using the book to understand the state of the u.s. economy 14.02 – last class, december 14, 2005...
TRANSCRIPT
Using the book to understand the state of the U.S. economy
14.02 – last class, December 14, 2005
Francesco Giavazzi
Overview
Despite significant disturbances…
• additional large energy price increases
• major hurricanes
… the US economy keeps growing
-2
-1
0
1
2
3
4
5
6
7
8
9
2001 2002 2003 2004 2005 2006
-2
-1
0
1
2
3
4
5
6
7
8
9
GDP Growth: Remarkable Stability
Source: Bureau of Economic Analysis and Blue Chip Economic Indicators
October 2005 Consensus
Forecast
May 2005 Consensus
Forecast
Note: Dashed lines represent average of the top and bottom 10 forecasts.
% Change - Annualized Rate % Change - Annualized Rate
Bottom 10
Top 10
Actual
… the US economy keeps growing, but
• is this growth rate consistent with stable inflation?
• are imbalances building up?
Trying to answer these questions using our model
1. Aggregate demand growth
Y = C + I + G
ΔY/Y = ΔC/C * C/Y + ΔI/I * I/Y + ΔG/G * G/Y
2. Okun’s law
u – u-1 = - b (ΔY/Y - ΔYn / Yn) = - b (ΔY/Y - 0.03)
3. Phillips curve (with πe = π-1 )
π – π-1 = - a (u – un )
• CA = S private + S public - I
AD
• Y = C + I + G
• ΔY/Y = ΔC/C * C/Y + ΔI/I * I/Y + ΔG/G * G/Y
• ΔY/Y = ΔC/C * 0.7 + ΔI/I * 0.2 + ΔG/G * 0.1
0
1
2
3
4
5
6
7
8
1998 1999 2000 2001 2002 2003 2004 2005
0
1
2
3
4
5
6
7
8
Real Personal Consumption Expenditures
% Change - Year to Year % Change - Year to Year
Source: Bureau of Economic Analysis
Consumer Spending Remains Robust
Note: Shading represents NBER recessions.
60
80
100
120
140
160
1998 1999 2000 2001 2002 2003 2004 2005
60
80
100
120
140
160
Michigan Consumer Sentiment
Conference Board Consumer Confidence
Index IndexBut Consumer Confidence Has Dropped Sharply
Source: University of Michigan and the Conference Board Note: Shading represents NBER recessions.
1100
1200
1300
1400
1500
1600
1700
1800
1998 1999 2000 2001 2002 2003 2004 2005
0
2
4
6
8
10
12
14
Single-Family Housing Starts
(Left Axis)
OFHEO Home Price Index (Right Axis)
Thousands of Units % Change - Year to Year
Source: Census Bureau and Office of Federal Housing Enterprise Oversight
Investment: Housing Starts and Home Prices Remain Strong
Note: Shading represents NBER recessions.
-20
-15
-10
-5
0
5
10
15
20
1991 1993 1995 1997 1999 2001 2003 2005
-20
-15
-10
-5
0
5
10
15
20
Source: Bureau of Economic Analysis
% Change - Year to Year % Change – Year to Year
All Other
Info Processing Equipment and
Software
Note: Shading represents NBER recessions.
Investment Growth Has Recovered Well
-3
-2
-1
0
1
2
1980 1985 1990 1995 2000 2005
-3
-2
-1
0
1
2
T - G: Changes in the full employment budget balance (percent of potential output)
Source: Congressional Budget OfficeFiscal Year
GRH-185
GRH-287
BEA90
OBRA93
BEA97
Note: Shading represents NBER recessions.
-5
-4
-3
-2
-1
0
1
2
3
1993 1997 2001 2005 2009 2013
-5
-4
-3
-2
-1
0
1
2
3
Federal budget forecasts
Source: Congressional Budget Office and Goldman Sachs. Note: Shading represents NBER recessions.
Percentage of GDPPercentage of GDP
Optimistic
Pessimistic
Forecast
AD
• ΔY/Y = ΔC/C * C/Y + ΔI/I * I/Y + ΔG/G * G/Y
• ΔY/Y = ΔC/C * 0.7 + ΔI/I * 0.2 + ΔG/G * 0.1
• ΔY/Y = 3 * 0.7 + 8 * 0.2 + ? = 3.7 + ?
