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http://clevelandfed.org/research/trends August 1996 Best available copy The Economy in Perspective Whither governt?zerzt?.. . Welfare as we know it is encling. The same can he saicl for agricult~ire, national defense, health care, ancl (though few public officials will openly aclmit it) Social Security. After many decades of vigorous expansion, big governlnent has become politically cliscreclited. What next? Voters call on governnlent to participate in econotnic life in various ways. Private-marltet transactions cannot always provicle the right amount of what economists call public goocls, like national defense or a space program. These goods and services benefit all, and excluding people from them is clifficult. But we also asli government to provicle such ~ l o ~ l p i ~ bgoocls lic as school lunches, grants to artists, highway and airport construction, ancl loans to snlall ixisinesses. We use the tax system to channel benefits to particular groups without spending money clirectly. For example, home nlortgage deductions benefit homeonmers who iternize on their tax returns! but clo nothing to help renters or homeownel-s who do not itemize. A~nericansalso use government to transfer resources among people through tax ancl spending programs. The largest colnponellt of Social Security, for instance, transfers resources f r o ~ younger, ~l worlting people to older, retired individuals. Insurance progralns form another class of government activities. &lost employers and e~nployeesare obliged to purchase workers' cornpensation and unemployment itlsurance, and most banks are forced to carry deposit i~lsurance. The government provides insurance only when it thinks that private cornpanies will not (or cannot) insure the risk at a reasonable price. During the past several decades, we have increasingly aslied the government to use transfer, insurance, credit, ancl direct-spending prog r a ~ n s to alter private-marliet outcomes. Current public disaffection with governrnent appears to stell1 prinlarily from a belief that too many goods ancl services are being proviclecl, that the benefici:~riesof some tr:insfer progrzlms are receiving Inore than they cleserve, ancl that the distorting effects of these myriad government progralns on the private economy have become too large. Voters now seen1 more willing to alloxv private firms to supply many of the goocls ancl services traditionally proviclecl by government agencies. At a minimum, this cornpetition motivates gover~lmentto operate Inore efficiently. At the extreme, it calls into question all government participation. Other clevelop~nentshave also forcecl serious consideration of private-marliet alternatives. Many people do not recognize how changes in capital marliets and risk rnanagelnent are extending the scope of private enterprise. The U.S. space program illustrates the confluence of these forces. In its early years, the space prograin was a purely governmental affair, with government committing the f ~ ~ n cancl l s bearing the rislts-both of which were substantial. Later, after the R&D costs were paicl, commercial ventures became more practical. Now that global capital and insurance ~narketshave cleveloped, enabling private co~npaniesto send satellites ancl other cargo into space and to hedge against the rislt of launch 2nd equipnlent failure, the government's role has climinishecl. Highways provide yet another example. The traditional method of funding a new state highway r e q ~ ~ i r voters es to approve the sale of longterrn boncls to be repaicl through either general tax revenues or toll charges. But private companies are perfectly capable of raising highway construction f~indsin capital marltets. Motorists using the highway can be billecl auto~natically after a scanner records their presence. Furthermore, with private funding, voters need not worr)~about the state using tax dollars to build unnecessaly roacls. California ancl Virginia have already grantee1 permission to private firms to I~uilcland operate segrnents of state highways. These clevelop~nentspoint to the wick range of options available to the American public as it reconsiclers how government should fit into the nation's econornic life. It will be interesting to see whether the public wants to circu~~lscribe the size of government or to recluce the role that governlnent plays. There is a big difference. The government can stop cloing many things and allow private ~narltetsto b e c o ~ n e ~lnoreactive. 13ut it can also instruct the private sector to d o what it \cants done. The government can order businesses to pay a minim~un wage, tell broadcast companies to provicle chilclren's programming. or force colnpaniesto purchase insurance from private carriers. The government can-ancl does-influence resource allocation without spending taxpayer funds or employing people. So ~uhifhelgoverment? It's too early to tell. But government rr~itfxt-? Not necessarily. http://clevelandfed.org/research/trends August 1996 Best available copy Monetary Policy Billions of dollars 420ICURRENCY OUTSIDE BANKS 1 Billions of dollars 1 480 1 MONETARY BASE Billions oi dollars a. Growth rates are percentage rates calculated on a fourth-quarter over fourth-quarter basis. Annualized gwwth rate for 1996 IS calculated on an estimated July over 1995:IVQ basis. b. Adjusted for sweep accounts. NOTE: Ali data are seasonally adjusted. Last plot IS estimated for July 1996. Dotted lines represent