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Twelfth Federal Reserve District
FedViews
January 8, 2015
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/
Mark Spiegel, vice president at the Federal Reserve Bank of San Francisco, states his views on the current
economy and the outlook.

Real GDP growth was revised upwards to 5.0% for the third quarter of 2014, 1.1 percentage points
above the previous estimate. The U.S. economy showed strong growth across the board, including
healthy increases in real personal consumption, business fixed investment, and net exports.
Consumer sentiment also neared post-recession highs according to the Thomson Reuters/University
of Michigan index and Conference Board surveys.

Despite this strength, we expect the pending GDP data to show moderate growth for the fourth
quarter of 2014 and continuing into 2015. There should be some payback from inventory buildups
that occurred during the exceptional growth experienced in the second and third quarters of last year.
We have already seen some signs of moderation, including modest declines in durable goods and
orders for core capital equipment in November.

Job growth has accelerated in recent months. This has brought unemployment closer to our estimate
of full employment levels, although the labor force still exhibits considerable slack. We expect this
slack to continue to diminish over the coming year.

Oil prices have plunged dramatically over the past six months, with West Texas Intermediate crude
prices falling by more than half to less than $50 a barrel. Declines in Brent crude prices were similar.
Other energy prices have also declined sharply, although not as much as oil. For example, natural gas
prices have fallen by nearly a third over the same period.

These falling energy prices, as well as reduced import costs due to recent strengthening of the U.S.
dollar, have contributed to keeping inflation low. Based on the headline PCE inflation measure,
overall prices fell 2% at an annual rate in November. The core inflation measure, which excludes the
volatile food and energy prices, indicates that prices were essentially flat. We expect future headline
inflation to dip as recent energy price declines work their way through the rest of the economy,
although they should have only a modest impact on core inflation. We continue to anticipate that
core inflation will move upwards over time towards the Federal Open Market Committee’s 2%
target.

Expectations of weak growth abroad are a primary source of weakness in our current outlook for the
United States. We anticipate limited growth in the advanced economies, particularly the euro area
and Japan. There is considerable uncertainty about the euro area, particularly with respect to future
European Central Bank asset purchases. Japanese growth appears to have stalled in 2014 following
the country’s consumption tax hike. Among emerging market economies, China’s ongoing
slowdown is also a source of considerable concern.
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 February 17, 2015.

Expectations for global growth are so low, however, that a positive surprise may emerge. First,
policy responses to economic difficulties abroad are likely to be accommodative. Second, the
aforementioned energy price declines and the strength of the dollar are both likely to boost growth in
the euro area and Japan in 2015.

Because the United States produces a substantial and growing amount of oil domestically, it is less
dependent on imported oil than Japan or the euro area. This is especially true for Japan since its
cessation of nuclear energy production after the 2011 Fukushima disaster. This discrepancy implies
that the recent decline in oil prices should have an even stronger positive impact on the Japanese and
euro-area economies than it is expected to have on the United States.

The dollar has appreciated quite dramatically over the past six months relative to the world’s other
major currencies, in particular the euro and the yen. Over that period, the dollar increased 11.3%
against the euro and 17.8% against the yen. The strength of the dollar should make Japanese and
euro-area exports, as well as domestic industries that compete against U.S. exports in those countries,
more competitive and help stimulate growth.

Positive news about growth prospects in the euro area and Japan is likely to be welcome because of
their importance as trading partners for the United States. However, the conditions expected to be
beneficial abroad may each affect the U.S. economy quite differently. In the case of energy price
declines, the United States is still a net oil importer, even if it is not as dependent as the euro area and
Japan. Thus, it is also likely to benefit from lower energy prices. In the case of the strong dollar,
however, the enhanced competitiveness of goods from the euro area and Japan must come at the
expense of goods produced elsewhere, including the United States. The adverse impact of the
stronger dollar on U.S. exports is likely to more than offset the positive effects from stronger growth
in the euro area and Japan.
Moving toward full employment
Return to moderate growth expected
GDP growth: Actual and FRBSF forecast
%
Quarterly percent change at seasonally adjusted annual rate
6
Q3
Unemployment rate and forecast
%
Monthly; seasonally adjusted, forecast is quarterly average
12
10
2
8
FRBSF
forecast
Actual
FRBSF
forecast
-2
6
Nov.
5.8
4
-6
2
2007
2008
2009
2010
2011
2012
2013
2014
2015
-10
2007
2008
2009
2010
2011
2012
2013
2014
2015
0
2016
Source: Bureau of Labor Statistics and FRBSF staff
Source: Bureau of Economic Analysis and FRBSF staff
...but core inflation still approaching target
Oil prices have plummeted...
Oil prices
$/barrel
120
PCE price inflation
%
Percent change from 4 quarters earlier
5
Brent
100
4
Overall PCE
price index
3
80
West Texas
Intermediate
FRBSF
forecast
2
60
1
Q3
Core PCE
price index
40
0
20
6/2014
7/2014
8/2014
9/2014
10/2014
11/2014 12/2014
0
1/2015
-1
2007
Source: Bloomberg
2008
2009
2010
2011
2012
2013
2014
2015
-2
2016
Source: Bureau of Economic Analysis and FRBSF staff
Global growth expected to be weak
Falling oil prices benefit Japan and euro area
%
Real GDP growth
%
Net Oil Imports as a Share of GDP, 2013
4
9
2013
2014 (projected)
2015 (projected)
8
3.5
7
3
6
2.5
5
2
4
3
1.5
2
1
1
0.5
0
Euro Area
Source: IFS, Consensus Forecasts
Japan
China
-1
U.S.
Japan
Euro Area
Source: U.S. Energy Information Administration, World DataBank
0
Strong dollar helps most foreign economies
Value of U.S. Dollar
%
Jan 1, 2014 = 100
120
Major world currencies
Euro
Yen
115
110
105
100
95
90
85
1/2014
3/2014
Source: Bloomberg
5/2014
7/2014
9/2014
11/2014
80
1/2015