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October 20, 2015 Where’s the Growth? By Howard Newman, President and CEO The Question of The Day 2 The Question of The Day 3 Today’s Talk 1. Is There a Growth Problem? 2. Conundrum for the FED 3. The Great Debt Debate 4. Investment and Productivity 4 Is There a Growth Problem? Growth Is on Everybody’s Mind IMF predicting lower growth globally FED delayed raising rates because of global growth and stability concerns Even the Democratic debate participants are running against the economic record of the past 7 years 6 The U.S. Economy Is Doing Just Fine Close to Full Employment Unemployment Rate 12% 10% 8% 6% 4% 2% 0% 2000 2001 2002 2003 2004 2005 2006 2007 Consumer is Alive and Well 2008 2010 2011 2012 2013 2014 2015 Inflationary Expectations “Well Anchored” 3.0% Source: St. Louis Federal Reserve 0.5% 2015 2014 2013 2012 2011 2010 2009 2008 0.0% 2007 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 -4% 2006 -2% 1.0% 2005 0% 1.5% 2004 2% 2.0% 2003 4% 2.5% 2002 6% 2001 Long Term CPI Inflation Expectation 8% 2000 10% YoY Growth in PCE 2009 7 Headwinds? Not Many Housing? Recovery proceeding Credit? Generally available Energy? Stable Fiscal Policy? Stable Slow Growth Abroad? Some concern 8 Nagging Concerns Real wage growth still inadequate Productivity growth remains muted Inequality is on everybody’s mind Strong dollar/problems abroad Why didn’t the FED tighten? 9 1947 1948 1950 1952 1953 1955 1957 1958 1960 1962 1963 1965 1967 1968 1970 1972 1973 1975 1977 1978 1980 1982 1983 1985 1987 1988 1990 1992 1993 1995 1997 1998 2000 2002 2003 2005 2007 2008 2010 2012 2013 Quarter over Sequential Quarter GDP Growth There Is a Secular Problem, Not a Cyclical One Real GDP Growth (Quarterly Rates, Annualized) 20.0% 15.0% 10.0% 5.0% Average: 3.3% 0.0% -5.0% -10.0% -15.0% Source: St. Louis Federal Reserve 10 So Here is Today’s Big Question 11 The FED Is Monetary Policy No Longer Effective? 13 The Decision to Defer FED’s decision to defer an interest rate increase pleased almost nobody Did it signal a concern about the U.S. economy? Did it signal a concern about the stability of the global financial system? Did it signal that the FED remains trapped in the deflation silo? 14 The FED’s Perspective: Deflation Deflation caused the Great Depression – Tight money, bank failures and the absence of credit Deflationary spiral impossible to address after it begins due to the “zero rate bound” constraint Growth requires credit-especially consumer and mortgage credit Focus on the health of the financial sector Cannot address the underlying macro causes of a crisis after it begins 15 The FED’s Perspective: Inflation Need some inflation so that monetary policy can be effective when needed Inflationary expectations are well rooted-and need to stay well rooted Current inflation is below the 2% target in adopted in 2012 Real interest rates reflect expectations about inflation Deflation still a major concern given the persistence of low inflation 16 The FED’s Longer Term Problem Monetary policy works by creating debt Debt increases the instability of the system Instability reflects the cumulative debt balance in the system Using monetary policy to grow the economy creates the very macro prudential risks the FED seeks to avoid-and using monetary policy to slow the economy actualizes those risks as debt holders seek to avoid capital losses 17 Why Is Monetary Policy Not Working? Rational expectations explanation – Inter-temporal budget constraint Sticky return requirements of investors – Required risk premium is a function of the activity, not the availability of capital – Driving returns down means driving asset prices up which makes investment unattractive Reduced consumption by savers at zero rates Will raising interest rates actually help the economy? 