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Twelfth Federal Reserve District
Economic Research Department
Federal Reserve Bank of San Francisco
101 Market Street
San Francisco, CA 94105
FedViews
Also available upon release at
www.frbsf.org/publications/economics/fedviews/index.html
FedViews – May 15, 2009
Bart Hobijn, research advisor at the Federal Reserve Bank of San Francisco, states his views on the current
economy and the outlook:
•
The economy shows many signs of continued weakness. That said, several indicators suggest that the
pace of contraction is slowing. This does not mean that economic activity is increasing, but that it might
bottom out in coming months. Historically, such indicators have signaled a turning point in the business
cycle and the onset of a recovery. Given current circumstances though, we expect the subsequent
recovery to be very slow compared to previous ones.
•
Continued weakness is particularly evident in the recent labor market data. Nonfarm payroll employment
declined by a substantial 539,000 jobs in April, as firms, operating in a weak and uncertain sales
environment, continued to cut costs. The very thin silver lining is that the April job decline was
significantly smaller than those in the previous three months. However, the unemployment rate has
increased to 8.9 percent.
•
The main drag on economic activity has been investment. This consists of four main components:
housing construction; commercial construction (offices, industrial buildings, retail space, and other
commercial real estate); purchases of equipment and software; and changes in inventories.
•
The commercial real estate market is going through a correction very similar to that of the housing
market. Prices of commercial real estate almost doubled between 2000 and 2007 and have since declined
by more than 20 percent. Vacancy rates have increased, the delinquency rate on commercial mortgages
has risen, and the pace of construction has slowed to a crawl. Starting in June, commercial-mortgagebacked securities (CMBS), which are an important source of financing in the commercial real estate
market, will be eligible collateral under the Federal Reserve’s Term Asset-Backed Securities Loan
Facility (TALF). Almost no CMBS have been issued in the U.S. since the summer of 2008.
•
The current technology-sector slowdown is of the same order of magnitude as the tech bust of 2001.
However, in this downturn, the inventory levels in the tech sector are much lower than in 2001. This
suggests that production might pick up relatively quickly when demand strengthens and inventories are
replenished. We expect such inventory replenishments to extend well beyond the tech sector and emerge
as one of the sources of GDP growth in the second half of the year.
•
Not all economic news has been dire over the last couple of months, supporting the view that the
economy might be close to its trough. The financial sector is showing signs of stabilization and earnings
reports of many Standard & Poor’s 500 companies have exceeded—admittedly low—market
expectations. As a result, stock market valuations have had a large rebound.
The views expressed are those of the author, with input from the forecasting staff of the Federal Reserve Bank of San Francisco. They are not intended to represent the views of others within the Bank or within the Federal Reserve System. FedViews generally appears around the middle of the month. The next FedViews is scheduled to be released on or before June 15, 2009. •
Most importantly, we have seen the resumption of securities issuances in several financial markets
that had come to a virtual standstill after September 2008. For example, substantial amounts of
consumer asset-backed securities (ABS) were issued in March and April. Such issuances were
almost nonexistent from October 2008 through January 2009. These issuances have coincided with a
continued narrowing of credit spreads across a wide range of markets.
•
In addition, the Federal Reserve Board’s Senior Loan Officer Opinion Survey indicates that
substantially fewer banks are tightening lending standards now than at the end of 2008. This will
presumably lead to easier access to credit for creditworthy consumers and businesses going forward.
•
These developments suggest a deceleration of the adverse feedback loop that is at the heart of the
current economic downturn. This loop is a cycle in which losses by banks and other lenders lead to a
tightening of credit, which in turn reduces spending by households and businesses. The resulting
drop in demand drags down the housing sector and the broader economy, contributing to greater loan
losses and tighter credit. This slowdown of the adverse feedback loop, as well as the easing of the
pace of job losses, have contributed to a jump in consumer confidence.
•
Going forward, stabilization of financial markets and institutions as well as fiscal and monetary
stimulus will provide momentum for positive economic growth by the end of this year. We do not
expect policy measures to be the only source of such momentum. Currently, some types of
economic activity are so unsustainably below trend, that we expect substantial corrections over the
next year.
•
One example is consumer purchases of durable goods. Auto sales are currently about 3 million units
a year below the estimated number of cars scrapped annually. If this level of sales persisted, then the
number of registered light vehicles in the U.S. would decline by more than 1 percent in 2009 alone, a
historically unprecedented decline in the stock of cars. Instead, it is more likely that households and
businesses will end up making at least a fraction of those postponed replacement purchases in the
coming months.
