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Twelfth Federal Reserve District
Economic Research Department
Federal Reserve Bank of San Francisco
101 Market Street
San Francisco, CA 94105
FedViews
October 8, 2015
Also available upon release at
http://www.frbsf.org/economic-research/publications/fedviews/
Reuven Glick, group vice president at the Federal Reserve Bank of San Francisco, stated his views on the
current economy and the outlook as of October 8, 2015.

Real GDP jumped to 3.9% in the second quarter of 2015, well above first-quarter growth of 0.6%.
Personal consumption expenditures, business investment, and residential investment all made
positive contributions to growth. In the six years since the Great Recession ended, real GDP growth
has averaged 2.2% at an annual rate, near the economy’s long-term trend of 2%.

We expect the U.S. economy to slow modestly in the third quarter because of reduced inventory
buildups and weaker net exports. Propelled by solid momentum in consumption spending, moderate
growth around the economy’s long-term trend should resume heading into 2016. Ongoing risks to the
growth outlook include possible spillovers from economic slowdowns in China and other foreign
markets and a further strengthening of the U.S. dollar.

Employment growth has slowed somewhat but remains consistent with an improving labor market.
Payroll employment increased by 142,000 in September, and the number of jobs added for July and
August combined was revised down by 59,000. Significant job losses were recorded in recent
months for the industries most exposed to overseas conditions, the energy sector and manufacturing.
Still, average gains over the past six months have been around 200,000.

The unemployment rate in August remained at 5.1%, which is very close to the 5.0% level that we
judge to be the natural rate of unemployment. Other signs of progress include lower unemployment
insurance claims and declines in broader measures of unemployment that include discouraged and
marginally attached workers. However, some measures of labor market slack, such as the labor force
participation rate and employment-to-population ratio, remain well below pre-recession levels. We
expect that the ongoing pace of job creation, though slowing, will be sufficient to bring the economy
temporarily below the natural rate in 2016.

Inflation, as measured by the change in the personal consumption expenditures (PCE) price index,
was 0.3% in the 12 months through August. Very low overall inflation is largely attributable to lower
prices of energy goods and services, which have fallen by over 16% in the past year. Excluding
energy as well as the typically volatile food component of spending, core PCE rose 1.3% over the
past 12 months. Inflation has remained below the Federal Open Market Committee’s 2% target since
mid-2012. Absent further declines in energy prices or a further strengthening of the U.S. dollar, we
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 16.
expect that stable inflation expectations and diminishing slack will push core and overall PCE
inflation up gradually towards 2%.

The PCE is a composite of the price changes of different products and services. Food and energy
account for roughly 11% of total consumer spending, while core goods (excluding food and energy)
account for 23% of spending, and core services (excluding energy costs of housing) account for the
remaining 66%.

In recent years, core services inflation has tended to be positive, except during the recession and the
early recovery. Core goods inflation has tended to be negative, with brief exceptions around 2009–10
because of tobacco tax hikes and 2011–12 because of rising textile and apparel costs. In recent
months both core goods and services inflation have slowed, that is, services inflation has been less
positive and goods inflation has been more negative.

The decline in core goods inflation can be attributed to declining import costs associated with the
appreciating value of the dollar as well as lower costs abroad. Because goods account for most
international trade, movements in exchange rates and foreign prices tend to exert more pressure on
goods prices than on service prices. Lower prices of imported consumption goods directly affect core
goods inflation. They also affect goods prices indirectly through imports of raw materials, such as
metals, plastic, and rubber, used in the U.S. production of goods for domestic consumers.

Core service inflation has been pulled down by more subdued increases in health-care service costs,
which represent a quarter of core services spending and 19% of overall core spending. Health-care
services inflation has been slowing for several years and fell off sharply in 2014, primarily from
capping of increases in Medicare payments to physicians.

The impact of import, energy, and health-care costs on core inflation can be gauged by “what-if”
exercises that remove these sectors from the calculation. Excluding relatively import-intensive (for
example, apparel and other nondurables) and energy-intensive (for example, transportation) sectors
would raise core inflation modestly, by around 0.2%. Removing health-care services spending from
the calculations would raise core inflation by an additional 0.3%.
GDP growth rebounded to 3.9% in Q2
GDP growth: Actual and FRBSF forecast
Employment growth continues
%
Quarterly percent change at seasonally adjusted annual rate
Nonfarm payroll employment
Thousands
Monthly change; seasonally adjusted
500
6
Q2
2
FRBSF
forecast
Actual
400
6-month
moving average
Monthly
change
300
Sep
142,000
-2
200
-6
100
2007
2008
2009
2010
2011
2012
2013
2014
2015
-10
2012
Source: Bureau of Economic Analysis and FRBSF staff
2013
2014
0
2015
Source: Bureau of Labor Statistics
Unemployment near natural rate
Inflation remains low
Unemployment rate
Monthly; seasonally adjusted; forecast is quarterly average
%
PCE price inflation
12
Percent change from 4 quarters earlier
%
5
4
10
Overall PCE
price index
8
3
Target rate
Sep.
5.1
2
Q2
6
FRBSF
forecast
1
Core PCE
price index
4
0
FRBSF
forecasts
-1
2
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
0
Source: Bureau of Labor Statistics and FRBSF staff
Personal consumption expenditure components
Health care
17%
2007
2008
2009
2010
2011
2012
2014
2015
Price inflation for goods and services is down
Core PCE goods and services price inflation
Food
7% Energy
4%
-2
2016
Source: Bureau of Economic Analysis and FRBSF staff
%
Percent change over previous 12 months, 3-month moving average
4
Core PCE services
price inflation
Nondurables
12%
3
Aug
2
Housing ex.
energy
16%
Durables
11%
Core PCE goods
price inflation
1
0
Financial
services
8%
Restaurants,
hotels,
recreation
Source: BEA July 2015
10%
2013
Other
services
12%
Food & energy: 11%
Core goods:
23%
Core services: 66%
-1
2007
2008
2009
2010
Source: Haver Analytics / BEA
2011
2012
2013
2014
2015
-2
Health care pulling down services inflation
Lower import prices reduce goods inflation
PCE core goods & imported consumer goods price inflation
Percent change over previous 12 months, 3-month moving average
Core PCE services and health-care price inflation
%
4
%
Percent change over previous 12 months, 3-month moving average
4
Core PCE services
price inflation
3
3
Aug
2
Imported consumer goods
price inflation
1
Aug
Core PCE goods
price inflation
2010
2011
2012
2013
2014
2015
-2
Inflation higher without certain sectors
%
Percent change over previous 12 months, 3-month moving average
3
Core PCE inflation
Core PCE inflation
without energy-intensive, without energy-intensive
import-intensive,
and import-intensive
and health care
2
Core PCE
price inflation
Aug
1
Source: Haver Analytics / BEA
-1
2010
2011
Source: Haver Analytics / BEA
2012
0
-1
PCE core price inflation without selected sectors
2011
1
Health-care
price inflation
0
Source: Haver Analytics / BEA
2010
2
2013
2014
2015
0
2012
2013
2014
2015
-2