May 2 Nov 4 May 2 Nov 4
Real GDP (Q4/Q4 Growth) 3.5 3.5 3.6 3.3
Core PCE Deflator (Q4/Q4 Growth) 1.9 1.8 1.8 2.0
Unemployment (Q4 Level) 5.2 4.9 5.2 4.9
2005 2006
Forecast Comparison: May and November 2005
Source: Federal Reserve Bank of New York
FRBNY Forecast
Is current growth rate consistent with stable inflation?
Okun’s law
u – u-1 = - b (ΔY/Y - 0.03)
0.03 derived from assumptions:
• productivity growth, 2%• labor force growth, 1%
Phillips curve
π – π-1 = - a (u – un )
un = ?
π – π-1 = 0 u = un ΔYn / Yn = ΔY/Y
Labor Market
• Until the hurricanes, solid employment growth
• Latest headline numbers are off, but distorted by hurricane effects
• Productivity growth remains solid
• Labor costs edging up
-400
-300
-200
-100
0
100
200
300
400
1998 1999 2000 2001 2002 2003 2004 2005
-400
-300
-200
-100
0
100
200
300
400
Employment Solid Until the Hurricanes Hit
Thousands Thousands
Source: Bureau of Labor Statistics
Change in Private Employment, Three-Month Moving Average
Note: Shading represents NBER recessions.
3
3.5
4
4.5
5
5.5
6
6.5
7
7.5
8
1991 1993 1995 1997 1999 2001 2003 2005
65.6
65.8
66
66.2
66.4
66.6
66.8
67
67.2
67.4
67.6
Source: Bureau of Labor Statistics
Unemployment Drifting Down, Participation Leveling
Unemployment(Left Axis)
PercentPercent
Note: Shading represents NBER recessions.
3
3.5
4
4.5
5
5.5
6
6.5
7
7.5
8
1991 1993 1995 1997 1999 2001 2003 2005
65.6
65.8
66
66.2
66.4
66.6
66.8
67
67.2
67.4
67.6
Source: Bureau of Labor Statistics
Unemployment Drifting Down, Participation Leveling
Unemployment(Left Axis)
PercentPercent
Participation(Right Axis)
Note: Shading represents NBER recessions.
Is current growth rate consistent with stable inflation?
u – u-1 = 0 ( or even < 0 )
Other evidence on potential output growth ?
u – u-1 = b (ΔY/Y - 0.03)
0.03 : depends on productivity growth
1003
-2
0
2
4
6
1998 1999 2000 2001 2002 2003 2004 2005
-2
0
2
4
6
Source: Bureau of Labor Statistics
Productivity GrowthNonfarm Business Sector
Output per Hour
% Change - Year to Year% Change - Year to Year
Note: Shading represents NBER recessions.
1003
-2
0
2
4
6
1998 1999 2000 2001 2002 2003 2004 2005
-2
0
2
4
6
Source: Bureau of Labor Statistics
Productivity Remains Solid, Unit Labor Costs UpNonfarm Business Sector
Output per Hour
% Change - Year to Year% Change - Year to Year
Unit Labor Costs
Note: Shading represents NBER recessions.
Which inflation rate should we look at ?
• Headline inflation reflects oil price surge
• Core inflation excludes food and energy: it moves closer to wages
1.5
2
2.5
3
3.5
4
4.5
5
1998 1999 2000 2001 2002 2003 2004 2005
1.5
2
2.5
3
3.5
4
4.5
5
Source: Bureau of Labor Statistics
Nominal Wages
ECI: Private Industry Wages
and Salaries
% Change - Year to Year% Change - Year to Year
Total PrivateAverage Hourly
Earnings
Note: Shading represents NBER recessions.
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
1998 1999 2000 2001 2002 2003 2004 2005
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
Source: Bureau of Economic Analysis
% Change - Year to Year % Change - Year to Year
Core PCE
Total PCE
PCE Deflator: Total Up Sharply, Core Relatively Flat
Note: Shading represents NBER recessions.
