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Twelfth Federal Reserve District
FedViews
Economic Research Department
Federal Reserve Bank of San Francisco
101 Market Street
San Francisco, CA 94105
November 10, 2010
Also available upon release at
http://www.frbsf.org/publications/economics/fedviews/index.php
Simon Kwan, vice president at the Federal Reserve Bank of San Francisco, states his views on the current economy and
the outlook:

The Federal Open Market Committee decided on November 3 to expand the Federal Reserve’s
holdings of securities to provide additional support for the economy. In addition to maintaining its
existing policy of reinvesting principal payments from its securities holdings, the FOMC authorized
purchases of a further $600 billion of longer-term Treasury securities by the end of the second quarter
of 2011. The Open Market Trading Desk at the New York Fed estimated the principal payments from
agency debt and agency mortgage-backed securities will be around $250 billion to $300 billion over
the same period. Taken together, the Desk anticipated that it would purchase $850 billion to $900
billion in longer-term Treasuries through the end of the second quarter of 2011. The FOMC also
decided to maintain its target for the federal funds rate at 0 to 0.25% and repeated its statement that
“economic conditions…are likely to warrant exceptionally low levels for the federal funds rate for an
extended period.”

Market participants had been expecting the Fed to engage in another round of large-scale asset
purchases for quite some time. Both nominal and real Treasury rates had been declining, and implied
inflation compensation of Treasury inflation-protected securities (TIPS) had been trending up. In
addition, stock prices had advanced. The exchange value of the U.S. dollar had declined, but had
mostly retraced the flight-to-quality appreciation that had taken place during the financial crisis.

In its November 3 release, the FOMC stated that “the pace of recovery in output and employment
continues to be slow.” Real GDP grew at a 2% annual rate in the third quarter, about in line with
expectations. We expect real GDP to grow at an annual rate of about 2.2% in the current quarter
before picking up gradually to an average of about 3.5% in 2011.

Household spending has been increasing gradually, but remains constrained by high unemployment,
modest income growth, lower housing wealth, and tight credit. Business spending on equipment and
software is rising. Core capital goods shipments rose again in September, the eighth consecutive
monthly increase. However, core capital goods orders fell slightly in September. Investment in
nonresidential structures remains weak.

The October employment report was better than expected. Private payrolls increased by 159,000
during the month. In addition, data for August and September were revised up and now show that
private payrolls rose by an average of 135,000 over the past three months.

The unemployment rate was unchanged at 9.6%. The below-potential economic growth of the past
few quarters was too slow to make a dent in the very high unemployment rate. With subpar growth,
the relatively steady unemployment rate reflected a decline in labor force participation, as workers
without jobs for an extended period left the labor force. The unemployment rate might have risen if
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 December 20, 2010.
labor force participation had remained constant. Consistent with our GDP forecast, we expect the
unemployment rate to decline only gradually over the next two years to about 8% by the end of 2012.

Measures of longer-term inflation expectations remain stable. Both the market-based measure of
TIPS implied inflation compensation five-to-ten years ahead and the projections of long-term
inflation by Thomson Reuters/University of Michigan Surveys of Consumers and the Survey of
Professional Forecasters have been within a fairly tight range. However, underlying inflation
measures have trended lower in recent quarters. Despite recent increases in energy prices and the
decline in the value of the dollar, the headline personal consumption expenditures price index
(PCEPI) rose only 0.1% in September from the previous month. The core PCEPI, which excludes
volatile food and energy prices, was unchanged in September and is up only 1.2% over the past 12
months. With considerable slack remaining in the economy, we expect core PCE inflation to be about
1% over the next 12 months. In the current environment, the uncertainty in our economic forecast is
higher than usual. As such, there is a small probability that inflation could fall into negative territory
over our forecast horizon.

With elevated unemployment and somewhat low inflation, progress towards the FOMC objectives of
maximum employment and price stability has been disappointingly slow. The FOMC decision to
expand its holdings of longer-term Treasury securities was intended “to promote a stronger pace of
economic recovery and to help ensure that inflation is at levels consistent with its mandate.”
Monetary stimulus via LSAP
Federal Reserve Securities Holdings
Projected
Financial conditions eased
Billions of Dollars
2800
Interest Rates
9/21
FOMC
Daily close
11/3
FOMC
Percent
4.5
10-year Treasury
2400
TIPS Inflation
Compensation
5-10 ahead
2000
3.5
GSE securities
1600
2.5
TIPS Inflation
Compensation
next 5 years
5-year Treasury
1200
1.5
Treasury securities
800
11/8
10-year TIPS
0.5
400
5-year TIPS
0
-0.5
Jan May Sep Jan May Sep Jan May Sep Jan May Sep Jan May
2007
2008
2009
2010
2011
Jan-10
Mar-10
Stock prices advanced
May-10
Jul-10
Sep-10
Nov-10
US dollar weakened
Stock Market Indices
Index
115
Daily close, January 2010 = 100
U.S. Trade Weighted Major Currency Index
Index
120
Narrow Nominal
110
110
105
100
Nasdaq
S&P 500
90
100
11/8
11/8
95
80
90
70
60
85
Jan-10
Mar-10
May-10
Jul-10
Sep-10
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Nov-10
Pace of recovery continues to be slow
Gross Domestic Product (GDP)
Percent
8
Percent change at seasonally adjusted annual rate
FRBSF
Forecast
Household spending increasing gradually
Real Personal Consumption Expenditures
3-month percent change at seasonally adjusted annual rate
Percent
10
6
8
4
Q3
6
Sep.
2
4
0
2
-2
0
-4
-2
-6
-4
-8
02
03
04
05
06
07
08
09
10
11
12
-6
00
01
02
03
04
05
06
07
08
09
10
11
Business spending on E&S rising
Nondefense Capital Goods (Ex. Aircraft)
Employers reluctant to add to payrolls
Bil. $
70
Seasonally adjusted, three-month moving average
Private Nonfarm Payroll Employment
Millions
118
Millions of employees; seasonally adjusted
Monthly Changes
New Orders
Jul.
Aug.
Sep.
Oct.
65
Sep.
60
116
117.0 K
143.0 K
107.0 K
159.0 K
114
From peak -7.4
112
Shipments
55
110
Oct.
50
00
01
02
03
04
05
06
07
08
09
45
11
10
Progress towards FOMC objectives
disappointingly slow
Unemployment Rate
106
00
01
02
03
04
05
06
07
08
09
10
Inflation expectations remain stable
Percent
11
Seasonally adjusted
108
Oct.
Percent
5
Inflation Expectations
TIPS inflation
compensation
5-10 ahead
10
Michigan survey inflation
5-10 ahead
9
FRBSF
Forecast
4
3
8
7
2
SPF median CPI inflation
6-10 ahead
6
5
1
4
3
00
01
02
03
04
05
06
07
08
09
10
11
12
Underlying inflation somewhat low
Core PCE Price Inflation
Percent
3.0
Percent change from four quarters earlier
2.5
2.0
Q3
1.5
1.0
0.5
FRBSF
Forecast
0.0
-0.5
-1.0
00
01
02
03
04
05
06
07
08
09
10
11
Note: 70/90/95% confidence intervals from historical forecast errors from 1986 to 2006
12
0
2004
2005
2006
2007
2008
2009
2010