Download FedViews

Twelfth Federal Reserve District
FedViews
November 8, 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
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 consistent with our forecast of a moderately growing economy and stable
inflation, setting aside the economic effects of Hurricane Sandy, which are difficult to estimate at this
point. We see growth picking up gradually over 2013 and beyond, but still expect significant labor
market slack even at the end of 2014.

Real GDP grew at a 2% annual rate in the third quarter, but the report illustrates a pattern evident in
recent data: a divergence between households and businesses in terms of both recent spending and
expectations about the future. Real personal consumption expenditures grew at a 2% annual rate in the
third quarter, matching GDP. And residential investment rose at a 14% annual rate, though it constitutes
less than 3% of GDP. At the same time though, inflation-adjusted business spending looked quite
different. Spending on nonresidential structures fell at a 5% rate, while spending on equipment and
software was unchanged.

Nonfarm payroll employment grew 171,000 in October, and data for the previous two months were
revised up substantially, according to the Bureau of Labor Statistics (BLS) survey of employers. The
BLS household survey showed the unemployment rate rising to 7.9% from 7.8%, reversing part of the
0.3 percentage point decline in September. The household survey also showed a substantial employment
increase in October. Measured over the past 12 months, civilian employment is now growing at rates not
seen since the mid-2000s. Of course, the nation still has a long way to go to make up for the substantial
job losses during the recession.

Faster job growth seems correlated with rising consumer optimism about the job market. A major
consumer survey showed that, in October, the percentage of respondents expecting the unemployment
rate to be lower in six months had risen to its highest level since March 1984. And optimism is not
limited to job market conditions. The expectations component of the Thomson Reuters/University of
Michigan Surveys of Consumers sentiment index has recently risen to levels not seen in five years. The
expectations component includes questions about how survey participants see their financial situation
over the next year and what economic condition they expect over the next one and five years.

Rising consumer optimism seems reflected in how consumers have been spending their money. Before
Hurricane Sandy, auto sales had been rebounding quite smartly. Home sales have been growing as well,
although they remain far below pre-recession levels. Over the past 12 months, existing home sales are up
11%, while new home sales have climbed 27%. Lower long-term interest rates have surely played a part.
But both homes and autos are long-term purchases, requiring a substantial financial commitment.
Consumers are unlikely to make these commitments if they are worried about the future.
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 17, 2012.

Other housing market indicators have turned positive as well. Inventories of unsold homes have declined
noticeably of late. Stocks of both new and existing homes are below their long-term averages, measured
relative to monthly sales. Home prices have begun to rise in a more sustained manner, though the
increases are not large. For example, the S&P/Case-Shiller 20-City Composite Home Price Index is up
2% over 12 months, while the CoreLogic Home Price Index is up 5%. Moreover, housing starts are
growing faster, rising nearly 35% over the past 12 months.

These improvements are showing up in builder sentiment, which, though still below average levels, has
jumped noticeably in recent months. However, the same thing cannot be said of business sentiment in
general. For instance, National Federation of Independent Business surveys show the shares of members
planning capital expenditures over the next three to six months or expecting higher inflation-adjusted
sales in six months remain below average. More importantly, these indicators have not improved much
over the past year.

This pessimism appears to be showing up in orders for nondefense capital goods, which have fallen
nearly 10% since their December 2011 peak. While this is nowhere near what one would see in a
recession, declines of this magnitude are rare at other times. In other data, manufacturing is a bright spot,
with orders rising in both September and October.

These declining orders for nondefense capital goods raise the risk that the economy will perform worse
than we expect. The looming federal “fiscal cliff” and the European financial crisis and recession also
pose risks to the outlook.

Even so, we expect the pace of growth will increase over time, once the economy works through the
effects of Hurricane Sandy, the drought in many parts of the country, and the fiscal tightening that we
anticipate at the beginning of next year as at least some fiscal cliff measures are implemented.
Specifically, we expect real GDP to increase roughly 2½% in 2013 and 3½% in 2014. This gradual
pickup won’t be enough to bring down the unemployment rate quickly. At the end of 2014, we expect the
rate to still be about 1½ percentage points above its inflation-neutral equilibrium level.

