Testimony for Hearings on FY 2008 Revenues Yolanda K. Kodrzycki Senior Economist and Policy Advisor Federal Reserve Bank of Boston Presented to: Massachusetts.

Testimony for Hearings on FY 2008 Revenues

Yolanda K. KodrzyckiSenior Economist and Policy Advisor

Federal Reserve Bank of Boston

Presented to:

Massachusetts House and Senate Ways and Means CommitteesJanuary 16, 2007

2

Summary of testimony

• Massachusetts economy poised to show moderate output and income growth in CY 2007.

• Projection premised on U.S. economy growing at or a little below its trend rate.

• Housing sector will put a damper on overall U.S. and MA economic growth in CY 2007.

• Labor force slowdown in MA poses longer-term uncertainties, but implications for revenue estimates not clear.

3

U.S. economic outlook for CY 2007

• Moderate growth expected– 2006: GDP grew at approximately its potential (trend)

2007: growth expected to be similar or a little weaker

• Energy prices– Recent declines boost real income and ease inflation

• Housing market– Presents a challenge

4

300

500

700

900

1100

1300

1500

Nov-90 Nov-92 Nov-94 Nov-96 Nov-98 Nov-00 Nov-02 Nov-04 Nov-06

2000

3000

4000

5000

6000

7000

Sales are down, but they appear to be flattening…

Source: Census Bureau.

Construction has slowed significantly, and will continue to slow…

New single-family sales (left scale)

Existing single-family sales (right scale)

Thousands of units, annual rates Thousands of units, annual rates

110012001300140015001600170018001900

Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06

Single-family permits

Single-family housing starts

Thousands of units, annual rates

Weak housing market is slowing the economy

5

… until the large stock of unsold homes are purchased

3.0

4.0

5.0

6.0

7.0

8.0

Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06

Nationwide, house prices have flattened.

Months’ supply of new 1-family homes at current sales rate

Ratio

OFEHO U.S. House Price Index (right scale)

New Home Sales, Median Price (left scale)

Dollars Index, 1980:Q1 = 100

Source: Office of Federal Housing Oversight (house price index) and Census Bureau.

150000

175000

200000

225000

250000

2002:Q32003:Q12003:Q32004:Q12004:Q32005:Q12005:Q32006:Q12006:Q3

250.00

300.00

350.00

400.00

450.00

6

But the consumer remains upbeat

126000128000130000132000134000136000138000

Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06

104000106000108000110000112000114000116000

Employment continues to expand steadily

Source: Bureau of Labor Statistics.

-400-300-200-100

0100200300400

Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06

Recent job growth has been a bit above the rate consistent with maintaining full employment

Monthly employmentgrowth consistentwith growth in the

labor force

Total nonfarm employment (left scale)

Private nonfarm employment (right scale)

Thousands Thousands

Change, 3-month moving average

Total nonfarm employmentaverage 3-month change

Private nonfarm employmentaverage 3-month change

7

Strong job growth and declining energy prices are boosting real incomes

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06

-3.00

-2.00

-1.00

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00Dollars per barrel

Real disposable personal income(right scale)

Domestic spot oil price(left scale)

Growth, previous 12 months

Sources: Wall Street Journal (oil) and Bureau of Economic Analysis (real DPI).

8

Capital spending fundamentals remain reasonable

47000

52000

57000

62000

67000

72000

Nov-03 May-04 Nov-04 May-05 Nov-05 May-06 Nov-06

Orders are running a bit ahead of shipments,suggesting modest investment growth

Source: Census Bureau (top panel) and Bureau of Economic Analysis (bottom panel).