18 The FED’s Conundrum The FED is caught between its two policy goals (full employment and price stability) and its macro prudential obligations. Macro prudential issues will always tilt the decision toward easing Deflation concerns tilt toward easing Cumulative easing may hurt animal spirits, investing and growth Short term stimulus may create a long term problem for the economy 19 The Great Debt Debate Crushed by Debt? 21 Aggregate Debt and Growth Negatively Correlated Selected Credit Classes as a Percent of GDP 350% ‘10-’15: 2.2% Debt as a Percent of GDP (%) 300% ‘99-’07: 2.5% 250% 200% ‘80-’99: 3.4% ‘50-’80: 3.8% 150% 100% 50% 0% Government Agency Debt (excl. Mortgages) Consumer Credit Municipal Debt Source: Federal Reserve Board, St. Louis Federal Reserve Note: Italicized numbers indicated compounded real GDP growth during the period. 1) Excludes U.S held debt of foreign institutions. Mortgage Debt U.S. Corporate Debt¹ Federal Government Debt 22 Growth Seems to Have Been Hurt by Relying on Consumption Average Personal Consumption Share of Gross GDP Average Percent Increase in Real GDP1 Year Share Growth 1960 – 1970 59.8% 4.5% 1970 – 1980 60.5% 3.4% 1980 – 1990 62.5% 3.2% 1990 – 2000 64.7% 3.4% 2000 – 2010 67.3% 1.7% 2010 – 2015 68.4% 2.2% Source: St. Louis Federal Reserve 1) Real GDP growth calculated by annualizing quarter over sequential quarter growth. 23 Investing Is Not Down Enough to Explain Subdued Growth Average Private Investment Share of Gross GDP Average Percent Increase in Real GDP1 Year Share Growth 1960 – 1970 16.5% 4.5% 1970 – 1980 17.9% 3.4% 1980 – 1990 18.5% 3.2% 1990 – 2000 17.3% 3.4% 2000 – 2010 17.8% 1.7% 2010 – 2015 15.4% 2.2% Source: St. Louis Federal Reserve 1) Real GDP growth calculated by annualizing quarter over sequential quarter growth. 24 Government Spending Not A Factor Average Government Spend Share of Gross GDP Average Percent Increase in Real GDP1 Year Share Growth 1960 – 1970 23.1% 4.5% 1970 – 1980 21.8% 3.4% 1980 – 1990 20.8% 3.2% 1990 – 2000 19.2% 3.4% 2000 – 2010 19.3% 1.7% 2010 – 2015 19.4% 2.2% Source: St. Louis Federal Reserve 1) Real GDP growth calculated by annualizing quarter over sequential quarter growth. 25 Net Exports Have Had an Impact Average Net Exports Share of Gross GDP Average Percent Increase in Real GDP1 Year Share Growth 1960 – 1970 0.6% 4.5% 1970 – 1980 (0.2)% 3.4% 1980 – 1990 (1.7)% 3.2% 1990 – 2000 (1.2)% 3.4% 2000 – 2010 (4.4)% 1.7% 2010 – 2015 (3.2)% 2.2% Source: St. Louis Federal Reserve 1) Real GDP growth calculated by annualizing quarter over sequential quarter growth. 26 Financing Housing Instead of Financing Investment ($bn) Net Imports of Goods and Services Residential Investment 1,000.0 Net Imports vs. Residential Investment1 800.0 600.0 400.0 200.0 0.0 (200.0) (400.0) (600.0) (800.0) (1,000.0) 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 Source: Bureau of Economic Analysis 27 Consumer Debt : Cause or Effect? Aggregate Consumer Debt $3,500 $3,000 Total Debt ($ bn) $2,500 ($ bn) Revolving Consumer Credit Auto Loans Student Loans Other Installment Debt Total 1951 $0 $6 $0 $19 $25 1975 $15 $57 $0 $135 $207 1985 $132 $212 $0 $267 $611 2007 $1,002 $801 $584 $228 $2,615 2015 $890 $958 $1,215 $249 $3,312 $2,000 $1,500 $1,000 $500 $0 Other Installment Debt Source: St. Louis Federal Reserve Student Loans Auto Loans Revolving Consumer Credit 28 The Two Faces of Debt Debt allows current consumption to increase – Monetary policy works by encouraging/discouraging consumption Debt requires future consumption to decrease – Less true if debt finances income – Compounded if debt finances consumption, including housing – Research shows that it would take a tax rate on future generations of 74% to satisfy the government’s inter-temporal budget constraint 29 Debt As a Macro Economic Variable Aggregate debt