growth ranges and are for reference only. SOURCE: Board of Governors of the Federal Reserve System. The semirlnni~al I:ecler;~l Iieser-v-e monctar!. polic). testimony :inel report to Congress. clcliverecl 11)i Chairm;~n Greenspan o n July 18. sutunlarizes [lie Fecl's viwv of ~ L I S rent economic conclitions ancl its outlooli for econo~nicperformance tl~rougki1997. The report :~lsoprovicles pro\.isionxl ~.angesfor inonet ; ~ yaggrcg:ites in 1997. Ch;~ir~n:inGreenspan reportecl that the econoln). performecl lvell in the first lialf o f 1996. After rising only 0.5041 in 199S:IVQ. real Gl>P incre;isecl :it a 2.29/0 annual Kite in 1996:IQ. ancl plrtial chta for 1996:IIQ inc1ic;kte significantly stronger growth since then. Ahout 1.4 nill lion \vorliers \yere ;~clcleclto nonfarm p a ~ ~ o l l s in the first six inonths of 1996, ;lucl Ji~nc's ~lncmploytllent rate fell to 5.3'%1. a sis-year low. At the s;imc tirne, the core intlation r;ltc. measureci I,y the Consumer I'rice Incles (CI'I) less foocl ancl energy [xices. increased :lt a 2.8% annual nlte over the first h:llf of 1996, a l ~ o u t0.6 percentage point lower t11:ln the srrlile periocl a year carlier. 'I'lie coesislence of ~nocleratcinflarate tion ;iilcl lo\\- i~nernploy~nent contraclicts the tratlitional supposirates tion th:~t Ion. ~~nemployment :uid/or higll c:~p:~cit)utilizr~tionrates necess;iril\; leacl to I~igherinf1;ition. ( L - O I ? ~ ~ ? I L K Y C/ N I 71e.xtp~g~) B, C) ES http://clevelandfed.org/research/trends August 1996 Best available copy BB (B Monetary Policy jcont.) Percent change, annual rate Economic Projections by FOMC Members and Other Reserve Bank Presidents, 1996 1 REAL GDP GROWTH 1 Change, fourth quarter to fourth quarter, percent February central tendency for1996 July central tendency for1996 July central tendency for1997 4.25-4.75 5-5.5 4.25-5 Real GDP 2-2.25 2.5-2.75 1.75-2.25 CPI 2.75-3 3-3.25 2.75-3 Nominal GDP Average level, fourth quarter, percent Civilian unemployment rate 5.55.75 About 5.5 5.55.75 12-month percent change 1 CONSUMER PRICE INDEX^ a. Shaded area represents the FOMC's central tendency for 1996. set in July 1996. b. Vertical line indicates break in data series due to survey redesign. SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; U.S. Department of Labor, Bureau of Labor Statistics; and Board of Governors of the Federal Reserve System. Looliing 21hc:lcl. the report fincis "gootl reasons to I,elieve that economic gron-th will mocle~ltesome. althoi~glithe ti~ningancl extent of the clon-rlturn :Ire ~lncertain."?'he psojections of the Fecleral Reserve Go\,-ernors :urlcl Reserve I3:lnk I'resiclents "reflect the 1 . i that ~ ~ sustainable economic growth is likely in store." l'lieir for.ec:ists for real GIII' growth center ~tro~incl 2.5%)for 1996 ;tticl 2.0'i/ir tor 1997. linemployn~ent n~tesare espected to remain aroilnd 5.50% to 5.75% through 1997. The forecasts for inflation. nieas~lreclI,y tlle four-cluarter change in the CI'I, :Ire for 3% to 3.25% in 1996 ancl 2.75%) to 3% in 1997. These h)recasts are consiste~ltwith 199195 infkltion rates. While there is little eviclence of an imminent inflation spike, the report cites "rno~lnting pressures in the Izti~orrnarliet" that must be closely monitoretl. It emphasizes that the Federal Reserve has hecome "especially vigilant to incipient inflationary j>ressures that coulti ultimately threaten tlle health of the expansion." In pursuit of lo\\- inflation, "the Fecleral Reser-ve res~iai~ls committee1 to preventing a sustained pickup in inflation ant1 ultimately :ichieving and preserving price st:tl,ility." (cor7fi1lrlcd or2 IIL~~PLI,:IC') e e e e e e http://clevelandfed.org/research/trends August 1996 Best available copy , lMonetary Policy (cont.) I Billions of dollars Billions of dollars 3950 THE M2 AGGREGATEa Billions 01 dollars 15,000 [ DOMESTIC NONFINANCIAL DEBT Percent I 1 23 GROSS SAVINGS AS A SHARE OF GDP a. Data for July 1996 are estimated. b. Growth rates are calculated on a fourth-quarter over fourth-quarter basis. Annualized growth rates for 1996 are calculated on a July over 1995:IVQ basis for M2 and M3, and on a May over 1995:lVQ basis for domestic nonfinancial debt. NOTE: All data are seasonally adjusted. Dotted lines are target ranges. SOURCES: Board of Governors of the Federal Reserve System; and U.S. Department of Commerce, Bureau of Econom~cAnalysis. T h e report inclucles tile P'ecler:il O p e n klarliet Colnmittee's (1;OhlC;) prc-)visional r-anges lor cle1)t ;ind the monetary aggregates in 1997: 1% to 7% for hI2 ancl 2U.i) to 6%)for M3, along xvith 3% to 7 %f'or clel~tin the clomcstic nonfinancial sec~tors.The s:ime sanges \\-cl-e set for 1990. In the first l1:iIf of tll:it !-ear. h I 1 ancl M3 growtll rates \Yere at the ilpper enel of their xinges, \\.llilc tile gro\\.til r.:ttc for c l c l ~\\.as ne;ii- its mielpoint. l'lw FOhl(;'s fosec;ists of inf1:ition ancl seal C;I)I' growth suggest that it \\-oLIIcI not 13e s~lrprisingto see M2 ancl hl3 gron.th rates :it the upper ericls of' their ranges througlio~~t 1996 >inel 1 9 9 7 . Cll:iil.rn:in Grecnsp;in once again c~nphasizecl"the critical importance to our nation's economic n.elkire of e fecleral continuing to r e c l ~ ~ cour I~ucigetcleficit." [He noted that furtller efforts ;it cleficit reduction will ine\'it:iI>ly recj~~ire Congress to acldl-ess the increase in entitlement spencling that \\-ill result from shifts in the ;ige composition of the na. statecl tion's :iclult p o p ~ ~ l a t i o nHe th;it "Ion-er i)uclget cleficits are the surest anci most ciirect \\/a!. to increase national saving," ~vllich in turn \\-ill Ion-es real interest rates. increase in\-cstment, ancl strengthen Americ:uns' ability "to compete even nlor-e etfecti\-cly in \vorlcl m;u.liets." 