The State of the Economy and the Role of Monetary PolicyDaniel BotkinMichael CassidyDaniel CraigKyle KorkusKevin Murillo

Meeting AgendaHeadwinds to the Economy

European Debt Crisis

Fiscal Cliff Situation

Alternate Fiscal Scenarios

Economic Growth Summary

Current GDP Analysis

Q4-2012 and 2013 GDP Prediction

Monetary Policy Analysis

Summary and Re-evaluation of Current Policy Tools

Suggestions for New Policy Tools

Final Monetary Policy Recommendations

Headwinds Against RecoveryEuropean Sovereign Debt Crisis

Source: World Economic Outlook Report Last Updated: 10/9/12, Note: Estimates Start after 2011

2005 2007 2009 20110

5

10

15

20

25

30

Unemployment Rate, Percent

2005 2007 2009 20110

30

60

90

120

150

180Federal Debt, Percentage of GDP

– Greece – Italy – Spain – Germany

Headwinds Against RecoveryEconomic Effects: Falling off Fiscal Cliff

Tax Effects Spending Effects

Source: Congressional Budget Office; Michael Ferolli, JP Morgan ChaseLatest updated: (CBO) 8/22/12

Gross Economic Effects:• $560 billion reduction in Nominal GDP• 3.5% projected reduction in Real Gross Domestic Product

Tax Effects Spending Effects

Expiration of Bush tax cuts - $280 billion $40 billion expiration of emergency unemployment benefits

Expiration of payroll tax holiday - $125 billion

$98 billion from Budget Control Act (mandated cuts)

Affordable Care Act - $18 billion $11 billion: reduction in Medicare payments

Government Spending:Multiple Scenarios

2011-01 2011-07 2012-01 2012-07 2013-01 2013-072300

2350

2400

2450

2500

2550

Billi

ons

of C

hain

ed 2

005

USD

An alternative fiscal scenario’s budget will keep most spending in place

But a fall off the fiscal cliff will cut spending drastically

Source: US Department of Commerce: Bureau of Economic AnalysisSeasonally Adjusted Annual Rates, Quarterly, Last Updated: 10/26/2012Estimations by the Congressional Budget Office, update 8/22/12

Dual-Mandate:Maximum Employment/Price Stability

1 7 13 19

4

5

6

7

8

9

10

Civilian Unemployment Rate, Percent

Sources: US Department of Labor: Bureau of Labor StatisticsMonthly, Seasonally Adjusted, Last Updated: 11/2 and 11/15 RespectivelyNote: Core CPI is the Consumer Price Index for All Urban Consumers: All Items Less Food & Energy

2005

-01

2006

-01

2007

-01

2008

-01

2009

-01

2010

-01

2011

-01

2012

-01

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Core CPI, Percent Change from One Year Ago

10-Year Average

“Do whatever it takes?”The Federal Reserve’s Balance Sheet Has Tripled Since 2008

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

-500000

0

500000

1000000

1500000

2000000

2500000

3000000

3500000

Recession Begins

Source: Board of Governors of the Federal Reserve SystemMillions of Dollars, Last Update 11/15/2012

Effective Federal Funds RateBetween 0-25 Basis Points Since 2009

2005 2006 2007 2008 2009 2010 2011 20120

1

2

3

4

5

Perc

ent

Source: Board of Governors of the Federal Reserve SystemNot Seasonally Adjusted, Monthly Percent, Last Updated 11/13/12

What is monetary policy doing:• Keeping interest rate targets between 0-25 basis points.• Mentioning in our statements the length of time the targets

are likely warranted until• Purchasing $40 billion worth of agency MBS per month

indefinitely• Finishing our maturity extension program, selling short-term

treasury bills and buying long-term treasury bonds in an equal amount, for a total of $675 billion between September 2011 and the end of December 2012