40
45
50
55
60
65
70
75
Jun-05 Oct-05 Feb-06 Jun-06 Oct-06 Feb-07 Jun-07 Oct-07 Feb-08
40
45
50
55
60
65
70
75
Source: Bloomberg
$/Barrel
May 13 (Last EAP)
$/BarrelCrude Oil Futures Prices
Oil Prices Remain Elevated
40
45
50
55
60
65
70
75
Jun-05 Oct-05 Feb-06 Jun-06 Oct-06 Feb-07 Jun-07 Oct-07 Feb-08
40
45
50
55
60
65
70
75
Source: Bloomberg
$/Barrel
May 13 (Last EAP)
$/Barrel
August 26 (Pre-Katrina)
Crude Oil Futures PricesOil Prices Remain Elevated
40
45
50
55
60
65
70
75
Jun-05 Oct-05 Feb-06 Jun-06 Oct-06 Feb-07 Jun-07 Oct-07 Feb-08
40
45
50
55
60
65
70
75
Source: Bloomberg
$/Barrel
May 13 (Last EAP)
$/Barrel
August 26 (Pre-Katrina)
August 30 (Post-Katrina High)
Crude Oil Futures PricesOil Prices Remain Elevated
40
45
50
55
60
65
70
75
Jun-05 Oct-05 Feb-06 Jun-06 Oct-06 Feb-07 Jun-07 Oct-07 Feb-08
40
45
50
55
60
65
70
75
Source: Bloomberg
$/Barrel
May 13 (Last EAP)
$/Barrel
August 26 (Pre-Katrina)
November 3 (Current)
August 30 (Post-Katrina High)
Crude Oil Futures PricesOil Prices Remain Elevated
2.1
2.2
2.3
2.4
2.5
2.6
2.7
2.8
2.9
3
3.1
3.2
3.3
2/1/05 3/14/05 4/21/05 6/1/05 7/12/05 8/19/05 9/29/05
2.1
2.2
2.3
2.4
2.5
2.6
2.7
2.8
2.9
3
3.1
3.2
3.3
Can we measure inflation expectations? TIPSPercentPercent
3-5 Years
0-2 Years
2-3 Years
Source: Bloomberg, 8:40AM quotes and FRBNY CalculationsNote: Data from 8/19/05 to 8/31/05 is
currently unavailable
So, what should the Fed do ?
• In 2 years the Federal Funds rate has been raised from 1,5 % to 4,25 %
• And financial markets expect more rate increases, with Fed Funds stabilizing around 4,5 %
0
2
4
6
8
10
1990 1992 1994 1996 1998 2000 2002 2004 2006
0
2
4
6
8
10
Funds Rate RatePercentPercent
Actual Fed Funds Rate
Source: FRBNY.
Last rate hike December 13
-0.5
0
0.5
1
1.5
2
2.5
1/2/04 3/26/04 6/18/04 9/10/04 12/3/04 2/25/05 5/20/05 8/12/05
-0.5
0
0.5
1
1.5
2
2.5PercentPercent
Source: Bloomberg and FRBNY Calculations
Higher nominal rates have raised real rates as well (TIPS Yields)
Five-Year Yield
Ten-Year Yield
Constructed Two-Year
Yield
Note: Two-year yield was constructed from a combination of interpolating and extrapolating yields of ten-year bonds maturing
1/15/2007 and 1/15/2008. Yields are not adjusted for carry.