Profits and productivity continue to promote investment

0.01.02.03.04.05.06.0

2000:Q3 2001:Q3 2002:Q3 2003:Q3 2004:Q3 2005:Q3 2006:Q3

5.0

6.0

7.0

8.0

9.0

$ Millions, SAAR

Manufacturers’ shipments of nondefensecapital goods excluding aircraft

Manufacturers’ new orders for nondefensecapital goods excluding aircraft

Growth, previous 4-quarters Share of GDP

Profit Share (right scale)Nonfarm productivity(left scale)

9

4.00

4.50

5.00

5.50

6.00

6.50

6/ 5/ 06 7/ 5/ 06 8/ 5/ 06 9/ 5/ 06 10/ 5/ 06 11/ 5/ 06 12/ 5/ 06 1/ 5/ 07

Financial conditions remain supportive

0.94

0.99

1.04

1.09

1.14

6/ 5/ 06 7/ 5/ 06 8/ 5/ 06 9/ 5/ 06 10/ 5/ 06 11/ 5/ 06 12/ 5/ 06 1/ 5/ 07

Broad stock price indexes are up over the past year

And the 10-year Treasury remains below 5%, with corporate yields maintaining recent spreads

Sources: Wall Street Journal (Dow Jones and Wilshire), Standard and Poor’s (S&P 500), Board of Governorsof the Federal Reserve System (treasury yield) and Merrill Lynch (Corporate yield).

Index, 6/1/2006 = 1.0

Dow Jones Industrial Average

Wilshire 5000

S&P 500

10-year Treasury rate, constant maturity

7-10 year Investment grade corporate yield

Percent

10

Massachusetts economic conditions

• Employment recovery has been only so-so…

-Since recession low point, MA has added 56,000 jobs, or 1.8 percent (vs. 4.8 percent nationally).

• But personal income growth is now on track.

• And forward-looking indicators point to solid economic growth for CY 2007.

11

Massachusetts’ job growth has been up and down on a monthly basis, but fairly steady year-over-year.

-25-20-15-10-5

05

101520

Nov-99 Nov-00 Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06

-8

-6

-4

-2

0

2

4

6

8

Nov-91 Nov-92 Nov-93 Nov-94 Nov-95 Nov-96 Nov-97 Nov-98 Nov-99 Nov-00 Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06

Monthly Employment Change in Massachusetts, Thousands of Jobs

Employment: Percent Change from Year Earlier

Source: U.S. Bureau of Labor Statistics

United States

Massachusetts

Note: Gray shaded area indicates 10 and 90 percentile boundaries for the 50 states.Source: U.S. Bureau of Labor Statistics.

12

Sectors with highest job gains: education & health services,

professional, scientific & business services,financial activities.

-0.1

1.6

-0.2

1.8

2.3

2.5

2.8

0.7

1.2

-0.5

0.8

0.6

1.6

1.9

1.6

0.1

-0.4

0.3

-0.4

1.9

0.4

-1.8

-0.60.2

-2.0 -1.0 0.0 1.0 2.0 3.0

Construction

Manufacturing

Retail Trade

Wholesale Trade

Trans., Warehousing, & Utilities

Information

Financial Activities

Professional & Business Services

Private Education & Health Services

Leisure and Hospitality

Other Services

Government

United StatesMassachusetts

Employment by Industry: Percent Change, Nov 2005 – Nov 2006

Source: Bureau of Labor Statistics

13

-4%

-2%

0%

2%

4%

6%

8%

10%

Q3-86 Q3-88 Q3-90 Q3-92 Q3-94 Q3-96 Q3-98 Q3-00 Q3-02 Q3-04 Q3-06

Source: Bureau of Economic Analysis

Note: Gray shaded area indicates 10 and 90 percentile boundaries for the 50 states.

United States

Massachusetts

MA real personal income now rising at almost the same pace as national.

Real Personal Income: Percent Change from Year Earlier

Source: Bureau of Economic Analysis.

14

Forward-looking indicators such as AIM business confidence and U Mass leading index are solidly in

positive territory.

-4

-2

0

2

4

6

8

Nov-00May-03Nov-03May-03Nov-03May-03Nov-03May-04Nov-04May-05Nov-05May-06Nov-0638

44

50

56

62

68

74

Source: Associated Industries of Massachusetts and the University of Massachusetts.

U Mass Leading Index (left scale) AIM Business Confidence (right scale)

Predicted growth over next six-months

Readings above 50 are generally optimistic

15

020406080

100120140160180

Source: Census Bureau.