•
Residential investment is also far below trend. A conservative estimate of the trend level of housing
starts is about 1.55 million a year. Between the beginning of 2001 and end of 2006 about 1.7 million
excess housing units (above trend) were started. In other words, in those six years, the U.S. housing
boom generated an overhang equivalent to more than a year of housing starts. A correction of 1.1
million units of this overhang has occurred since the start of 2007 because of the reduction in
residential investment. If activity returns to trend in 12 months, then the rest of this overhang would
be worked off. This is a very optimistic scenario, positing a high growth rate of residential
investment. If the return to trend is slower, an “underhang” in residential investment would most
likely occur. Either way, it is unlikely that residential investment will remain at its current depressed
levels for a long time.
•
In sum, we expect GDP growth to turn positive by the fourth quarter of this year. However, we
envision a much slower recovery than those of the past four recessions. In fact, we only expect GDP
growth to return to its trend level by the end of 2010. The result is a gap between GDP and potential
GDP in excess of 6 percent.
•
We expect this persistent slack in the economy will result in a peak unemployment rate of around 9.5
percent and a very slow decline in the rate during 2010 and 2011.
•
Finally, in light of the large degree of economic slack we are forecasting over the next two years, we
expect inflation to remain relatively low.
Job losses continue to pile up
Nonfarm Payroll Employment
Investment main drag on economy
Millions
140
Millions of employees; seasonally adjusted
Sources of GDP Growth
Percent
Contributions of final demand to GDP growth (annualized rates)
4
Monthly Changes
Jan.
Feb.
Mar.
Apr.
-741 K
-681 K
-699 K
-539 K
138
Net exports
2
Consumption
Government
0
136
From peak -5.7 M
-2
134
-4
132
Apr.
-6
130
-8
Investment
128
2000
2001
2002
2003
2004
2005
2006
2007
2008
2007Q3
Commercial real estate prices falling
Commercial Real Estate Prices
CPPI and TBI, commercial real estate price indices
-10
2009
Index
(Jan. 2000=100)
200
2007Q4
2008Q1
2008Q2
2008Q3
2008Q4
2009Q1
Lack of investment pulling down tech
Tech Pulse Index
Percent
50
Percentage change at annual rate
40
175
30
CPPI
20
150
10
TBI
0
125
-10
100
-20
-30
75
-40
50
85
88
91
94
97
00
03
06
09
-50
1971
1976
1981
1986
1991
1996
2001
2006
Note: 12-month moving average in deviation from historical mean
Some thawing of credit markets
Consumer ABS Issuance
Fewer banks tighten lending standards
Billion $
Monthly total: Auto, credit cards, and student loans
40
Banks' Willingness to Lend to Consumers
Index
100
Senior Loan Officer Opinion Survey: Diffusion Index
80
35
60
30
40
25
20
0
20
-20
15
-40
10
-60
2005
2006
2007
2008
2009
5
-80
0
-100
1966
1971
1976
1981
1986
1991
1996
2001
2006
1
Car sales lower than scrappage
Light Vehicle Sales
We are working off housing overhang
Housing Starts
Million
vehicles
18
Annual unit sales (millions of vehicles)
Million units
Seasonally adjusted annual rate, three-month moving average
2.5
17
Sales
2.25
16
2
15
Overhang
could get
worked off
in a year
Overhang
1.7M units
14
Trend
13
1.75
1.5
Correction
1.1M units
12
Estimated scrappage
1.25
11
1
10
0.75
9
0.5
8
2003
2004
2005
2006
2007
2008
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
2009
Note: 2009 sales data based on first quarter
Note: trend housing starts are assumed to be 1.55 million a year
Expect gradual recovery
Slow recovery compared to past
Real Gross Domestic Product (GDP)
Percent
8
Percent change at seasonally adjusted annual rate
Real Gross Domestic Product (GDP)
Index
Index, normalized at 100 at peak of GDP
110
1981
6
FRBSF
Forecast
108
2001
4
106
1991
1973
2
104
0
102
-2
Q2
100
-4
FRBSF
Forecast
98
-6
Q1
96
-8
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
0
2010
1
2
3
4
5
6
7
8
9
10
11
12
13
14
Quarters since peak of GDP
Unemployment outlook
Continued slack reduces inflation
Unemployment rate
Percent
10
Seasonally adjusted
Core PCE Price Inflation
Percent
3
Percentage change from four quarters earlier
9
2.5
8
2
FRBSF
Forecast
FRBSF
Forecast
7
6
1.5
1
5
0.5
4
2005
2006
2007
2008
2009
2010
0
2011
95
00
05
10
2