousingSingle-family sales (left)Single-family permitsNational house price index excl. distressed sales (Core Logic, right scale)including distressed sales (right scale)

Th

ou

san

ds

12

-mon

th p

ctg

. ch

an

ge

Sources: Census Bureau (permits), National Association of Realtors (home sales), Core Logic (house price indexes), Haver Analytics

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Why is housing so weak? What will help it recover?

Low housing demand, sizable vacant stock 1/3-1/2 of existing home sales are REO, etc.

Why is demand weak? Unemployment Fear of job loss Low and falling house prices

Weak house price expectations mute demand Low house prices affect equity

What will help? We will return to this

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Negative Equity is a significant problem

Eliminates some down payments and thus weakens sales

Limits or eliminates refinancing options

22.5

5

72.5

Equity position as of 2011:Q2 (Core Logic)

Negative equityNear-negativePositive equity

Sources: Core Logic

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Expect a very challenged housing market for some time

200

200

200

200

200

200

200

200

200

200

200

200

201

201

201

201

201

201

201

201

300

400

500

600

700

800

900

Historical data

Macro Advisers Forecast

Real residential investment spending

Sources: Census Bureau, Macroeconomic Advisers

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A foreign threat

20080101200807312009030220090930201004302010113020110630-6.0

-1.0

4.0

9.0

14.0

19.0

24.0Sovereign spreads over comparable German

ratesGreeceIre-landPor-tugal

Sources: Reuters, Haver Analytics

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What to make of elevated inflation?

Both overall and so-called “core” measures have risen of late

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

4

Core CPI, 3-mo. ChgCore CPI, 6-mo. Chg.Core CPI, 12-mo. Chg.Cleveland Fed weighted median, year-over-year

Sources: Bureau of Labor Statistics (CPI), Federal Reserve Bank of Cleveland (weighted median), Haver Analytics

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Commodity price hikes signal widespread inflation?

Little influence of commodity prices on wages

Many temporary factors—auto prices (Japan), energy, food—have led to spikes in overall inflation

But no acceleration in wages—2/3 of production cost

2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 20

0.5

1

1.5

2

2.5

3

3.5

4

4.5

ECI (right scale)

Sources: Bureau of Labor Statistics , Haver Analytics

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Most likely inflation scenario

Commodity price pressures are easing We will see a gradual decline in inflation

to somewhere between 1 and 2%

Sources: The Wall Street Journal, Haver Analytics

201101032011020920110318201104262011060220110711201108172011092360708090

100110120130140150160

CopperWheatOilCotton

Ind

ex,

Jan

20

11

=

10

0

Jan. 2011

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New England has generally fared better than the rest of the country…

200

200

200

200

200

200

200

200

200

200

200

200

201

201

201

201

201

201

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0 Civilian unemployment ratesRI

US

CT

New England

MA

ME

NH

VT

… although the states

vary significantly

Sources: Bureau of Labor Statistics, Haver Analytics

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In part because the housing cycle was less pronounced here

1995

:Q1

1996

:Q1

1997

:Q1

1998

:Q1

1999

:Q1

2000

:Q1

2001

:Q1

2002

:Q1

2003

:Q1

2004

:Q1

2005

:Q1

2006

:Q1

2007

:Q1

2008

:Q1

2009

:Q1

2010

:Q1

2011

:Q1

100

120

140

160

180

200

220

240

260 House prices indexes, 1995=100

Boston (Case-Shiller)

NE (FHFA)

Ind

ex, 1

99

5:Q

1=

10

0

Sources: Case-Shiller, FHFA, Haver Analytics

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But delinquencies and foreclosures are still a

significant problem

20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 200

1

2

3

4

5

6 Delinquent 90 days or more, % of all mortgagesRI

USNECT

Sources: Mortgage Bankers’ Association, Haver Analytics

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Effective Macro Housing Policy

HAMP has not worked as well as hoped, HARP has not worked as well as hoped, Hope for Homeowners didn’t work at all

HAMP-UP has had very limited take-up What to do?

Forbearance for unemployed/economically stressed homeowners

Expedite unavoidable foreclosures Incentives to convert owner-occupied stock to rental stock House price insurance that limits exposure to severe price

declines Limit late “push-backs” by Fannie/Freddie (e.g. after 2 or 3

years) More dramatic measures?

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With the crisis now hitting close to home, we’re hopeful that effective action

will be taken soon

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What Hath the Fed Wrought?

Quick tour of our liquidity and alternative monetary policy efforts

The Crisis evolved in two phases:1. Liquidity crisis (shortage of short-term funds)2. Macro crisis

Made more complicated by the Zero Lower Bound We responded to the two phases with two

types of tools Lending to institutions that couldn’t get short-

term funds Pursuing policies to lower longer-term interest

rates (QE1, QE2, “Twist”)

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What the Fed did and whyPhase I: Liquidity programs

Enormous effort to fix short-term credit markets (“liquidity”)

2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 20

200

400

600

800

1000

1200

Assets on the Federal Reserve Balance Sheet

CB Swaps CPFF TAF

Bil

lio

ns o

f $

Sources: Federal Reserve Board H.4.1 Release, Haver Analytics

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What the Fed did and why Hitting the Zero Lower Bound

20 20 200 20 20 20 20

0 20 20 20 200 20 20 20 20

1 200

1

2

3

4

5

6Target federal funds rate

At the “zero lower bound”

Sources: Haver Analytics

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What the Fed did and whyPhase II: Macro stimulus programs

Liquidity policies phase out, macro stimulus policies phase in, viz our balance sheet

0

500000

1000000

1500000

2000000

2500000

3000000

Agency and MBS

CB Swaps

CPFF

TAF

Treasuries

Sources: Federal Reserve Board H.4.1 Release, Haver Analytics

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Phase II: Alternative ways to stimulate the economy

We’re stuck at the ZLB How do we normally affect the economy?

By moving the federal funds rate This in turn affects key borrowing rates:

Auto loans Mortgages Business loans Education loans

Also effects equity valuations, the exchange value of the dollar

When stuck at the ZLB, pursue policies to affect these rates directly

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Our latest alternative policy: Operation Twist (II)

Leaves size of balance sheet the same Sell short-term Treasuries, buy long-term

Goal: to lower long-term interest rates

Likely effects Lower long-term rates (15-25bps)—pretty confident Spur spending, increase jobs 0.5-0.7M—less confident

Fed Balance Sheet: AssetsBefore Twist

After Twist

Short-term Treasury securities (3 years or less, incl. Bills)

$535B $135B

Long-term Treasury securities (6 years or greater)

$567B $967B

Mortgage-backed securities $995B $995B

Sources: Federal Reserve Bank of New York, http://www.newyorkfed.org/markets/soma/sysopen_accholdings.html

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…and a small measure to help housing

Re-investing maturing/prepaid MBS back into MBS

Reverse some of the widening spread between mortgage rates and Treasuries

201101032011021620110401201105172011063020110815201109281.52.02.53.03.54.04.55.05.5

1.2

1.4

1.6

1.8

2.0

2.2

2.4

30-year fixed rate mortgage (left scale)

Sources: Federal Reserve Board H.15 Release (10-year Treasury yield), NY Times (30-year mortgage rate), Haver Analytics

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Summary

It has been a fascinating period

The Fed has done things it never did before

To accomplish two goals: Keep financial markets working, so that

business can continue To directly stimulate the economy, to create

economic growth and employment