1 http://clevelandfed.org/research/trends August 1996 Best available copy -- B) Q e c r Interest Rates Percent, u~eeklyaverages 75 YIELD CURVES~ Percent lo 130-YEAR TREASURY YIELD AND FEDERAL FUNDS RATE 1 a. Three-month and six-month instruments are quoted from the secondary market on a yield basis; other instruments are constant-maturity series. b. End-of-period quarterly averages of daily data. All observations are fourth-quarter data except 1996, which is for the second quarter. SOURCE: Board of Governors of the Federal Reserve System. The yielcl cur\.e lias Ilattenecl sliglltly in the past month. \\.it11 shot-1 I-:ltes rising ancl long sates uncl1:inged. 'I'he r:lte on 3-nlontll Tre:ls~~ry bills movecl up se\-en I~asis points to 5.3W1.Ixit .%-yearI)ontls slion-eel 110 change. !'lie closel!- \\-:~tchecl3-ycxr. 3-month spre:icl st:~nclsat 114 Ixlsis pc~ints.\\-ell al,o\-e the historical a\,emge of SO. ancl the 1>op~11:tr 1O-).e;~r, 3-month spreacl st:~nclsx t 155.:llso :lhove its mean of 120. As a ro~igh inclicator of fut~lrceconomic gro\\.th, the relati\.cl). stc'ep ).ielcl cur\-e is consistent n.ith al~ove-avemge:icti~.ity over the nest four cl~iartel-s. Althoc~gli the yield cur\;e h:ls stccl'enecl since 1995, it may still 1001.: flat in relation to the extreme \.slues re:~checlearlier this clecatle, as tlie cl1:u.t comparing 30-year Tre:lsL I S ~yielcls ancl tlie federal funcis r:ltc (litel.;llIy the long ancl the short o f it) shonx. It's \vorth noting that in contrast to 11iucli o f the decacle. \\,hen the federal fi~nclsrate was positi\,ely associatecl with thc long rate. in 1996 the rates have clivergecl. ,c1.'\in# the >.ieiclcLlIve is funclamentally I: three-cli~iiensio~~l pro1~lem. I,eca~~se the cur-ve 110th t\\;ists ancl shifis up ancl do\vn over tirne. A 3-1) pesspective inclicates that the big rise in I994 \\-as not a parallel shift. I t also shon-s ho\v the high 1x1~ invertecl ctil-\-eof 1981 first steepc11ccl in 1982 ancl then clropped do\vn\varcl. On tile other 2i:~nd.it allows is to see hen- in\,ersions occurrecl as :t res~iltof short ntes rising, not long rates fillling. http://clevelandfed.org/research/trends August 1996 Best available copy Inflation and P r i m Difiusion index, net percent rising loo PURCHASING MANAGERS' PRICE SURVEY June Price Statistics Annualized percent change, last: 1995 6 mo. 12 mo. 5 yr. avg. 0.8 3.5 2.8 2.9 2.6 2.2 2.8 2.7 3.1 3.0 2.1 2.9 2.9 3.1 3.2 7.2 2.3 2.6 1.5 2.1 0.7 1.6 1.7 2.6 4.4 6.3 3.1 5.4 Irno. Consumer Prices All items Less food and energy Mediana Producer Prices Finished goods Less food and energy 2.9 Commodity futures pricesb -32.2 12-rnontli percent change Percent oi iorecasts GO ITRENDS IN THE CPI IDISTRIBUTIONOF ECONOMISTS' 1997 CPI FORECASTS~ 1 FOiAC central tendency as oCJuly199GC FOMC central tendency as 01 February 1996' 1993 1994 1995 1996 1997 18-22 23-2 7 28-32 3.3-3.7 Annualized percent change 3.8-42 a. Calculated by the Federal Reserve Bank of Cleveland. b. As measured by the KR-CRB composite futures index, all commodities. Data reprinted with permission of the Commodity Research Bureau, a KnightRidder Business Information Service. c. Upper and lower bounds for CPI inflation path as implied by the central tendency growth ranges issued by the FOMC and nonvoting Reserve Bank presidents. d. Consensus forecast of the Biue Chip panel of economists. SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; the Federal Reserve Bank of Cleveland; the Commodity Research Bureau; the National Association of Purchasing Management; and Blue Chip Economic Indicators, January 16 and July 10, 1996. After- Incrc,L\lng '11 .I ~ ~ \irglltl\ t e above -t'W) clu~rng the f r~st f ~ c\ month4 of I990 tile Cons~~rncr 1'1 Ice Inclex (CI'I) rnocle~~~tcci to .t11 .Innuahzed r,ite of le\\ th,m I('(, In 1i11lc The core ret'l~l pllcc ~ncllc'~to~\ the C1'1 e\cluclrng foocl .me1 energ) ,~ncl the nncd1,111(:1'1 \\ere 1117 2 2'kt id 2 100, r espectn el\ Whole\,lle p11c e 111~1e.1ses IK)\\evc.1, .~ccele~,ltecl .I 1)1t rn Iilnc Aftel legr\tellng e\scr~tr~~Il\ n o cll,tnge c l i ~ t ~ ttl~~gcf115t fi\e montll4 of the ye,ir. the 1'1 ocli~cer1'1 Ice Incle\ excl~~cling fooci .inel energ! goocls lose at a 2.9% clip. A sirriilar pattern ~ 2 1 1 1 I)e seen in reports from iiicli~strial ~>~~ctlasiing managers. i\Rer posting nine consecutive monthly I-eaclings I~elo\\;550 (which suggest net price cleclines). the purch:ising 111anagess' price incles movecl bacli up to the 50 m:tsli. In other \vorcls, the proportion oi' p ~ ~ r c l ~ a s im:ln:lgers ng n-ho note rising prices is now :tl)out e\.en \vitli those \\.ho see thern cleclining. 7he steppeel-up pace of consumer price increases this year prompteel the Feelel-a1Open M:lrliet Committee (FObiC) to revise its 1096 C11 ' projec- tions i~pwarcl.from :I centl.al tencleric). range centesecl o n 2.3% to one ce~ltesetlon 3. 1%. 7'he group sees the 1997 gro\\-th rate o f the CI'I slo\ving to l,et\\-een 2XiW! anel 3%. ?'he 1:ltest Uli~cChip survey inclicates that ccono~nistsexpect next )-ear's inflxtion rates lo I,e similar to this yc:lr's. As o f Ji111-,more than iii%t of thc 13lue Chip economists projectecl CI'I ir7cre:lses i11 the 2.3% ro 3.204) range. Cotltr:lry o p i ~ l i o ap~~s pe:ls to be few anel evenly balanced. 