Download Fed Challenge 2016

Fed Challenge 2016
Current State of the Economy
• The economy went into a recession in Year3:Q3 and Year3:Q4.
• Since then, the economy has recovered for the most part.
• We will look into some key indicators in more detail.
Real GDP
• Real GDP growth started out at 3 % in Year1:Q1 and slowed down in the years
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afterwards.
It went into the negative territory as the economy went into a recession in Year3:Q3
and Q4.
The GDP grew again soon after the recession
The growth rate stood at 2.95% in the recent period, almost the same rate as the
high in the last 5 years.
The recovery of GDP in terms of growth rate has been satisfactory, coming back
close to the high in the last 5 years
Actual and Potential GDP
• The actual GDP growth rate has consistently been outpaced by the potential
GDP growth rate.
• That may point to an underemployment of resources in the economy.
Consumption
• In Year 1, consumption was quite stable, growing around 2% every quarter.
• Consumption started to slow down in Year 2. The growth rate slowed down
from 2.1% in Year2:Q2 all the way to 1.2% in Year 4:Q1.
• The growth picked up in Year 4: Q2 and reached 2.6% in Year 5:Q4
Investment
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Investment had been slowing down before it went into declines in Year3:Q2.
It contracted by as much as 0.8% in Year3:Q4.
Investment stopped declining in Year4:Q2 and started to grow again.
It grew by 0.75% in the most recent quarter.
Government Spending
• Leading up to the recession, the government slowed down till it reached no
growth in Year3:Q4.
• The growth picked up before it slowed down again in Year4:Q3
Net Exports
• Net Export was on decline most of the periods except for two occasions. It
worsened from Year2:Q1 all the way till Year3:Q4 when it declined by 0.8%.
• The decline slowed down briefly before it worsened again in Year 4:Q3.
• In Year 5:Q4, the net export declined by 0.55%
Labor Market: Unemployment Rate
• U3 stayed quite stable between 5.5.% and 5.7% till Year3:Q3 when the
unemployment rate shot up to 6.2% and reached 6.5% in Year 4:Q1.
• It declined till it reached 5.8% in Year5:Q4.
• The current U3 is slightly above the natural unemployment rate (5.5%)
• U6 was in double digits all the time. At one point, it reached as high as 14.1%
in Year 4: Q1.
• It came back since then but it still stood at 12.7% in Year5: Q4.
Labor Market: Labor Participation Rate
• Labor participation rate has been decreasing.
• It could be a warning sign if the decline is due to workers giving up hopes on
looking for a job, leaving the labor force.
Labor Market: Average Hourly Earnings
• Average hourly earnings were on an upward trend. It went from $16.60 to
$18.05 from Year 1:Q1 to Year5:Q4.
• However, the growth of average hourly earnings was almost flat in the most
recent periods. It even went down slightly in the most recent quarter.
• It may indicate a lack of demand for workers
Inflation (Core PCE)
• Inflation has been mild.
• Inflation rate as measured by the Core PCE had been in the range of 2-2.4%
until Year4:Q4. It hit as low as 1% in Year 5: Q3.
• It most recently stood at 1.4%
Inflation (Headline PCE)
• Inflation rate as measured by the Headline PCE showed similar pattern with
a little bit more fluctuations.
• It reached as high as 4% in Year 4:Q3
• It has come down significantly since then.
• After a brief deflation in Year 5:Q2 and Q3, the economy has a headline
inflation as low as 1.2%
Inflationary Expectation
• Inflationary expectation has been quite consistent with the actual inflation.
• It has come down quite significantly and stays at 1.9% in the most recent
quarter
Consumer confidence
• Consumer sentiment index in Table 6 shows that consumer confidence
dropped sharply in Year3:Q3 which coincided with the recession.
• It recovered afterwards but it remained at a moderate level in the 70s.
• As we are seeing a rise in consumer confidence, consumers are likely to
spend.
• This may explain why we see a decent growth in consumption after the
recession.
Oil prices
• Oil prices have been on a downward trend
• It dropped from as high as $118 per barrel in Year3:Q1 to as low as $44 in
Year 5:Q4
• Oil is an essential input of productions of almost all goods and services (as
fuel and energy sources),
• Falling oil prices will lower cost of production, boosting the aggregate
supply, driving down prices and consequently, mitigating inflationary
pressure, if there is any.
Fed Funds Rate
• The Fed Funds Rate (FFR) has been declining since the downturn.
• It went from 5.16% in Year3:Q2 to 4.09% recently.
Dual Mandate
• The Fed is mandated by the congress to accomplish two goals: maximum
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employment and low inflation.
Although the economy has recovered, the recovery has not been robust.
On the front of employment, unemployment rate (U3) is still above the natural rate.
U6 is alarming.
Labor participation rate has been declining and the average hourly earnings grew
slowly and even dipped most recently.
The actual GDP rate constantly falling short of the potential GDP. This is
consistent with an underemployment.
Dual Mandate
• On the inflation front, the inflation rate has been very low. Lower than what
most would think is optimal (2%)
• Falling oil price, low inflationary expectations and moderate consumer
confidence lead us to believe that there is low chance of imminent
inflationary threat.
Policy Recommendation
• Considering that there is room for improvement in the labor market and
there is no imminent inflationary threat, we believe the best course of option
is to adopt expansionary monetary policies to lower the interest rate
• Lower interest rates could lead to more robust demand for goods and
services.
• As the economy picks up, the labor market could continue to improve.