increases financial instability Aggregate debt ties the hands of the monetary authorities Aggregate debt dampens animal spirits and hampers investment 30 Investment and Productivity There’s Something About Investing 32 Since 2000, the U.S. Created 11 Million Jobs Non-Farm Payrolls (000’s) 145,000 142,371 Non-Farm Payrolls 140,000 138,365 135,000 132,767 130,000 133,500 131,009 129,649 130,147 125,000 120,000 2000 2001 Source: St. Louis Federal Reserve 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 33 Secular or Cyclical: Healthcare Healthcare Jobs (000’s) 19,500 18,500 17,500 Healthcare Jobs (000’s) 16,500 15,500 14,500 13,500 12,500 11,500 10,500 Jan 2000 1) Jan 2001 Jan 2002 Source: Bureau of Labor Statistics. Jan 2003 Jan 2004 Jan 2005 Jan 2006 Jan 2007 Jan 2008 Jan 2009 Jan 2010 Jan 2011 Jan 2012 Jan 2013 Jan 2014 Jan 2015 34 Secular or Cyclical: Leisure and Hospitality Leisure and Hospitality Jobs (000’s) 15,500 15,000 Leisure & Hospitality Jobs (000’s) 14,500 14,000 13,500 13,000 12,500 12,000 11,500 11,000 10,500 Jan 2000 Jan 2001 Source: Bureau of Labor Statistics. Jan 2002 Jan 2003 Jan 2004 Jan 2005 Jan 2006 Jan 2007 Jan 2008 Jan 2009 Jan 2010 Jan 2011 Jan 2012 Jan 2013 Jan 2014 Jan 2015 35 Secular or Cyclical: Manufacturing Manufacturing Jobs (000s) 18,500 17,500 Manufacturing Jobs (000’s) 16,500 15,500 14,500 13,500 12,500 11,500 10,500 Jan 2000 Jan 2001 Source: Bureau of Labor Statistics. Jan 2002 Jan 2003 Jan 2004 Jan 2005 Jan 2006 Jan 2007 Jan 2008 Jan 2009 Jan 2010 Jan 2011 Jan 2012 Jan 2013 Jan 2014 Jan 2015 36 Where Are Jobs Being Created? (Jobs in 000’s) January 2000 September 2015 Variance (#) Secular Growth in Employment 14,959 22,153 7,194 Cyclical Growth in Employment 94,980 105,099 10,119 Declining Employment 20,842 15,119 (5,723) 130,781 142,371 11,590 Total Non-Farm Employment Source: Bureau of Labor Statistics. 1) Changes shown in real GDP is from 1999 - 2014. GDP is in chained 2009 dollars. 37 Creating Jobs without Creating Productivity Change Between 2000 – 2015 Jobs1 GDP2 Annual Change in Labor Productivity Secular Growth 48.1% 46.1% (0.1)% Cyclical Growth 10.7% 30.8% 1.1% Declining Employment (27.5)% 39.1% 4.4% 8.8% 33.3% 1.4% Total Source: Pine Brook internal analysis, Bureau of Economic Analysis, and Census. 1) Change in jobs represents growth from seasonally adjusted annualized data from Jan 200 – Sept 2015. 2) Change in GDP is from 1999-2014. Data set only available annually. GDP is in chained 2009 dollars. 38 Investing Creates Productivity and Wage Growth Change Between 2000 – 2015 Aggregate Capital Expenditure ($bn) % of Total Aggregate Capital Expenditure Aggregate Capital Expenditure ($) per Average Worker Aggregate Capital Expenditure ($) per New Worker Secular Growth $1,335 8.7% $72,367 $185,538 Cyclical Growth $9,925 64.8% $139,688 $980,863 Declining Employment $4,048 26.4% $243,878 n/a $15,308 100.0% — — Total Source: Pine Brook internal analysis, St. Louis Federal Reserve 39 Summary and Conclusion: Where’s the Growth? Summary The U.S. economy is growing, but not at a rate to make everyone happy The FED’s statutory obligations of full employment and price stability conflict with its macro prudential obligations Debt overhang looms large and may be impacting investment For most of this century, the US has been creating too many jobs in productivity resistant industries –perhaps because they have not attracted investment, or perhaps because of other factors 41 The US has a “Use of Proceeds” Problem The economy has been creating jobs that are productivity resistant Over-investing in housing may be creating drag on US productivity Recent drivers of recovery-energy, housing and credit expansion-have done what they can do Absent a change in policy and politics, “more of the same” is the most likely outcome for the US economy 42