22?0 of the respoilcients Only al>oi~t (cotziiiz~rc~d otz tzc~.xlp~~gej http://clevelandfed.org/research/trends August 1996 Best available copy Inflation and Prices (cant.) Annualized 12-ciiarier percent change -ION MEASURES Investment Price Changes (Data through 1996:lQ) Annualized percent change, last: 4 qtrs. 1.2 1.1 1.6 Structures 2.5 3.1 2.7 Producers' durable equipment 0.8 0.4 1.7 Computers GDP Nonres~deniial PCE ~nvestmenl 40 qtrs. Nonresidential investment Information processing -3.4 CPI 12 qtrs. -12.6 -3.1 -2.5 -11.5 -11.0 Industrial equipment 2.9 2.6 3.3 Transportation equipment 2.3 1.8 2.7 Government Residential expend~iures invesirnent Percenl oi toial weight IRELATIVE WEIGHTS O F MAJOR CPI AND PCE COMPONENTS I 4-quarier percent change Durables 1 Nondurables Medical services Other servlces CPI NOTES: CPI represents the all-items Consumer Price Index for all urban consumers. All other measures are chain-weighted price deflators for GDP and selected major components. PCE represents the chain-weighted price deflator for the Personal Consumption Expenditures component of GDP SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; and U.S. Department of Commerce, Bureau of Economic Analysis. cspect ini'i:~tion lo lop j.2'l.i~ nest t~~:lllyhzt1.e continuecl to eclge ch:~in-weighteel incles have I,een year. \.irti~:~Il). iclentical to the prolon.er." Incleecl, the average incre:tse r~~rining I>elo\\-the CI'I, partll- t ~ e portion th:kt especl ii1~'iationto he in the GI>I' chain-~i~eightecl price cause the former 17uts clifferent less t1i:ln 2.800. incles has been almost percentage \\.eights o n certain co~nnloclities. With consunier price increzlses point less than the CI'I over tlie past Among the iinpol.tant clifferences is scerningl\. S L L I C I ~ iri the neigh1)orthree yc;lrs. A large share of' that clifthat housing is \veightecl more l1oocl o f 3'l.il. sorile Iix\-c \\-onclereci ference stellis from prices of nonres11e:tvily i n tlie CI'I, nhile meclical icleiltial in\.estrnent goocls, \vhich whether the CI'I is acc~~r:ltel\. me:isc;ue receives a smzlller ~veight.Still, have Ixxn strongly affecteel 1,); co~i- the imp:~cl of computer prices is r ring the econor~i!-'sunclerlying infl:ltionar). tlirusl. In his recent testiiinuccl sharp cleclines in co~nputer clear here also. Using the cli:linmony I~efol-e Congress, l:eclcr.:~l prices. This is not a p:lrticul;~rl\.11e\\. \\.eighteel ~~ppro;lch. consumer ciurItesel-1.e I3oarcl Chairman Alan elex-elopment. In klct, accorciirig to al~legoocls prices have incrcasecl at C;reensp;in noreel that "incrc:~sesin C~I)I)-l~;~secl price data, c o m l ~ ~ ~ t e21r mte o f about I/L tu 1 ~~ercent:lge rnol-e co~nprehensi\.c.anel 1xrll:117s ["'ices ha\.e avel.agccl an 11?/11ann~lal point less tli:ln CI'I dul-ahle goocls more representati\.c..cl~:~in-\\.ci~hted mte of clccline for the past clecacle. ~xicessince 1992. rncasures 01 consull1c.r prices ... :LCE\rn \\.itliin the consun~iergoocls :ires. price increases reportecl hy the http://clevelandfed.org/research/trends August 1996 Best available copy WageTrends Percent change, year over year 8 AVERAGE HOURLY EARNINGS AND INFLATION Percent change year over year 7 LABOR COMPENSATION AND PRODUCTIVITY I Percent change, year over year 9 EMPLOYMENT COST INDEX [ Percent change, year over yea1 8 UNIT LABOR COSTS SOURCE: U.S. Department of Labor, Bureau of Labor Statistics. June from their year-ago le\.el. ancl \When inflation acceler;~tes,so clocs lia\.e generally outpaced gains in the the pace 'at which lal,or costs inConsumer Price Index (CI'I) since crease. The con\.crse, i~owc\.er.is micl-1995. Similarly, the Lvages ancl not tnie: that is, rising lal>orcosts clo sal;~riesco~llponentof the eniploynot lencl to inf1:ation. \Vage-push ment cost illdex increasecl 3.2?41in theories of i11fl:ation ignore the CSLI1996:IQ. These narrow lal~or-price ci:al role of money: \Vitlio~~t esccsmeasures, however, d o not incl~lcle sive money growth. high \\rages cannot translate into :1 s~istainecl, Ixnefit costs. which have model.atecl clclrirlg [he current business exp:angener:d rise in oiitp~itprices. sion. Combining both, the total emRecent incre:lses in Ir11,or compensatior~may encoutagc er-ror~eo~~sployment cost illelex has matcl~ed the economy's 3% underlying inflaxv;~ge-baseclviews o f infl:ation. Avertion rate since 1993. age hourly earnings rose 3:tOf1 in .1,he most comprehensi\.e meas- ure of the price of I:~l,os-total cornpensation per ho~ir-aclv:1ncccl 3.6% on a yea~-over-)~e;1r basis in S')')h:IQ, folloxving gains o f 3.8% ;~ncl3.6% in the final bvo cluarters of 1995. Ho\vever the effect of ch:lnges in tot:d labor compensation o11 o ~ l t put also clepencls on cliang,-, in lat~orprocluctivity. In 1996:IQ. gains in 1:abor proeluctivity helpecl holcl unit l:~borcosts to a ~ n o c l e ~2.5'!4). ~te 1ncre:ases in unit l a l ~ o rcosts have genesxlly lagged the unclerlying pace of inflation since 1991. http://clevelandfed.org/research/trends August 1996 Best available copy EconomicActivity Real GDP and Components, 1 9 9 6 : l l ~ ~ (Advance estimate, s.a.a.cb) chanae. billions of 1992 $ I 70.8 Real GDP Consumer spending 42.9 Durables 20.1 Nondurables 9.0 Services 14.4 Business fixed investment Equipment Structures Residential investment Government spending National defense Net exports Exports Imports Change in business inventories Percent change from preced~ngquarter s a a r 50 / GDP AND BLUE CHIP FORECAST" Percent