Meeting AgendaHeadwinds to the Economy

European Debt Crisis

Fiscal Cliff Situation

Alternate Fiscal Scenarios

Economic Growth Summary

Current GDP Analysis

Q4-2012 and 2013 GDP Prediction

Monetary Policy Analysis

Summary and Re-evaluation of Current Policy Tools

Suggestions for New Policy Tools

Final Monetary Policy Recommendations

Real GDP Growth in 2012:Y=C+I+G+NX

2012-01 2012-04 2012-07-1000

1000

3000

5000

7000

9000

110001.95% 1.25% 2.00%

Consumption Investment Government Spending Net Exports

(Bill

ions

of C

hain

ed 2

005

USD

)

Source: US Department of Commerce: Bureau of Economic AnalysisQuarterly, Seasonally Adjusted; Last Updated 10/26/2012

– Annualized Growth Rate

Consumption Gains in 2012:Retail, Durable Goods, and Auto Sales Increase

2005-01

2006-01

2007-01

2008-01

2009-01

2010-01

2011-01

2012-01950

1000

1050

1100

1150

1200

1250

9

11

13

15

17

19

21

Sales: Durable GoodsLight Weight Vehicle Sales

Source: US Department of Commerce, US Census Bureau, US Department of Commerce: Bureau of Economic AnalysisSeasonally adjusted, Monthly; Last Updated: Retail Sales-11/14/12, Durable Goods-10/29/12, Auto Sales-11/06/12

2005

-01

2006

-01

2007

-01

2008

-01

2009

-01

2010

-01

2011

-01

2012

-01

-15%

-10%

-5%

0%

5%

10%

15%

Retail Sales, % Change from 1 Year Ago

Billions of Units

Millions of Units

Housing Prices:Standard and Poor’s Case-Shiller Index

2007

-01

2007

-07

2008

-01

2008

-07

2009

-01

2009

-07

2010

-01

2010

-07

2011

-01

2011

-07

2012

-01

2012

-07130.00

140.00

150.00

160.00

170.00

180.00

190.00

200.00

210.00

Source: Standard and Poor’s20-City Monthly Index, January 2000=100, Last Updated 10/31/12

Aug-2012 Index142.7

Consumers More Optimistic Than Businesses

2008

-01

2008

-07

2009

-01

2009

-07

2010

-01

2010

-07

2011

-01

2011

-07

2012

-01

2012

-07

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%Business Confidence Consumer Confidence

Perc

ent C

hang

e fr

om a

Yea

r Ago

Source: University of Michigan/Thomas Reuters, National Federation of Independent BusinessMonthly, Seasonally Adjusted; Last updated - Consumer: 11/9/12 Business: 11/13/12Consumer Confidence Index 100=1966Q1 Business Confidence Index 100=1986

Consumer Confidence Indexed by Thomas Reuters/University of MichiganSmall Business Optimism Indexed by National Federation of Independent Businesses

Investors are as Wary of Fiscal Uncertainty

2011-01 2011-04 2011-07 2011-10 2012-01 2012-04 2012-07-2%

0%

2%

4%

6%

8%

Percent Change of Real Gross Domestic Private InvestmentPercent Change of Real Private Nonresidential Fixed Investment

Source: U.S. Department of Commerce: Bureau of Economic AnalysisQuarterly, Seasonally AdjustedLast Updated: 10/26/2012

Production and Manufacturing:2011 Compared to 2012

Source: Board of Governors of the Federal Reserve SystemMonthly, Seasonally AdjustedLast Updated: 11/16/2012 Note: New Orders are all Capital Goods Excluding Aircraft

2011

-01

2011

-04

2011

-07

2011

-10

2012

-01

2012

-04

2012

-07

2012

-10

-3%

-2%

-1%

0%

1%

2%

3%

Percent Change, Indus-trial Production Index, 3M-Moving Aver-age

Percent Change, New Orders, 3M Moving Av-erage

Underwhelming Wages and Incomes20

07-0

1

2008

-01

2009

-01

2010

-01

2011

-01

2012

-01

0.00%

0.10%

0.20%

0.30%

0.40%

Average Hourly Wages, 3M Mov-ing Average

2011

-01

2011

-07

2012

-01

2012

-07

9900

10000

10100

10200

10300

10400

Real Disposable Personal Incomes

Billi

ons o

f Cha

ined

200

5 Do

llars

Source: US Department of Labor: Bureau of Labor Statistics; US Department of Commerce: Bureau of Economic AnalysisSeasonally Adjusted, Monthly; Last Updated: 10/29/12 and 11/2/12

