Economic Summary — SF Fed President Williams
Last week, San Francisco Fed President John Williams gave a speech about the economy that I found interesting. Here are some of his stats and ideas:
1. The housing crash wiped out almost $6.5 trillion in household wealth.
2. The economy continues to improve. Economic output has been expanding and private employers have added jobs every month for over two years. The unemployment rate has fallen from 10% to 8.2%.
3. Motor vehicle sales are up nearly 14% in the first six months of 2012 (YOY) and more than 50% from their recession lows.
4. Business investment in equipment and software rose over 8% during the past year (in real terms).
5. The volume of new commercial and industrial loans has been rising. We see the banks with the highest regulatory ratings expanding their lending and the weaker banks can’t do this.
6. Two major developments weigh on the economy: (A) the budget squeeze at all levels of government; and (B) the European sovereign debt crisis (which has led to renewed stresses in global financial markets).
7. With respect to the first major development (the government budget squeeze), the federal government is unwinding all of the reduced taxes and increased spending. State and local governments have been cutting spending and employment in the face of lower revenue. Overall, combined federal, state and local government payrolls have dropped by more than 600,000 workers in the past three years. The government has turned into a significant drag on growth.
8. Furthermore, the temporary payroll tax cut and extended unemployment benefits are set to expire at the end of the year. In addition, caps on discretionary government spending will go into effect. “More generally, my contacts say that concerns about the looming budget deadline make businesses reluctant to take on new projects.”
9. With respect to the second development (Europe), the current approach, based mainly on fiscal austerity, can’t solve the problems (on its own).
10. Approximately 20% of our exports go to EU countries. Many of these countries are already in recession and this has slowed our export growth. But, a second (and more important) link is through the financial markets.
11. The financial markets link (to Europe) has had several effects. The positive has been low interest rates (as investors have sought the safety of U.S. Treasuries). But two bigger negatives have been: (A) the increased value of the dollar (which hurts our ability to export); and (B) the risk aversion which has pushed down the value of stocks and corporate bonds.
12. The slowdown in domestic demand and the global strains have pushed Williams to lower his GDP estimate to 2% this year and 2 ¼% next year.
13. Over the past year, the economy has added ~150K jobs per month. The unemployment rate has fallen by nearly 1%. The trend in job growth is probably lower now. Williams expects 100K – 150K jobs per month (which is higher than we’ve seen over the past three months). As a result, he expects that the unemployment rate will remain at or above 8% until the second half of 2013.
14. Williams expects the inflation rate to come in below the Fed’s 2% target both this year and next. This is the result of (A) the sluggish labor market (limiting compensation costs); (B) the stronger dollar holding down import prices; and (C) the global growth slowdown has pushed down the price of oil and other commodities.
15. European credit markets could freeze up as happened in the U.S. in 2008. If that were to happen, the U.S. economy could be severely damaged. Our exports to Europe would fall sharply. And, even though U.S. financial institutions have been paring their exposure to Europe, our financial markets would probably still be severely disrupted.
16. As an example of the potential spillover, he cited recent research at the SF Fed that over the past few years, when European corporate debt spreads have widened, U.S. debt spreads have responded roughly 2/3 as much. He said that if the spillover from Europe were severe enough, much of the progress made in our own financial system could be undone. We might find ourselves in a renewed credit crunch, which would take a terrible toll on the economy.
17. Williams estimates that full employment now would result in a 6 ¼% unemployment rate.
18. He believes that inflation will fall to 1 ¼% this year and rebound to 1 ¾% next year.
19. We must provide sufficient monetary accommodation to keep our economy moving towards our employment and price stability mandates.
20. Continuing Operation Twist will put further downward pressure on longer-term interest rates. But, the extension of the program will probably have a relatively modest impact on the economy.
21. If further action is called for, the most effective tool would be additional purchase of longer-maturity securities, including agency mortgage-backed securities. These purchases have proven effective in lowering borrowing costs and improving financial conditions.
Have a great week.
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