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Twelfth Federal Reserve District
FedViews
June 14, 2012
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 at the Federal Reserve Bank of San Francisco, states his views on the current
economy and the outlook.

After growing at a fairly strong pace at the end of last year, real GDP has decelerated. Some of the
slowdown is probably due to temporary factors, such as a payback for unseasonably warm winter
weather that may have accelerated economic activity earlier this year. However, a broad range of
economic indicators for the second quarter, including payroll job growth, personal income, and
manufacturing orders, have come in softer than we expected.

Recent data suggest that the recovery has less momentum than we anticipated. This evidence,
coupled with increasing strains in global financial markets, has led us to mark down our forecast for
GDP growth for 2012 and 2013. Our current view is that real GDP will grow about 2 to 2½% this
year and next.

This forecast is based on interpreting the recent data as signaling a temporary soft patch, similar to
what occurred a year ago, not a more persistent slowdown. As a result, we think that average growth
over the past three quarters of 2.2% is a better gauge of the underlying strength of the recovery than
the most recent data.

The main risk to the pace of the recovery is a further escalation of the financial crisis in Europe. That
would reduce European demand for U.S. exports and would accelerate the recent flight to safety in
financial markets that has fueled demand for U.S. Treasury securities. Because of this flight to
safety, yields on 10-year U.S. Treasuries have fallen to historic lows. This trend tends to strengthen
the dollar and increase risk premiums on corporate bonds and equities. A stronger dollar makes U.S.
exports more expensive for foreign buyers, while higher risk premiums push up financing costs and
lower stock market valuations.

The combination of the European crisis and slowing growth in some emerging market economies has
already led to a weakening of global demand. That, in turn, has prompted steep declines in
commodity prices. Falling commodity prices, combined with only a gradual drop in the high
unemployment rate, suggest that inflationary pressures will be very limited. Thus, we expect inflation
as measured by the personal consumption expenditures price index to remain below a 2% annualized
rate this year and next.

In line with the revisions of our forecast for GDP growth, we have raised our forecast for the
unemployment rate. We now expect the rate to remain above 7.5% throughout 2013. This implies a
marked slowdown in the pace of decline of the unemployment rate relative to what has taken place
over the past year.
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 July 16, 2012.

This unemployment rate forecast is shaped by our view that a substantial part of the rate’s 1
percentage point decrease over the past nine months occurred because many workers, especially the
long-term unemployed, gave up looking for jobs and left the labor force until conditions improve. If
labor market conditions do improve, as our forecast implies, then we expect those workers to rejoin
the labor force. As they resume their search for work, they will be counted as unemployed again.

Consistent with the falling unemployment rate, indicators of labor market churn suggest that labor
market conditions have gradually improved over the past 12 months. The quits rate, which measures
the number of workers who voluntarily leave their jobs, mostly people who decide to pursue better
opportunities, has been steadily increasing. In addition, the job finding rate, as measured by the
fraction of unemployed in a given month who are employed the following month, has been steadily
increasing over the past year, though it’s still near its historic low.

These alternative labor market indicators suggest that payroll job gains of about 150,000 per month
over the past year are probably more indicative of the labor market’s overall momentum than were
April and May’s disappointing job gains. Our unemployment rate forecast is based on a rate of labor
market recovery comparable to that of the past year. Such a pace is only slightly higher than what is
needed to keep up with population growth. The result would be only a very slow and gradual decline
in the unemployment rate.
Continued gradual recovery
Euro crisis is not abating
GDP Growth: Actual and FRBSF Forecast
Percent
6
10 year government bond yields
Percent
8
Spain
6
2
Italy
Actual
FRBSF
Forecast
4
-2
France
United States
-6
2
Germany
Japan
0
2006
2007
2008
2009
2010
2011
2012
2013
-10
Inflation expected to remain in check
PCE Price Inflation
Jan
Feb
Mar
Apr
May
Forecast slow decline in unemployment
Percent
5
Unemployment rate and forecast
Percent
12
4
FRBSF
Forecast
Jun
FRBSF
Forecast
10
3
8
2
6
1
4
Unemployment rate
Actual
2
0
2007
2008
2009
2010
2011
2012
2013
-1
Unemployment durations remain a concern
Unemployment rate split up by duration
52+ weeks
27-52 weeks
15 -26 weeks
5 -14 weeks
< 5 weeks
Unemployment rate
Percent
12
05
06
07
08
09
10
11
12
13
0
Slight improvement in odds of finding job
Share of unemployed who are employed next month Percent
40
Job finding rate
10
30
8
6
20
4
10
2
0
1967 1972 1977 1982 1987 1992 1997 2002 2007 2012
0
1967 1972 1977 1982 1987 1992 1997 2002 2007 2012
… and more people are switching jobs
Share of employed who voluntarily leave their job Percent
3
2.5
2
Quits Rate
1.5
1
0.5
0
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012