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Twelfth Federal Reserve District
FedViews
February 13, 2014
Economic Research Department
Federal Reserve Bank of San Francisco
101 Market Street
San Francisco, CA 94105
Also available upon release at
http://www.frbsf.org/economic-research/publications/fedviews/
Vasco Cúrdia, senior economist at the Federal Reserve Bank of San Francisco, provides his views on current
economic developments and the outlook.

Recent data continue to indicate a strengthening recovery. Fourth-quarter real GDP growth suggested
a little less momentum than we expected in domestic demand. We expect a further modest dip in
GDP growth in the current quarter, reflecting two main factors. First, firms are likely to reduce their
accumulation of inventories following a sizable increase in the second half of 2013. Second, weak
retail sales in January suggest somewhat weaker near-term growth in consumption. Some of this
weakness is likely associated with bad weather and the termination of extended unemployment
benefits. Nevertheless, we expect more solid growth overall for 2014.

The January labor market report confirmed that jobs continue to grow. The average increase in
nonfarm payroll employment was almost 180,000 over the past six months. December and January
fell well short of that pace, partly due to inclement weather. Other elements of the January report
were more encouraging, with increases in labor force participation and employment-to-population
ratios.

The unemployment rate declined again in January, and we expect it to keep declining. However, the
rate remains above our estimate of the natural rate of unemployment, which signals persisting slack
in the economy. Overall, we view these data as consistent with a sustained but gradual recovery in the
labor market.

Inflation remains subdued and well below the longer-run goal of 2% set by the Federal Open Market
Committee (FOMC). This is due in part to lower inflation in energy and medical services, which we
expect to be temporary, as well as ongoing economic slack. As the temporary factors dissipate and
economic slack narrows, we expect inflation to rise gradually towards the 2% objective.

Consumption is historically the main demand-side driver of GDP growth. In the six decades prior to
the Great Recession, consumption contributed an average of 2.2 percentage points to annual GDP
growth of 3.5%. Since the beginning of the recovery in mid-2009, consumption has contributed only
about 1.5 percentage points per year. Although this is an improvement over the 2008–09 recession, it
is still below the historical norm.

The contribution of durable consumption goods to real GDP growth has recovered to levels similar to
its historical average, around 0.5 percentage point. The shortfall in the consumer contribution has
been in nondurables and, especially, services.

The pattern among the components of consumption in the recovery can be partly explained by low
interest rates resulting from monetary policy actions since the recession. Consumption of durables is
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 March 21, 2014.
highly responsive to interest rates. By contrast, nondurables and services consumption are more
dependent on a broad-based improvement in economic conditions, including labor income and
consumer confidence. It is therefore normal to expect consumption of services to be slower in
response to monetary policy stimulus.

We expect consumption growth to pick up as the labor market continues to recover, improving
households’ labor income and economic prospects. Additionally, lower debt and higher net worth—
boosted by higher equity and housing prices—should make households gradually more confident and
willing to consume more.

Fixed investment is another important component of GDP, normally accounting for about 0.7
percentage point per year of growth. Investment was a substantial drag in the recession but has since
bounced back to its historical patterns, supported by low interest rates. Importantly, the housing
market was considered a significant headwind early in the recovery, but it has improved substantially
in the last two years, returning the contribution of residential investment close to levels consistent
with historical patterns.

Unlike other components of GDP, government purchases continued to support growth during the
recession. During the recovery, government spending has fallen, which has subtracted from growth.
However, we expect this headwind to abate.
We expect moderate growth
Employment continues to grow
Nonfarm Payroll Employment
Gross Domestic Product (GDP)
Percent
Percent change at seasonally adjusted annual rate
FRBSF
Forecast
Q4
Millions
140
Millions of employees; seasonally adjusted
Monthly Changes
5
Oct.
Nov.
Dec.
Jan.
0
237.0 K
274.0 K
75.0 K
113.0 K
138
Jan
136
6 month average:
177.5 K
134
132
-5
130
-10
2007 2008 2009 2010 2011 2012 2013 2014 2015
128
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Bureau of Economic Analysis and FRBSF Staff
Unemployment continues to decline
Inflation remains subdued
Unemployment Rate
PCE Price Inflation
Monthly observations; seasonally adjusted
Percent
12
Percent change from four quarters earlier
10
Overall
PCE Price
Index
Unemployment
rate
Jan
Percent
4
8
Forecast
6
Natural rate
(FRBSF)
4
2
Core PCE
Price Index
Q4
0
2
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: Bureau of Labor Statistics and FRBSF staff
Real GDP and its components
-2
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: Bureau of Economic Analysis and FRBSF Staff
Consumption of services below normal
Personal Consumption Expenditure Components
Average % change at seasonally adjusted annual rate
Contributions to real GDP growth
Real
GDP
growth
PCE
Fixed
invest.
19472007
3.5
2.2
20082009
-2.8
20092013
2.4
Inventory
accum.
Govt.
purchases
0.7
0.1
0.6
-0.1
-1.2
-2.6
-1.0
0.7
1.2
1.5
0.7
0.5
-0.3
0.0
Contribution to real GDP; seasonally adjusted annual rate
Percent
1.5
1.0
Net
exports
0.5
0.0
Source: Bureau of Economic Analysis.
Services
Nondurable Goods
-0.5
Durable Goods
-1.0
1947-2007
2008-2009
Source: Bureau of Economic Analysis
2009-2013
Fixed investment bounced back
Fixed Investment Components
Contribution to real GDP; seasonally adjusted annual rate
Percent
1.0
0.5
0.0
-0.5
Residential
-1.0
Nonresidential
-1.5
-2.0
1947-2007
2008-2009
Source: Bureau of Economic Analysis
2009-2013