change, last: Quarter quarters 4.2 3.7 14.1 2.5 2.2 2.6 1.6 2.2 Percent chanoe, s a.a.r i a. Chain-weighted data In 1992 dollars. b. Seasonally adjusted annual rate. c. Seasonally adjusted. SOURCES: U.S. Depadment of Commerce, Bureau of the Census and Bureau of Economic Analysis: and Blue Chip Economic Indicators, April 10 and July 10, 1996. ., h;l\;e spillecl into the current clc1;irter: I hen, lollowiilg the strong monthly 'I'he acl\.arice esrilnate Lor scconclI-Io~isingstarts have bee11 f l ~ ~ c t ~ ~ a t i nclata g that c:Ime o u t I>et~v-\ieetl April clwirter GI)f' gro\\-th is a strong near the relatively high level of' 1.5 :incl June, tiley revisetl their first-half 4.2%), i111 n ~ ) r et11;ui 2 perwnt;ige million units since early spring. gro\v-th projections up\\-3rd by more pc>ints from the first clu:lrter :~ncl:iIOther areas of spending strength t11a11 one-thirci (to .30/0). From ~niclmost l\\;ice the gro\\-th r~ktcaiitici).ear. Iio\vever. the prevailing vie\\. last q~larter included consumer 172ted by rllosl an:ilysts \vhen the clur.al>Ies,i ~ i ~ s i n e ecluipment, ss and among anal!,sts has the econo~ny's cparter began. 'i'irt~lallye\.eq. major the go\fernrnent sector. Of the clogro\\.th mte mocler-ating l~acli to sector of the economy poslccl a rnestic spending categories. only ~111oi1t :I\-er;ige--or perh;ipssliightly Iiealthy increase 1;ist c1~1:lrter.;I sign conlnlercial construction sho\vecl :i l>clo\\.-l~). early 1997. Eco~lonlic that the proiongecl bi~sinessesp;knclccline from the first cluarter. growth in the second half of 1996 is sion rernnins \-igoroi~s.'I'lle 1;irgcst ~ s ~ x c t to e d11e slightly under 2M%, incrc;ise \vas in resiclential ~OIISISLIC- Wlle~ithe second quarter I>egan. frilling to just l~elo\\-2%) in 1997. lion, \vIlich gre\\. 15.1Oi1. f$i~sincss economists expected a first-llalf gro\vtli rate 01' slightly less than 2?h. (cot/tii/iied ot? iieL'vIJ I L I ~ C ) aclivit). in this sector ;lppe;krs to http://clevelandfed.org/research/trends August 1996 Best available copy Net perceni rising Index, 1987 = 1.00 1 INDUSTRIAL PRODUCTION B~llionsof current dollars 270 I B~ll~ans of curreni dollars 50 NONDEFENSE CAPITAL GOODS ORDERS AND BACKLOGS 70 PURCHASING MANAGERS' INDEXES Percent of forecasts Rn , BLUE CHIP INDUSTRIAL PRODUCTION FORECAST (JULY 10, 1996) I Annualized percent change NOTE: All data are seasonally adjusted. SOURCES: U.S. Department of Commerce. Bureau of the Census; Board of Governors of the Federal Reserve System; the National Association of Purchasing Management; and Blue Chip Economic Indicators, July 10, 1996. 1'eril:lps the biggest change in th:~n h0?6 indicatecl highel- orcless. econo~llicgro\vtll cluring the past six 'I'his is the 1:trgest proportion noting months has Ixen a slurp revival in orclers growth in al~llostt~x-o )-ears. industri:~l acti\-ity. Af'ter sllo\ving In the c:lpit:ll gootls :ma, n-llel-e i?~~siness :~cti\.ityin the past se\.el.al only a small net incre~lsei l l 1995 (alwut 10/i,,), inclust~.i:~lo ~ ~ t p cex~t ).e;lrs 11:~sIxen phenomen:il, gro\\.tli p;lnclccl an :lnnr~alizetl 5'?6 ~ILII-ing iiiclic:itors Ilzlve shown sol~icrecent the first h:llf of 1996. Reports fl-om signs o f le\.eling off. Nonclefcnsc i~lclustrial~x~rchasing ~~xunagcrs sugc.al?itlil goocis orciers have been flrlct ~ ~ : ~ t i naround g $45 billion per gest that rli;~nuf:~cturing strcngtll is lilicly to continue over tile near month lor i~l~out eight 11iorltlls no\\., tcr[li, \While 55(% oS ~1~1rc1~:~sil~g IIKLI~-:incl the l>acl<logof capital goocls Il:ls :lgt't'S 11111from only ,4596in jan~iary) 1,een slon.i~~g its rate of increase repol-tecl o ~ ~ t prising c ~ t in June, more since Jar-u~ary.Still, the plateau in 1)usiness ini.estment is occ~~rring at a Ilistoric;~lly high level, perhaps I: sign tli;lt these inclristries have finally neared their capacit).. 'i'he oc~tioolifor the indusirk~lsector is reason;il~lyI~rigllt.Nearly 700/i1 of c.conosnists sul-\-ey-cclin July anticip:ite gro\\-ti1in I996 inclustrial outllllt L o he i l l tile 2%1 to 3(!/i1range, n.hilc, a l ~ o i ~ 25% t expect 3% to ~ ( W I gron,tll. For 1997. about ~45% of' tllose sur\~eyecl foresee inc1~1stsi;ll gro\i.tll in the 2%) to 3% range. vcrsus :~ro~lncl "iOVii \vho expect 3% to 4%. e a s e * ea CB http://clevelandfed.org/research/trends August 1996 Best available copy @3 GrowthAccounting Percent of GDP 36 Percent oi GDP 12 INVESTMENT-TO-GDPRATIOS~ I Sources of Real GDP Growthb (Average annual percent change) 19511959 19601969 19701979 19801989 19901993 19511993 3.5 4.1 2.9 2.5 1.5 3.1 = Capital stock 1.1 1.3 1.1 0.8 0.5 1.0 1.0 1.6 1.1 1.1 0.2 1.2 1.4 1.2 0.7 0.6 0.8 0.9 GDP + Labor hours + Productivity Thousands o i 1987 dollars per employed person 45 CAPITAL-STOCK-TO-EMPLOYMENT RATIO Sources of Labor Growthb (Average annual percent change) Labor hours 19511959 19601969 19701979 19801989 19901993 19511993 1.0 1.6 1.1 1.1 0.2 1.2 1.1 1.4 0.9 0.7 1.1 0.1 0.4 0.0 -0.1 0.2 0.1 -0.2 0.3 -0.3 0.0 = Working-age 0.8 pop. + Labor force participation 0.0 rate + Employment rate 0.0 + Hours per worker 0.2 0.3 -0.5 -0.1 -0.1 -0.1 a. 1996 data are for the first quarter. b. Components may not sum, due to rounding. SOURCES: U.S. Department of Commerce. Bureau of Economic Analysis; and U.S. Department of Laboi, Bureau of Labor Statistics. 'I'he [J.S. is experiencing a c21pir;ll spending i,oom, lee1 11); investlnent in inform;ition processing equipment. ~xirn;iril!. colnputers. 