Apart from short-run swings in the price of oil and agricultural goods, we see little inflationary pressure
in the economy. Inflation is expected to remain below the Federal Reserve’s 2% target for several years.

Our forecast takes into account the stimulus measures announced by the Federal Reserve’s policy
committee in September. The Federal Open Market Committee said then that the Fed will buy additional
agency mortgage-backed securities at a pace of $40 billion per month until substantial progress toward
the Fed’s maximum employment goal is evident. It also said it anticipates that exceptionally low levels
for the benchmark federal funds rate will be warranted at least through mid-2015.
Recent growth has been uneven
Jobs grew faster than expected in October
Third Quarter Growth Rates
Employment
Real, seasonally adjusted, annualized
Residential
Investment
GDP
PCE
Equipment
and
Structures Software
Imports
Exports
%
16
14
12
10
8
6
4
2
0
-2
-4
-6
Source: Bureau of Economic Analysis
%
4
12-mo. change, seasonally adjusted
Civilian
2
0
Monthly Changes
Non-farm Civilian
Jul. 181K -195K
Aug. 192K -119K
Sept. 148K
873K
Oct. 171K
410K
-2
-4
Non-farm
-6
01 02 03 04 05 06 07
Source: Bureau of Labor Statistics
08
09
10
11
12
Home sales recovering
Consumers most optimistic since recession
Home Sales
Consumer Expectations
Index
120
Not seasonally adjusted, 1966:Q1 = 100
100
Seasonally adjusted annual rate
N
Average
6.0
1200
1000
80
Millions
6.5
Thousands
1400
800
New
home sales
Existing
home sales
5.5
Sep.
4.5
5.0
4.0
600
60
3.5
400
40
86 88 90 92 94 96 98 00
Source: University of Michigan
02
04
06
08
10
12
3.0
2.5
200
00 01 02 03 04 05 06 07 08 09 10 11 12
Source: National Association of Realtors
Declining housing inventory overhang…
…means less pessimistic homebuilders
Homebuilders: Housing Market Index
Months of Supply
Months
15
3-mo. moving average
Seasonally adjusted
80
60
Existing Homes
10
Average
Q3
5
New Homes
20
Sept.
0
80
84
88
92
96
00
04
08
Source: Census Bureau, National Association of Realtors
40
12
0
85
88
91
94
97
00
03
Source: National Association of Homebuilders
06
09
12
Other business sentiment not improving
No rebound in planned investment
% Planning Capital Expenditures Next 3-6 Mos.
% Expecting Higher Real Sales in 6 Mos.
Seasonally Adjusted
Net %
40
%
50
Seasonally Adjusted
40
20
Average
Average
Q3
30
0
20
Q3
-20
-40
86 88 90 92 94 96 98 00 02 04 06 08
Source: National Federation of Independent Business
10
12
Pessimism shows in capital goods orders
Nondefense Capital Goods (excluding Aircraft)
Seasonally adjusted, 3-mo. moving average
$ bil.
70
10
0
86 88 90 92 94 96 98 00 02 04 06 08
Source: National Federation of Independent Business
10
12
We forecast gradual pickup in growth...
GDP Growth: Actual and FRBSF Forecast
%
6
65
New orders
2
60
Actual
Sep.
FRBSF
Forecast
55
-6
50
Shipments
-2
45
00 01 02 03 04 05
Source: Census Bureau
06
07
08
09
10
11
12
05
…while inflation remains subdued
PCE Inflation
%
5
% change from four quarters earlier
Overall PCE
Price Index
4
3
FRBSF
forecast
Core PCE Price
Index
2
1
Q2
0
-1
-2
04
05
06
07
08
09
10
Source: Bureau of Economic Analysis
11
12
13
14
06
07
08
09
10
11
12
13
14
-10