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Twelfth Federal Reserve District
FedViews
June 9, 2011
Economic Research Department
Federal Reserve Bank of San Francisco
101 Market Street
San Francisco, CA 94105
Also available upon release at
www.frbsf.org/publications/economics/fedviews/index.php
Bart Hobijn, senior research advisor in the Economic Research Department of the Federal Reserve Bank of San
Francisco, states his views on the current economy and the outlook.

GDP grew at a 1.8% annualized rate in the first quarter of 2011, a significant slowdown from the fourth
quarter of 2010. Several temporary factors helped push down first-quarter GDP growth. Data released in
recent weeks suggest that this sluggishness will persist longer than initially anticipated. We now forecast
second-quarter GDP growth will come in at around a 2½% annualized rate. But growth should rebound
in the third quarter. We expect GDP to expand at an annualized 3½% rate in the second half of the year
and to continue to strengthen throughout 2012.

Among the temporary factors that have pushed down GDP growth are the effects of the supply chain
disruptions caused by the earthquake in Japan, the recent tornadoes and floods in the South and Midwest,
and the spike in commodity prices, especially oil. The winding down of these temporary factors
depressing economic activity should contribute positively to GDP growth in the third quarter.

In addition to these temporary factors, however, other data signal that the recovery’s momentum is
weaker than earlier data had suggested. The pace of hiring slowed in May, with only 54,000 jobs added
to nonfarm payrolls. This increase was far below the average of 182,000 jobs per month gained from
January through April.

After declining by a percentage point earlier this year, the unemployment rate has stalled around 9%
since February. In May, it ticked up a tenth of a percentage point to 9.1%. Consistent with our forecast of
sluggish GDP growth, we now expect the unemployment rate to decline to around 8% by the end of
2012.

Growth of household spending has tapered off. Personal consumption expenditures grew at an annual
rate of 0.6% in April, well below the first-quarter pace of 2.2%. Meanwhile, real disposable personal
income declined at an average annualized rate of 0.4% in the three months ending in April 2011. This
suggests that the purchasing power of U.S. households is not growing at the rate it was in the second half
of 2010.

Some of the effects of reduced income growth on consumer spending could potentially be offset by
increases in household wealth. However, since the beginning of May, U.S. stock market indexes have
declined about 6%. Moreover, homeowners continue to see the value of their houses—their most
important investment—decline. House prices are continuing to slide in most parts of the country,
although the rate of decline varies substantially from state to state.
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 July18, 2011.

Since consumer spending makes up 71% of expenditures in GDP, the drag that declining house prices
cause on consumption is important for understanding the momentum of the recovery. More than threequarters of U.S. household spending comes from people who own their homes rather than rent.

The final factor pointing to reduced momentum of recovery is the slowdown in the manufacturing
sector’s growth. Manufacturing has been a pocket of strength during the past six months. However,
industrial production did not grow in April, partly because of the supply chain disruptions related to the
Japanese earthquake. In addition, the Institute for Supply Management manufacturing purchasing
managers index showed a sharp decline in the share of manufacturers reporting growth in their activity
levels in May. The Federal Reserve Bank of San Francisco’s Tech Pulse Index showed a similar
deceleration in tech-sector growth.

On the upside, foreign demand for U.S. goods was robust in April. Over the past year, the dollar value of
U.S. exports increased 18.8%.

The anticipated sluggishness of the recovery implies that the economy will continue to show substantial
slack. This should restrain underlying inflationary pressures. Consequently, we expect headline inflation
to wane as the effects of recent commodity price increases wear off. We anticipate that headline PCE
inflation will subside below a 1½% annualized rate in the second half of this year.
GDP growth expected to improve
Soft patch or reduced momentum?
GDP growth and FRBSF forecast
Annualized quarterly GDP growth; seasonally adjusted
GDP growth
8%
May 12, 2011
FRBSF forecast
Weak
Medium
Strong
4
0
Current
FRBSF forecast
Spending:
Consumption,
investment,
govt outlays,
and exports
D
Demand:
d
Households, businesses,
govt, foreigners
Production:
Goods & svcs
-4
Income & wealth:
Wages, interest,
dividends, housing,
equity
-8
2006
2007
2008
2009
2010
2011
2012
Pace of hiring suggests momentum slowing
%
8
Sluggish recovery in unemployment
Unemployment rate and forecast
GDP growth and changes in payroll employment
%
12
Jobs (millions)
GDP growth
(left axis)
FRBSF
forecast
(left axis)
4
3
10
2
9.1
1
0
0
-1
Change in payroll
employment
(right axis)
-4
7.9
FRBSF
Forecast
6
4
Unemployment rate
2
-2
0
-3
-8
8
00 01 02 03 04 05 06 07 08 09 10 11 12
2006 2007 2008 2009 2010 2011 2012
Source: Bureau of Labor Statistics and FRBSF staff
Inflationary pressure should be transitory
PCE Price Inflation
Share of consumer spending by homeownership status
Percent change from four quarters earlier
5%
2007
2008
2009
2010
2011
2012
60
3
40
22
23
30
20
1
10
0
-1
Source: Bureau of Economic Analysis and FRBSF
%
55
50
2
FRBSF
Forecast
2009 consumption spending
4
Actual
2006
Most consumption driven by homeowners
0
Hom eowner with
Hom eowner
m ortgage
without m ortgage
Source: Consumer Expenditure Survey
Renter
House prices continue to slide
Slower expected pace of tightening
Home Price Index: 4-quarter growth
Non seasonally adjusted; quarterly data; Mar-10 to Mar-11
Implied by Fed Funds and Eurodollar Futures
3%
-1.9
-5.6
-2.4
-7.0
-9.1
-1.0
-10.9
0.8
-3.8
-10.8
-1.6
-0.5
3.0 -3.6
-1.6
-4.2
-0.7
-1.2
2.8
3 7 -0.8-2.8
-3.7
-2.5
-0.1
-0.6 -2.4
-0.1 -2.2
-2.6
-1.8
-1.8
-1.9
-3.1
-4.1
-3.0-3.5 -5.8
-1.2
-1.1
-8.2
0.5
-5.2
1.8
Forward Fed Funds Rate
0.7
2.5
-0.5
2
-2.1
-2 3
-2.3
Last FOMC: 4/27/2011
-2.1
1.5
-3.3
1
-3.7
-0.2
Most Recent: 6/9/2011
0
-1.4
Source: Federal Housing Finance Agency
0.5
Apr-11
Oct-11
Apr-12
Oct-12
Apr-13
Oct-13