13ilsiness fixed in\.estment has risen horn 90h ol' C;l)I1 in 1991 to 11%1t l i ~ ~ hiss this year. ?'he espansion is partic~iI;isly \\'elcome after the torpid pace o f capital accumulation in the 1930s. i\ltliougii \.iral to a sust:lined economic exp;knsion, in\.e,strnent in capital is not ils sole contributor, ISconomists often identil'y tllree l~roadsources of economic growth: exp:~nsionof the capital stocli (in\.estment). increases in the availal>le \\.orlif<)rce (labor hours), and ilnprovements in total factor productivity. Changes in this last component capture the effects on econornic growth of such intangiI ~ l e s:is :tdvances in ec1uc;~tionancl technology. which enhance the :117ility of' capital ancl labor to procluce gootls ancl services. 13et\\-een 1951 and 1993. the I2.S. economy grew at a 3% average an- nual rate. ancl e:ich of these three hietors contril~utecleclually to the ncl\.ante. The overall pace of C.S. economic gso\vth, ho~\.ever:has deceleratecl l ~ e c : ~ ~of~ the s e s l o ~ ~ sate e r of capital accumulation and Inore hesitant :lclv:inces in total factor producti\.ity. t\ flattening of the capital-to1:il~orratio is also eviclent aftel- 1970. O\.e~illgro~vthin lal~orilo~u-sh:is ilclcl L-lirly steady, clespite tile en-:~tic I~eh:l\.ior of many of its unclerlying components. http://clevelandfed.org/research/trends August 1996 Best available copy Labor Markets Change, tiiousands of workers" /AVERAGE MONTHLY NONFARM EMPLOYMENT GROWH I Labor Market Conditionsa Average monthly change (thousands of employees) 1995 Year Payroll employment Goods-produc~ng Manufactur~ng Construction Service-producing Services Computer R e t a l l trade Federal govt. 185 -5 -12 9 190 110 11 36 9 1996 May June llQ 273 407 27 53 5 19 22 31 246 354 110 160 1 3 15 81 77 20 61 July 220 16 -4 22 204 90 9 86 -4 193 1 -20 25 192 28 10 89 37 Average for period 1 -200 1 1 1 1 1 1 1 1 1990 1991 1992 1993 1994 1995 1996 1 1 1 1 110 May June July 1996 to dale Percent Percent 64.5 I Civilian unemployment rate (%) 5.6 5.4 5.6 5.3 5.4 Nonfarm workweek (hours) 34.5 34.4 34.2 34.7 34.3 ILABOR MARKET INDICATORS~'~: Percent oi tolal unemployed 40 IDURATION OF UNEMPLOYMENT, 1996 EZ] January July 1990 1991 1992 1993 1994 1995 1996 Less than 5 weeks 5 lo 14 weeks 15 to 26 weeks 27 weeks or more a. Seasonally adjusted. b. Production and nonsupervisory workers. c. Vertical line indicates break in data series due to survey redesign SOURCE: U.S. Department of Labor, Bureau of Labor Statistics. I.al,or mirliets contin~~ecl to gron. at goocl ~ ; I c in " July. ;is nonkirnl p;iyroll ct-nployment increasecl by 193,000. 'I'his I~ltesifig~lse/,rings jolw gro\vth for 1996 to :in :i\.er-age of 230.000 per month. \vhich is n i u c l ~Ilighcr th;ln the 1995 rate. Ernployrnent growth rvithirl the goocls-produci~igsector was virt~l:tlly flat in July. <;onstrilction firrus aclclvcl 25.000 \vorliers, I)ut tlianclk~ctciring trimmed payrolls for the seconel monrll in :I so\\. (-20.000). 1.JnLISLI:III\ ~111;11/joh ;idclitiot~sin 1ie;~lth ;~ncll,~~sincss set-\.ices, as \vvll ;IS net ;i cleclines in several other componellt inclustries. lee1 to a particu1arl)- n.eali ~ x ~ s t i nfor g the narrow setvices category last mo~ltli(28,000). E\.en so, this incl~lstr).,\vhich incl~ltlesestablishments lilie hotels. hospitals. ancl enginevring firms, h;is accounted for ne;lrly half of all new jobs createcl so fal-this );ear. Itet:iil tmcle ernploymen1 contin~ ~ et co lespaticl strorigly in July. sisit~g 13)- S9.000, hle:inwhile, gor.wntnent pa)-rolls p o s ~ e da n above-zivelage rise I ~ e c a i ~of s e eclucation-relatecl hiring fix tile tie\\- school year. 'I'he civili:in c~neti~ployment sate eclgecl LIPto 5.-I(%in July after hilling to a sis-ye:ir lo\v in June. The proportion of nc\~;l).~lnemployetlIVOI-kcrs has ren~ainecl~~nchatlgecl since the heginning of the year. while long-tertn jot~lessness(the sh:ire o f persons iinrmployecl for 27 weeks or longer) h:~s risen noticeaIAy. 111cleecl. 1i:ilf o f ;ill jol,less \vorl-LC[:.5 tlo\v kice ;in ~rncmploymentspell of 8.0 eelis is or niore. nhich is some\\.h:~t higli b). 1iistoric:il starlclards. - ~ ~ O l l t i t i iOli l ~ I~~~clJ " Y / ~ I ~ ~ < ~ c J ) e @ B B e http://clevelandfed.org/research/trends August 1996 Best available copy * Labor Markets (cont.) Median weekly earnings (dollars).1993 Median weekly earnings (dollars),1993 I '"" EARNINGS BY INDUSTRY 1 EARNINGS BY OCCUPATION I Percent change 111total employmenl, 1989-95 Percent 1 l 6 CHANGE IN TOTAL EMPLOYMENT BY 1993 MEDIAN EmpIoyment Change and Earnings in Selected Occupations Change in total employment, 1989-95 Thousands of jobs Services Managerial Professional specialty Clerical Sales TPUa Operators Percent change Igg3 median weekly earnings ($) 1,302 27.6 598 2,214 563 184 19.2 9.0 20.4 578 305 250 315 13.3 463 FIRE^ Clerical -392 -12.4 342 a. Transpodation and publlc utilities. b. Finance, insurance, and real estate. SOURCE: U.S. De~artrnentof Labor, Bureau of Labor Statistics. What t!-pes o f ne\\- jolx are emerging in tile clynamic U.S. econo ~ n y ?In tlie li\-el?-clcl~ateon this cl~~estion, some cite el-iclencc that tlie openings arc nlostl\. in lower~xlyitlgintl~~stries. I11 their \-ic\\-.the counts). is losing higher-p:iying jolx in dunilde manut~cturing:lncl gaining lon,-\\,i~gcservice sector jobs. A less clis~n:il picture is painteel when enlploynlent is consiclercd by occupation. I<eccntly, higher-pilying occulxltions hiive genenilly been 21ssociatecl n.ith tlle gre~itestemplo).