Real Net Exports:Falling Euro Area Incomes Will Likely Affect Trade Balance

2005

-01-

01

2005

-07-

01

2006

-01-

01

2006

-07-

01

2007

-01-

01

2007

-07-

01

2008

-01-

01

2008

-07-

01

2009

-01-

01

2009

-07-

01

2010

-01-

01

2010

-07-

01

2011

-01-

01

2011

-07-

01

2012

-01-

01

2012

-07-

01

-800.000

-700.000

-600.000

-500.000

-400.000

-300.000

-200.000

-100.000

0.000

Billi

ons

of C

hain

ed 2

005

Dol

lars

Source: U.S. Department off Commerce: Bureau of Economic AnalysisSeasonally adjusted, Quarterly, Last Updated: 10/26/2012

Dollar/Euro Exchange Rate:Recession in Euro Area Could Lead to Depreciation of Euro

2011

-01

2011

-04

2011

-07

2011

-10

2012

-01

2012

-04

2012

-07

2012

-10

1.2

1.3

1.4

1.5

US

Dol

lars

per

1 E

uro

Source: European Central Bank Statistical Data WarehouseDaily, Not Seasonally AdjustedLast Updated: 11/16/2012

Predicted Annual GDP Growth:Q4-2012 – Q4-2013

2011-01 2011-07 2012-01 2012-07 2013-01 2013-07-1.00%

-0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

Under current policy:We predict 1.7% annual growth

Should we fall off fiscal cliff:We predict -.5% annual growth

Source: US Department of Commerce: Bureau of Economic AnalysisPrediction by authors

Meeting AgendaHeadwinds to the Economy

European Debt Crisis

Fiscal Cliff Situation

Alternate Fiscal Scenarios

Economic Growth Summary

Current GDP Analysis

Q4-2012 and 2013 GDP Prediction

Monetary Policy Analysis

Summary and Re-evaluation of Current Policy Tools

Suggestions for New Policy Tools

Final Monetary Policy Recommendations

Back To The Main Question• Is short-term unemployment more of

a threat to our fulfillment of the dual-mandate than the risks of long-term inflation?•Are we, as policy-makers, past the “do

whatever it takes” stage of this recovery?

Credit Easier to Obtain:Federal Reserve Board Lending Survey

DATE

2007-04-01

2007-07-01

2007-10-01

2008-01-01

2008-04-01

2008-07-01

2008-10-01

2009-01-01

2009-04-01

2009-07-01

2009-10-01

2010-01-01

2010-04-01

2010-07-01

2010-10-01

2011-01-01

2011-04-01

2011-07-01

2011-10-01

2012-01-01

2012-04-01

2012-07-01

-40

-20

0

20

40

60

80

Note: “Net Percentage of Banks Tightening Standards for New and Used Auto” did not become a series until Q3-2011

Source: Board of Governors of the Federal Reserve SystemMonthly, Not Seasonally Adjusted; Last Updated: 10/31/12

Net Percentage of Domestic Respondents Tightening Standards on Consumer Loans: – Prime Mortgage Loans – Credit Cards – New and Used Auto Loans

Policy Recommendations:Taylor Rule Negative Regardless of Fiscal Cliff Resolution

2000

-01

2002

-01

2004

-01

2006

-01

2008

-01

2010

-01

2012

-01

-6

-4

-2

0

2

4

6

8

Fiscal Cliff Resolved: -

0.562910092Fiscal Cliff Un-

resolved: -4.280119658Pe

rcen

t

Pre-2012: Inflation Target 2%Output Gap Parameter: .5Inflation Gap Parameter: .5

2012 and Onward: Inflation Target 3%Output Gap Parameter: .67Inflation Gap Parameter: .33

Personal Consumption/SavingsRate

2005

-01

2006

-01

2007

-01

2008

-01

2009

-01

2010

-01

2011

-01

2012

-01

1%

3%

5%

7%

88%

90%

92%

94%

96%

Source: U.S. Department of Commerce: Bureau of Economic AnalysisMonthly, Seasonally Adjusted Annual RateLast Updated: 10/29/2012

