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Twelfth Federal Reserve District
FedViews
May 14, 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/
Òscar Jordà, vice president at the Federal Reserve Bank of San Francisco, states his views on the
current economy and the outlook.

The initial estimate of real GDP growth for the first quarter of 2015 came in at 0.2%, lower than
expected and well below the 2.4% annual growth rate for 2014.

The weakness in the first quarter is attributable to a number of factors. Unusually harsh weather at
the beginning of the year in parts of the country kept consumers away from stores. Net exports fell
unusually rapidly. The appreciation of the dollar over the past few months made U.S. products more
expensive abroad, and sluggish economic conditions in Europe and parts of Asia reduced foreign
demand for U.S. goods. In addition, the West Coast dockworkers’ labor dispute disrupted the normal
flow of goods to export markets. The decline in net exports pushed real GDP growth down by more
than one full percentage point.

The massive drop in oil prices during the second half of 2014 caused domestic oil and gas extraction
industries to consolidate operations significantly. In turn, spending on new equipment and
exploration of new wells and mines fell nearly 50%. Although lower oil prices benefit consumers,
restrained investment in the energy sector left its mark on real GDP growth.

Because many of these factors are transitory, we remain optimistic that the economy will rebound
from the first-quarter weakness. The dollar appears to be stabilizing, the outlook for our European
trade partners is improving, and the West Coast port slowdown has been resolved, thus alleviating
some of the conditions dampening net exports. Oil prices appear to be stabilizing, which should help
investment in that sector normalize.

In addition, monetary policy remains highly accommodative, growth in employment and real
incomes is solid, and household wealth is improving as house prices revive. All of these elements
suggest the economy is on surer footing than the first-quarter reading of real GDP growth indicates.
In light of these conditions, we expect real GDP growth to move above its trend rate of 2% during
the second half of 2015. Absent other forces, and with employment and inflation near or at mandate
levels, we expect the economy to settle around trend in the second half of 2016.

Several factors continue to weigh down inflation, which rose only 0.3% at an annual rate as
measured by the headline personal consumption expenditures (PCE) price index. These factors
include the stronger dollar, which made imported products cheaper and put pressure on domestic
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 June 19, 2014.
producers to keep prices down, and gasoline prices, which remain near recent lows. Core PCE
inflation, which removes volatile food and energy prices, proved more resilient, rising 1.3% percent
over the past 12 months. As some of the downward forces on inflation dissipate and real GDP
growth picks up, we expect core PCE price inflation to move gradually toward the Federal Open
Market Committee’s 2% target.

Employment data show that 223,000 new jobs were created in April. This is close to the average rate
of job creation in 2014 and marks a significant rebound from the 85,000 jobs added in March. The
employment cost index shows signs that labor compensation is starting to pick up. These two factors
should provide a more solid foundation for household income, which in turn should boost consumer
spending.

The unemployment rate, at 5.4% in April, continues to drift toward our 5.2% estimate of the natural
rate. We expect a recovery in economic growth in the second half of this year to push the
unemployment rate below the natural rate around the middle of this year and keep it there for the
duration of our forecast horizon.

Looking further into the future, some economists have raised concerns about how a maturing
workforce will affect long-term U.S. economic growth. The rapid aging of the working population in
Japan since the mid-1990s is indicative of things to come. This has become more visible in the
industrialized world including the United States and eventually will also affect many developing
economies.

Aging populations are expected to consume less and save more. This, in combination with other
factors such as low nominal interest rates and slower productivity growth, has led to some concern
that the United States and other economies could enter a new normal of low economic growth. This
phenomenon has been dubbed secular stagnation.

Although the U.S. economy has grown at a lower rate than the average following all post-World War
II recessions and exhibits some of the characteristics of a secular stagnation scenario—low interest
rates, low inflation, and low growth—these conditions are also in line with another explanation. The
recent pattern of deep recession and gradual recovery is consistent with what would be expected
following a financial crisis. In fact, statistical analysis suggests that the U.S. recovery thus far has
actually proceeded at a somewhat better rate than the historical experience of other countries after a
severe financial crisis would predict.
Growth expected to rebound
Core inflation expected to approach target
GDP growth: Actual and FRBSF forecast
%
Quarterly percent change at seasonally adjusted annual rate
PCE price inflation
%
Percent change from 4 quarters earlier
5
6
4
Q1
Overall PCE
price index
2
Actual
FRBSF
forecast
-2
3
2
Q1
Target rate
1
Core PCE
price index
0
FRBSF
forecast
-6
-1
2007
2008
2009
2010
2011
2012
2013
2014
2015
-10
Source: Bureau of Economic Analysis and FRBSF staff
2007
2008
2009
2010
2011
2012
2013
2014
2015
-2
2016
Source: Bureau of Economic Analysis and FRBSF staff
Brisk job creation resumes
Nonfarm Payroll Employment
Unemployment closer to natural rate
Thousands
Seasonally adjusted, monthly change
450
Unemployment rate and forecast
%
Seasonally adjusted monthly observations, forecast is quarterly average
12
400
10
350
6-month moving
average
Monthly
change
Apr.
223,000
300
8
Apr.
5.4
250
200
Natural rate
(FRBSF)
150
6
FRBSF
forecast
100
2
50
0
2012
2013
2014
2015
2007
Source: Bureau of Labor Statistics
4
2008
2009
2010
2011
2012
2013
2014
2015
2016
0
Source: Bureau of Labor Statistics and FRBSF staff
The world is turning gray
Financial crisis, not secular stagnation
Working-age population as percent of total population
Real GDP per capita
75
Percent change from start of recession
%
15
Average post-WWII recession
recovery: 2.3% per year
70
Other advanced
economies
Japan
%
10
65
5
Actual
recovery: 1.4% per year
60
USA
0
Developing
economies
55
-5
50
JST model prediction for financial crises
Projected
1950
1960
1970
1980
Source: United Nations
1990
2000
2010
2020
2030
2040
45
2007
2050
2008
2009
2010
2011
2012
2013
Source: Author's calculations based on Jordà, Schularick, and Taylor (2013)
-10
2014