- ment growth. This is because the t\\-o fastest-growing occupiltio~lsof tlie last seven years are professional speci:llists :i11ct managers. lmth of \vhich 1i:ive i~bove-average~veekly earnings. 'l'hese clata inclicate that the Arncric:~~ job-creating machine 111:i). not neecl :I tune-up as badly as m:my c1:iim. Further investigation tells a richer story. When occuprttio~lslvithin a single industry are orclerecl hy weelcly earnings in 1993 and classified into three roughly eclual g r o ~ ~ p sthen . most of the jolx growth o\.cr the 1989-75 period occurrecl in tlie highest-earning ancl the lo~vest-earninggroups. ?'lie miclclle g r o ~ ~actually p lost employees o n net. 'l'his is consistent with tlie iclea that clianges in the occupation ancl inclustry ]nix contril>utecl to the increaseel ineq~~ality of weelily earnings experienced during this time. I-Io\~e\.~r. tile trencl for 199.i ancl I995 \\.as clifferent: I\lost of tlie jolx growth n.:ls in the highest-e:lrning occc~piitio~is within a n inclustl-~7. g e e * @ a http://clevelandfed.org/research/trends August 1996 Best available copy * Regional Conditions Thousands o i claims 500 AVERAGE WEEKLY INITIAL UNEMPLOYMENT I REASONS FOR SEPARATION, 1995: IVQ 1 I cancelled 2% J F M A M J J A S O N D a. F~ve-yearaverage, 1991-96. SOURCE: U.S. Department of Labor, Bureau of Labor Statistics. In nonrecession:is!, t i ~ ~ i enearl!, s, ;i tenth of :ill initial uncml,loyriierit insurance cl:ii~iisrcsillt horn iiiass layoffs. A m:iss l;iyofS, in \\.hicll a siiigle plrint la!.s ott' :it least 50 I\-orliers Sor more than 30 clays. puts consiclerable pressure o n a conil~ii~nit)-'s social sel-vices. f3ccailse tlic 1:ist cluartes of 1995 \vas c1i:i~icterizecl1,). a n cspancling cconoiii\. tliroi~gliout riiost of the cotinti.)., ii o f i r s :in opportunity to stilcl!. thc features of' Inass Iziyofls clusing ;i nonreccssion: I I ~pesiocl. States l>orclering the Great si~rpsise.Incleeci. in 1795:IVQ tiearly Ii:i\,c rel:iti\.cly high r:ites of mass half of 2111 jol3 losses sesulteci psimarla).offs. pertlaps reflecting tlie ily from the seasonal nature of tlie greater prevalence of these e\.ents in \vorli. This hictor is clearly shown in the t ~ i n s ~ ~ o s t a t eq~iipiiierit io~l ancl the p a t t e s ~of~ initial unemployment c l u ~ i l ~ lgoocls e manuhictiiring seccompensation claims. However, it tors. I3oth he~ivilysepresentecl in this nay be e\.en more important th:in region. On average, transportation these clata suggest, since mass layec~iiipiiient171ants are three times the offs [nay I>e Inore seasonal than size of all m:inuf;rcti~siti plants, ancl otller sepas:itio~i,s, or sorile of the man~ificti~ringig plants :iver-:igc three season:ility of iiicli\-iclual layoffs ixmay times the size of ~ionrnani~kict~~ringngI3e clncelled oiit \\.lien many layoff:.; estzil~lishrncnts. :ire aggreg:ltecl. \i mass l;iyoff' is not necessarily :i (cotztii~lied017 )re.~tpc~gc) http://clevelandfed.org/research/trends August 1996 Best available copy Regional Conditions (cont.) Percent Perceni 60 UNEMPLOYED PROFESSIONALS AS A SHARE OF ALL JOBLESS WORKERS U S UNEMPLOYMENT RATE Techn~calsales, and Service occupations Percent of labor ioice 50 CIVILIAN LABOR FORCE BY OCCUPATION: MID WEST^ Serwce occupaiions Managerialand proiess~onalspecialty - ----- -- -->- -= * -"-/ -- ___ _- I_ "-a- _l* Operators labricators and laborers = -~~"--A-+&-za. x*~*- " C_"__ ^ _ Preciston production crail and repalr - _- * - - ? S s - - _ - a. Excludes agriculture, fishing, and forestry. SOURCE: U.S. Department of Labor, Bureau of Labor Statistics 'The 1990 recession has heen clescrit>ecl as "\\.hire collar" 1,eca~ise of the nlirnl>erof m:wagers ;mcl professionals \\.lie \\.ere I;iicl olt'. A looli ;it Ilo\v this rcr.ession hit clitfercnt ret s just 1io\v the \\.bitegions ~ ~ o i nLIP collar occupations n.ere ;itfectecl. w i t i ~ ~ ~ \ \ . i d~ ei i, ; ~ ~ i ; i~incl g ~ r sprofessionals Ilad a lon.er u~iemplo).rnent rate than a n y other ni:tjor occupational g r o ~ ~cl~iring p [he entire period, inclctcling the n-01-st of' the recession. ( I Iistoric:~ll)-,ope~itorsoften experience jol~less rates that zue cl~~ziclruple those of managers ancl ~xokssionais.)However, starting in 1990. tlie jol>less rate of managers zinc1 17rofessionals increaseel relati~.e to total 17.S. unemploy~ncnt.One pussil>le re:ison is the regional nlix of the recession. In recent years, the cinemployment rates in Ne\v- 'l'orli ancl California have incluclecl niore managers ;i~-~d profession;i1s t l i : ~clicl ~~ tile sates 1'0s the inclc~strialklici\vest. Tile 1990 recession affecteel Xe\v h ~ l (\\-hicli i hacl an utlemploymcnt rate of 6.6%)in 1791) :incl Czilifo~.ni:i (6.79/i,)more t1ia1-1it clicl Ohio (5.8*41). gi\-ing the coast;ll states greater n-eight among the regional components of t ~ n e ~ ~ ~ p l o y mIncleecl, ent. iri Ohio tlie satio of iinern1>lo)-eclmxnagers to :ill johless \ \ . o ~ l i e sfell ~ during tlie rccessiorl. I-Io\\.e\.er. the indclstri:il Miclwest still sho\\;s some of the nation's occup:ition:ll trencl to\\.arcl more man:igcrs ancl professionals. *l'liis may \yell Ile rellectecl in future recessions. n.hen riianagers at-1~1engineers ~naiieup Inore of the region's ~inernpio\.ecl. I http://clevelandfed.org/research/trends August 1996 Best available copy Banking Conditions FDIC-Insured Commercial Banks by Asset Size Percent of all inslituiions 55 TOTAL ASSETS OF COMMERCIAL BANKS I (Number) 1986 1989 1992 1995 All institutions 14,181 