Existing single-family sales

Thousands of units, annual rates

0

500

1000

1500

Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06

Single-family permits

Housing units, seasonally adjusted

Massachusetts housing sales and constructionhave slowed.

16

0%

5%

10%

15%

20%

25%

Q3-00 Q3-01 Q3-02 Q3-03 Q3-04 Q3-05 Q3-06

Repeat Sales Home Price Index: Percent Change from Year Earlier

Source: Office Of Federal Housing Enterprise Oversight

United States

Massachusetts

Home price appreciation has downshifted: MA house prices fell in the 2nd and 3rd quarters.

Note: Gray shaded area indicates 10 and 90 percentile boundaries for the 50 states.

17

0

0.5

1

1.5

2

2.5

3

3.5

4

2003:Q1 2003:Q3 2004:Q1 2004:Q3 2005:Q1 2005:Q3 2006:Q1 2006:Q3

Subprime

All loans

0

0.5

1

1.5

2

2.5

3

3.5

4

2003:Q1 2003:Q3 2004:Q1 2004:Q3 2005:Q1 2005:Q3 2006:Q1 2006:Q3

Subprime

United States Massachusetts

Foreclosures have risen in recent months,especially in subprime market.

Foreclosures initiated in quarter, as a percent of loans in pool.

Source: Mortgage Bankers Association

All loans

18

Construction accounts for a relatively small share of the MA economy.

0%

2%

4%

6%

8%

10%

12%

14%

Jan-1985 Jan-1987 Jan-1989 Jan-1991 Jan-1993 Jan-1995 Jan-1997 Jan-1999 Jan-2001 Jan-2003 Jan-2005

Nevada

Arizona

United States

Massachusetts

Source: Bureau of Labor Statistics

19

0

10

20

30

40

50

60

Q3-96 Q3-98 Q3-00 Q3-02 Q3-04 Q3-06

0

5

10

15

20

25

30

Q3-96 Q3-98 Q3-00 Q3-02 Q3-04 Q3-06

Sources: National Real Estate Index, CB Richard Ellis.

0

5

10

15

20

25

30

Q3-96 Q3-98 Q3-00 Q3-02 Q3-04 Q3-06

0

10

20

30

40

50

60

Q3-96 Q3-98 Q3-00 Q3-02 Q3-04 Q3-06

United States

United States

United States

United States

Boston

BostonBoston

Boston

Note: Shaded areas indicate 10 and 90 percentile boundaries for 60 selected metropolitan areas.

Recovery in commercial real estate markets may provide a boost to offset softer housing.

Office Vacancy Rates, Downtown Office Vacancy Rates, Suburban

Adjusted Asking Rent per S/F, Downtown

Adjusted Asking Rent per S/F, Suburban

20

The MA labor force has not grown since 2000-- constraint on future job growth?

Source: Bureau of Labor Statistics

0.92

0.96

1

1.04

1.08

1.12

1.16

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006*

Index, 1996 = 1.00

**Assuming zero net in-commuting in 1996, then increasing gradually to 60,154 in 2004. Source of 2004 net in-commuting estimate: Massachusetts Institute for a New Commonwealth. Mass Economy: the Labor Supply and Our Economic Future, Table 8, page 38.

*2006 annual average estimated as average of January-October seasonally adjusted data.

US

MA MA, adjusted for cross-state commuting**

21

Concerns focus on loss of 25- to 44- year olds.Massachusetts Population by Age Group

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

2000 2001 2002 2003 2004 2005

Po

pu

lati

on

Under 18 18 to 24 25 to 44 45 to 64 65 and over

Source: Census Bureau

22

For FY 2008+ revenue estimates:LF slowdown

• is occurring nationwide • may not constrain income growth.

Dates Massachusetts United StatesLong-term historical trend 1969-1996 0.8 1.9

Last 10 years 1996-2006 0.4 1.2

Late 1990s boom 1996-2000 1.0 1.6

Post 1990s boom 2000-2006 0.0 1.0

Source: Bureau of Labor Statistics