3.00
3.25
3.50
3.75
4.00
4.25
4.50
4.75
Jul-05 Nov-05 Mar-06 Aug-06 Feb-07 Aug-07 Feb-08
3.00
3.25
3.50
3.75
4.00
4.25
4.50
4.75
Source: Federal Reserve Board
Percent Percent
May 13 – Last EAP August 8: Day Before August FOMC September 19: Day Before September FOMC November 1: Current
May 13
What do financial markets expect?Expected Funds Rate Path Has Risen, Steepened
3.00
3.25
3.50
3.75
4.00
4.25
4.50
4.75
Jul-05 Nov-05 Mar-06 Aug-06 Feb-07 Aug-07 Feb-08
3.00
3.25
3.50
3.75
4.00
4.25
4.50
4.75
Source: Federal Reserve Board
Percent Percent
August 8
May 13 – Last EAP August 8: Day Before August FOMC September 19: Day Before September FOMC November 1: Current
May 13
Expected Funds Rate Path Has Risen, Steepened
3.00
3.25
3.50
3.75
4.00
4.25
4.50
4.75
Jul-05 Nov-05 Mar-06 Aug-06 Feb-07 Aug-07 Feb-08
3.00
3.25
3.50
3.75
4.00
4.25
4.50
4.75
Source: Federal Reserve Board
Percent Percent
August 8
September 19
May 13 – Last EAP August 8: Day Before August FOMC September 19: Day Before September FOMC November 1: Current
May 13
Expected Funds Rate Path Has Risen, Steepened
3.00
3.25
3.50
3.75
4.00
4.25
4.50
4.75
Jul-05 Nov-05 Mar-06 Aug-06 Feb-07 Aug-07 Feb-08
3.00
3.25
3.50
3.75
4.00
4.25
4.50
4.75
Source: Federal Reserve Board
Percent Percent
November 3
August 8
September 19
May 13 – Last EAP August 8: Day Before August FOMC September 19: Day Before September FOMC November 1: Current
Expected Funds Rate Path Has Risen, Steepened
May 13
But how powerful is the Fed ?
• Investment depends on “long” rates
• but the Fed only controls “short” rates
3.00
3.25
3.50
3.75
4.00
4.25
4.50
4.75
0 1 2 3 4 5 6 7 8 9 10
3.00
3.25
3.50
3.75
4.00
4.25
4.50
4.75
Source: FRBNY Calculations
Percent Percent
May 13
October 24
The Yield Curve Has Risen and Flattened
Maturity Date (Years)*Estimated using off-the-run Treasury securities
November 3
3.25
3.50
3.75
4.00
4.25
4.50
4.75
5.00
5.25
0 1 2 3 4 5 6 7 8 9 10
3.25
3.50
3.75
4.00
4.25
4.50
4.75
5.00
5.25
Source: FRBNY Calculations
Percent Percent
May 13
October 24
But “Conundrum” Remains in Forward Rates
Maturity Date (Years)
November 3
-2
-1
0
1
2
3
4
5
1992 1994 1996 1998 2000 2002 2004
-2
-1
0
1
2
3
4
5
Short-Term Real Rates Up, Long-Term FlatTreasury Yield minus Philadelphia Fed Survey Inflation Expectations
Percent
Source: Federal Reserve Board and Philly Fed
Percent
1-Year
10-Year
Note: Shading represents NBER recessions.
NX
• Export growth has strengthened
• But imports keep running faster than exports
• Current account deficit has leveled off (as percent of GDP)
CA = S private + S public - I
Net National Saving = (Private + Public Saving) – Investment
= Current Account
= (Exports – Imports) + Net Investment Income
0
1
2
3
4
5
6
7
1998 2000 2002 2004
0
1
2
3
4
5
6
7
0
1
2
3
4
5
6
1998 2000 2002 2004
0
1
2
3
4
5
6
Note: Shading represents NBER recessions.
Real Disp. Personal Income
Real PCE
Personal Saving Rate(% of DPI)
% Change - Year to Year
Percent
% Change - Year to Year
Percent
Source: U.S. Bureau of Economic Analysis.
Households Saving
Forecast
-3
-2
-1
0
1
2
1980 1985 1990 1995 2000 2005
-3
-2
-1
0
1
2
Public SavingsChanges in the full employment budget balance (% of potential output)
Source: Congressional Budget OfficeFiscal Year
GRH-185
GRH-287
BEA90
OBRA93
BEA97
Note: Shading represents NBER recessions.
-800
-700
-600
-500
-400
-300
-200
-100
0
1998 1999 2000 2001 2002 2003 2004 2005
-8
-7
-6
-5
-4
-3
-2
-1
0
The Current Account DeficitSAAR, Bill$, BOP Basis
Source: Bureau of Economic Analysis
% of GDP
% of GDP (Right Axis)
Current Account Balance (Left Axis)
US external debt: 25% of gdp
Figure 2: US External Assets and Liabilities, 1982-2002
-20%
-10%
0%
10%
20%
30%
40%
1980 1985 1990 1995 2000 2005
Pe
rce
nt
of
We
alt
h
Foreign Assets
Foreign Liabilities
Net Foreign Assets