– Real Consumption/Real Income – Real Savings/Real Income

Housing Market: Showing Signs of Improvement

2007

-01

2008

-01

2009

-01

2010

-01

2011

-01

2012

-01

400

600

800

1000

1200

1400

1600Housing Starts

Thou

sand

s of

Uni

ts

Source: U.S. Department of Commerce: Census Bureau, National Association of Home Builders/Wells FargoMonthly, Seasonally Adjusted Annual Rate, Index, Monthly, Seasonally Adjusted Last Updated: 10/17/2012

2011

-10

2012

-01

2012

-04

2012

-07

2012

-1015

25

35

45

Wells Fargo Housing Market Index

Inde

x 10

0=Pe

rfec

tly O

ptim

istic

Beveridge Curve

3.0 4.0 5.0 6.0 7.0 8.0 9.0 10.01.5

2.0

2.5

3.0

3.5

4.0

Unemployment

Job

Vanc

acy

Rate Expansion

Recession '01

Recession 2007-2009

Expansion

Source: US Department of Labor: Bureau of Labor StatisticsMonthly, Seasonally Adjusted

Hiring, Turnover, and Quit Rates are Not Back to Pre-Recessionary Levels

2005-01

2005-07

2006-01

2006-07

2007-01

2007-07

2008-01

2008-07

2009-01

2009-07

2010-01

2010-07

2011-01

2011-07

2012-01

2012-071.0

2.0

3.0

4.0 Hiring Rate-3m moving average

Turnover Rate -3m moving av-erage

Job Openings Rate -3m mov-ing average

Quit Rate -3m moving average

Layoff Rate - 3month moving average

Perc

ent

Source: U.S. Department of Labor: Bureau of Labor StatisticsMonthly, Seasonally AdjustedLast Updated: 11/02/2012

Construction Employment:Impact of Housing Crash on Employment

2002

-01

2003

-01

2004

-01

2005

-01

2006

-01

2007

-01

2008

-01

2009

-01

2010

-01

2011

-01

2012

-01

5000

5500

6000

6500

7000

7500

8000

Thou

sand

s of

Per

sons

In 4 years, Construction Employment fell from 7.720 to 5.477 millions of persons

Source: US Department of Labor: Bureau of Labor StatisticsSeasonally Adjusted, MonthlyLast Updated: 11/2/12

Forward Guidance

•To keep the Federal Funds Rate between 0 to 25 basis points through mid-2015.

7-3 Proposal

•Governor Charles Evans’ proposal to tolerate 3 percent inflation in order to target a level of 7 percent unemployment or lower.

Monetary Policy Effects:Forward Guidance Has Been Effective in Lowering Yields

2007-01 2008-01 2009-01 2010-01 2011-01 2012-012.5

3.5

4.5

5.5

6.5

7.5

8.5

30-Year Treasury Bond 48 Month Auto Loan AAA Corporate Bond30 Year Mortgage

Source: Board of Governors of the Federal Reserve SystemNot Seasonally Adjusted, MonthlyLatest Update: In order top left to bottom right: 11/15/12, 10/5/12, 11/13/12, 11/13/12

Proposal: Qualitative Easing

• Sell $40 billion worth of short-term treasury bonds to fund $40 billion dollars a month purchases of agency mortgage-backed securities• Target housing market and long-term

interest rates and will not add to the monetary base

Meeting AgendaHeadwinds to the Economy

European Debt Crisis

Fiscal Cliff Situation

Alternate Fiscal Scenarios

Economic Growth Summary

Current GDP Analysis

Q4-2012 and 2013 GDP Prediction

Monetary Policy Analysis

Summary and Re-evaluation of Current Policy Tools

Suggestions for New Policy Tools

Final Monetary Policy Recommendations

Policy Recommendations

•New Qualitative Easing: Purchase 40 billion dollars of agency mortgaged backed securities a months funded by the sale of 40 billion dollars worth of short term treasuries.•Keep our Federal Funds rate target at 0-25

basis points until mid-2015.