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Twelfth Federal Reserve District
FedViews
October 13, 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
Bharat Trehan, research advisor at the Federal Reserve Bank of San Francisco, states his views on the current economy
and the outlook.

Recent data have been somewhat better than expected, helping ease concerns that the economy may
be stalling.

Payroll employment rose by 103,000 in September. At the same time, payroll data for July and
August were revised up by an average of about 50,000 jobs per month. So it now looks like the
economy added roughly 96,000 jobs per month in the third quarter. However, the unemployment
rate remains stuck at 9.1%. Moreover, initial claims for unemployment insurance are still hovering
around the 400,000 level, which suggests little improvement in the unemployment rate in the near
future.

Orders for nondurable goods excluding aircraft rose by 0.9% in August, while shipments rose by
2.8%. Over the past six months, orders have grown at about an 18% annual rate, while shipments
have grown at a 19% rate. While this is unambiguously good news, surveys indicate that business
sentiment is subdued, suggesting that capital spending is likely to remain restrained.

Manufacturing output also grew at a healthy rate in August, pushed along by an increase in motor
vehicle demand and an easing of supply chain restrictions arising from the Japanese earthquake and
tsunami in March. Vehicle sales jumped from a 12.1 million annual rate in August to a 13.1 million
rate in September. Other consumption data were not as encouraging. Real personal consumption
expenditures were unchanged in August. Over the past three months, consumption expenditures
have increased at a 1% rate.

On net, we view these data as positive for output growth in the third quarter, but they have not led to
other significant changes in our forecast. We expect that real GDP will grow moderately through the
end of next year. Such slow growth is unlikely to push down the unemployment rate this year, and
we anticipate only modest declines next year. So, the unemployment rate is projected to remain
above the full employment level for quite a while.

There are some serious downside risks to this outlook. The economic outlook has worsened
worldwide of late, and in particular in the developed economies. The sovereign debt crisis in Europe
creates a significant risk that economic growth, both globally and in the United States, could fall
noticeably below even the reduced forecasts shown here.

The continuing European debt crisis has flared up in the past few months as European policymakers
struggle to deal with issues related to Greek debt, the recapitalization of European banks, and
funding for the European Financial Stability Facility, the euro zone vehicle for making loans to
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 November 14, 2011.
member states. For much of this year, credit markets have considered the debt of three sovereign
European states—Greece, Ireland, and Portugal—to be riskier than low-grade U.S. corporate debt.

The European debt crisis has led to increased volatility in financial markets, with alternating spells of
optimism and pessimism triggered by stories and rumors of actions, plans, or simply discussions
aimed at addressing the situation. Stock markets outside Europe remain depressed as well, indicating
that the crisis is global in scope.

Investors have engaged in a general flight from risky to safe assets. Accordingly, U.S. Treasury
yields have declined sharply, helped along by recent monetary policy actions. Yields on high-grade
risky corporate bonds have not fallen as much, while yields on low-grade bonds have actually risen
quite substantially.

Finally, given our forecast of moderate real GDP growth and persistently high levels of
unemployment, we see little reason to expect higher inflation. Instead, inflation is projected to
decline a bit from recent levels and stay at or slightly below the level that most Federal Open Market
Committee participants appear comfortable with.
Employment Continues to Grow, Sluggishly
Nonfarm Payroll Employment
Millions
140
Millions of employees; seasonally adjusted
Monthly Changes
Jun. 20 K
Jul. 127 K
Aug. 57 K
Sep. 103 K
138
Unemployment Rate Still Unusually High
Unemployment Indicators
Percent
11
Thousands
700
Sept
650
600
136
From peak -6.7 M
134
9
550
8
500
Unemployment rate
(right scale)
450
Sep. 132
400
130
350
2001
2003
2005
2007
2009
2011
Orders (Almost) Back to Previous Peak
250
10/1
5
Initial claims
(left scale)
2000
2002
4
2004
2006
2008
Consumption Growth Remains Sluggish
$ billions
70
Aug.
Seasonally adjusted, three-month moving average
New orders
3
2010
Real Personal Consumption Expenditures
Non-defense Capital Goods (ex. Aircraft)
7
6
300
128
10
2005$ (bil)
10000
Seasonally adjusted annual rate
Monthly Changes*
May.
Jun.
Jul.
Aug.
65
Aug.
0.19 %
-0.93 %
4.27 %
-0.38 %
9500
9000
60
8500
Shipments
55
8000
50
7500
45
2000
2002
2004
2006
2008
2010
2002
2004
2006
Gross Domestic Product (GDP)
Percent
8
FRBSF Forecast
2010
Growth Projections Revised Down Everywhere
IMF World Economic Outlook GDP Projections
for 2011 and 2012
6
4
Q2
2008
*Annualized
Output Expected to Grow at Moderate Pace
Quarterly percent change at seasonally adjusted annual rate
7000
2000
2
Percent (Q4/Q4)
5
June
Projections
4
Sept
Projections
3
0
-2
2
-4
1
-6
-8
2005
2007
2009
2011
-10
2013
0
11 12
11 12
World Adv. Economies
11 12
U.S.
11 12
Euro Area
11 12
Japan
Some European Sovereign Debt Scarier
than U.S. Low-Grade Debt
But It Looks Like a Global Crisis Now
Stock Market Indices
10-Year Government Bond Yields
Percent
Greece
Portugal
Ireland
Spain
Italy
Low Grade Bond Yield
10/11
Index
110
January 4, 2008 = 100
10/10
28
MSCI
emerging markets
90
23
U S S&P 500
U.S.
18
60
Europe DJ STOXX
broad price index
8
JPN TOPIX
2010
Jan-08
2011
High Quality Debt Yields Down,
Helped by Policy Statements
Interest Rates
FOMC statements: 8/9 9/21
10/07
Low-grade bond yield
8
7
BAA bond
6
AAA bond yield
5
4
30-yr. conforming
mortgage
10-yr Treasury
3
2
2-yr Treasury
1
Fed funds target
1/1/10
5/1/10
9/1/10
10
9
1/1/11
5/1/11
9/1/11
0
Aug-08 Mar-09
Oct-09 May-10 Dec-10
50
40
3
2009
80
70
13
2008
100
Jul-11
30