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Twelfth Federal Reserve District
FedViews
Economic Research Department
Federal Reserve Bank of San Francisco
101 Market Street
San Francisco, CA 94105
September 10, 2015
Also available upon release at
http://www.frbsf.org/economic-research/publications/fedviews/
Kevin J. Lansing, research advisor at the Federal Reserve Bank of San Francisco, states his views on the
current economy and the outlook.

Real GDP growth in the second quarter of 2015 was revised up to 3.7% at an annual rate, a substantial
pickup from first-quarter growth of 0.6%. Personal consumption expenditures, residential investment,
and state and local government spending all posted solid gains during the second quarter. In the six years
since the Great Recession ended, real GDP growth has averaged 2.2% at an annual rate.

We expect the U.S. economy to grow slightly above its 2% long-term trend for the next four quarters,
and then return to trend by the end of 2016. Downside risks to the growth outlook include possible
spillovers from economic slowdowns in China and other foreign markets and a continued strengthening
of the U.S. dollar, which would pose a headwind for net exports.

Payroll employment increased by 173,000 in August, resulting in a year-to-date gain of 1.7 million new
jobs. Since bottoming out in February 2010, payroll employment has increased by 12.6 million. The
continued strong job growth pushed down the unemployment rate to 5.1% in August, which is close to
the level that we judge to be the natural rate of unemployment. It should be noted, however, that other
measures of labor market slack, such as the employment-to-population ratio, have yet to fully recover.

Inflation, as measured by the four-quarter change in the personal consumption expenditures (PCE) price
index, 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 would expect PCE
inflation to rise gradually towards 2% as economic slack continues to dissipate.

Long-term nominal interest rates have declined recently after rising during the first half of 2015. Recent
movements reflect a “flight-to-safety” in response to investor concerns about economic slowdowns in
foreign economies and the prospect that such events could have negative spillovers for U.S. economic
growth. At the short end of the yield curve, the two-year Treasury rate continues to trend upward as
investors anticipate that the liftoff date of the federal funds rate from zero is drawing closer.

Stock market gains have been an important feature of the U.S. economic expansion. Since bottoming out
in early 2009, the Standard & Poor’s (S&P) 500 stock market index has trended upward for more than six
years with occasional brief corrections. The most recent correction took the form of an approximate 10%
drop in the index, reflecting investor concerns about China and foreign markets. Stock prices in China, as
measured by the Shanghai Composite Index, underwent an enormous boom during the first half of 2015,
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 October 13, 2015.
but have since retraced most of the prior gains. This pattern is reminiscent of the boom-bust episode that
occurred in the Shanghai index during 2007 and 2008. Nevertheless, the Shanghai index remains above
the level that prevailed at the beginning of 2015.

The median U.S. house price has nearly recovered to its pre-recession peak. In some parts of the country,
house prices have reached all-time highs. Movements in construction employment have tended to track
movements in the median house price with a lag. Consequently, continued increases in house prices
should contribute to more homebuilding activity and construction jobs. However, new housing starts are
still about 50% below their prior peak, suggesting that homebuilders are exercising caution in light of the
substantial overbuilding that occurred during the bubble years of the mid-2000s.

When viewing any substantial run-up in asset prices, history tells us that the phrase “this time is
different” should be met with a healthy degree of skepticism. Still, the increase in U.S. house prices
since 2011 differs in significant ways from the housing boom experienced during the mid-2000s. The
prior episode can be described as a credit-fueled bubble in which housing valuation (as measured by the
house price-to-rent ratio) and household leverage (as measured by the mortgage debt-to-income ratio)
rose together in a self-reinforcing feedback loop. In contrast, the more recent episode exhibits a lesspronounced increase in housing valuation together with an outright decline in household leverage—a
pattern that is not suggestive of a credit-fueled bubble.

Advocates of leaning against bubbles point out that bubbles can distort economic decisions, including
employee hiring, contributing to imbalances that may take many years to unwind. States with the largest
house price booms from 2003 to 2006 experienced faster employment growth during the boom years and
more severe employment drops during the bust years in comparison to states with the smallest house
price booms. While employment in both groups has rebounded, the additional jobs lost in states with the
largest prior housing booms have yet to be fully recovered.
Output growth rebounds
Solid labor market gains continue
Real GDP
%
Quarterly percent change at seasonally adjusted annual rate
Nonfarm payroll employment
Thousands
Seasonally adjusted, monthly change
6
6-yr avg 2.2%
FRBSF
forecast
500
4
Q2
Actual
Monthly
change
0
400
6-month
moving average
2
300
-2
-4
200
Aug
173K
-6
100
-8
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
-10
2012
2013
2014
0
2015
Source: Bureau of Labor Statistics
Source: Bureau of Economic Analysis and FRBSF staff
Unemployment continuing downward
Inflation expected to return to target
Unemployment rate
%
Monthly; seasonally adjusted; forecast is quarterly average
Personal consumption expenditures price inflation
%
Percent change from 4 quarters earlier
12
5
4
10
Overall PCE
price inflation
3
8
Target
FRBSF
6
forecast
Aug.
5.1
2
Q2
1
Core PCE
price inflation
4
FRBSF
forecasts
2
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
0
Source: Bureau of Labor Statistics and FRBSF staff
0
-1
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
-2
Source: Bureau of Economic Analysis and FRBSF staff
Interest rates remain low
China slowdown leads to equities volatility
Interest rates
%
Weekly average
Stock market indices
Index
Weekly price index, 100 = 1/5/2009
8
350
Shanghai
Composite
7
300
6
30-year mortgage
250
5
9/10
S&P 500
4
200
3
9/8
150
2
Ten-year Treasury
Federal
funds rate
2007
2008
Source: FAME
100
1
Two-year Treasury
2009
2010
2011
2012
2013
2014
2015
0
50
2007
2008
2009
Source: Yahoo Finance
2010
2011
2012
2013
2014
2015
Housing market recovery continues
Latest housing boom is different
House prices, housing starts, and construction employment
Seasonally adjusted index, 100 = pre-recession peak
Index
Debt-to-income and price-to-rent ratios
Index
Seasonally adjusted index, 100 = pre-recession peak
110
110
Median house prices
100
90
Mortgage debt
Income
July
Construction
employment
70
90
Q2
80
50
Q1
30
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
10
60
House price
Rent
New housing starts
70
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
50
Sources: Flow of Funds, BEA, CoreLogic, and BLS
Sources: BLS, Census Bureau, CoreLogic, and Haver Analytics
Boom states resume rapid appreciation
Median house prices
Housing bubble effects persist
Index
Index, 100 = Jan 2003
Nonfarm payroll employment
Index
Seasonally adjusted index, 100 = pre-recession peak
200
110
States with smallest
house price booms
2003-2006
180
July
105
160
States with largest
house price booms
2003-2006
100
140
April
95
120
States with smallest
house price booms
2003-2006
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: Corelogic
States with largest
house price booms
2003-2006
100
80
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Sources: BLS and Corelogic
90
85