12,707 Less than $100 million 11,394 9,722 8,291 6,659 $100 million to $1 billion 2,448 2,607 2,791 2,861 $1 billion to $10 billion 306 334 329 346 Greater than $10 billion 33 44 51 75 Percent of all inslitutions 11,462 9,941 Total instiiutions 700 1 CHANGES IN THE NUMBER OF INSURED 1 NOTE: Boundaries used to separate institutions by asset size are expressed in nominal terms, creating a distortion in the comparisons over time SOURCE: Federal Deposit Insurance Corporation. The consoliclation of the Ix~nliinginclustry that 1,egan in the micl-1980s has been clri\.cn prim:trily I)y changes in tile regi~l:~tions o n 1,:mks' g e o g ~ i p l ~expansion. ic At the beginning of i11e century, most states reclc~iseclImnlis to be unit I>at~Iis, that is, to Ila\,c only one office. In t i ~ n c ,states 1,cgan to allon int12st:lte i)r:~ncliing,I>ut continueci to prohil~itinterst:ltc Ixinching :rncl the accluisiiion of' local I):inlis 11y oi~t-of-statel>;lnlis. In the 1950s. 1,anlis atteml~tecl to avoicl this prohi1,ition .!,I eleveloping 1,:inli holcling companies (BHCs) xvith I ~ a n k s locatecl in varioiis stcttes. f-Io\vever, in 1956 the I>ouglas Amendment to the Rank EIolcling Company Act stoppeci this it~itiativ-c. I t prohihiteel a BMC frolll :~ccluiring a l~anlioutside the company's home stste without autl~orizationf;.on~the target h:rnl-',. L s state. Restrictions on banlts' geograpllic es~>ansiotnhacl pushecl their ni~mber to a post-Ile~>ressiol11 high o f al,out 14,500 in 1784, cvhen regul;~tolybar.riers on interstate banking I)eg;ln to f r ~ l l . States startrcl to allo\\ oi~t-of- state BEICs to accliiire home-st:1te 11:~nlts.I ~ u ~-n:iintainecl t the I,an o n interstate l>l-anchitlg;th:~t is, they clid not :lllow the acck~iirecl1,anlis to be converteel into 1,t;lnches o f the o i ~ t of-st:~tc I~anks.In p;lrallel nith these regulatory changes, the number of 1,anlis steaclily clroppecl, mainly 1,ecause of incre:~seclmerger activity. One implic:~tion o f banking consolielation. p;lrticillarly in the 1990s, is the greater i~llportarlce of the I:~rgest iristitiitiol1s. l'heir number has increasetl significantly. as has (co~ititiiled011 I I ~ ' . Y ~ ~ I ~ C ) http://clevelandfed.org/research/trends August 1996 Best available copy Banking Conditions (cont.) Percen! Percenl ? RETURN ON ASSETS j 1 > Noh-INTEREST INCOMC EARNINGS ASSETS 0.6 03 00 Percent 1991 Percent " I NON-INTEREST EXPENSVEARNINGSASSETS Percent 14 Percent 12 25 10 2.0 30 8 1.5 6 1 4 .o 05 0 0. 0. 1991 Percenl 30 Percenl 14 All ~nst~tut~ons Less than $100 rnill~onIn assets $1 b ~ l l ~ to o n$10 b ~ l l ~ olnnassets SOURCE Federal Depos~tInsurance Corporation their share of tlie industry's clelxxits :tnd assets. Banliing consolicl:~tion has affected the inelustry's perfor~~lance hecause 1,anlcs of clifferent sizes I1:~ve clilferent \\-:tys of cloing tx~siness.For instance, larger I,anlis tcncl to Il:tve higher op".;tting costs. 7'he)- malie 1110re lo:tns th:it turn oiit to he i~ncollectable. have higher [~lnclingcosts. :tiid i n c ~ ~ gre:lter r non-interest expenses. Hon.ever. their non-interest income is si~fficientlyhigh to overcwme these costs. In aclclition, their 1991 $100 million to $1 b~llionIn assets More than $10 b~llionin assets easier :tccess to capital marliets allo\\:s the111 to opervte with lo\ver capita1,'asset mtios. This explains ~ . h tiley y clo better in terms of return o n equity hilt not (in the case of the very largest banks) in ternls of return on assets. These results seein to :LCcorcl \\.ith recent research that fails to fincl economies of scale for the very l~lrgest1,anks. As espectccl, the 1994 en:lctment of the lilterstate Uanlcitlg and 13ranching Efficiency Act bt,- w n a ne\v w:lve of bank mergers. I-fo\\,- ever. the effects of this consoliclation will cliffer from those clri\,en 11y the regi~lato~y changes of the 1980s. Tlie 1994 act's trlost important change is that it permits BHCs to convert their hanlis. even if they :ire loc.ated in sevelxl states, into a single network of I~ranches.This will illost liliely have a greater i~npacton larger banliing organizations by giving them an opportunity to recluce their non-interest expenses. an are21 in which smaller 1,anlis ll:l\-e traclition;llly 11:icl more success. e a ( P e http://clevelandfed.org/research/trends August 1996 Best available copy e International Developments Index, January 1971 = 100 600 IPURCHASING POWER PARITY~ Percent change from correspond~ngmonth oi prevlous year I 30 CONSUMER PRICES I a. Purchasing power parity IS calculated by combining exchange-rate changes with Consumer Price Index movements for the U.S. and Japan or Germany, respectively. NOTE: Prior to January 1991, German data represent West German figures. SOURCES: DRIIMcGraw-Hill: and Board of Governors of the Federal Reserve System. Nomin:il exchange rates fl~rctuate substantially ancl often seem unrelatecl to short-run movemenis in such f~rnclamentals: ~ sincome o r tracle l,:rlances. Nonetheless. ccrtain long-run relationships itr\.ol\-ing exchange mtes may he relial~le. I11 pastic~ilar. many economists view exchange rates ;is 1.csponcling t o clifferences in price le\.els. 1 lowever, exchange rates m:i!. lalie rriore t i ~ n e to responcl frilly to price-level clifferences than once \v:is tlro~rglit.Since 1971. I:.S. inf1:i- tion rates have usually been higher than Germany's or Japan's, ancl the cloll;rr has \veakened against 1,oth the 11iark ancl the yen. Calculations of purchasing p o n e s parit). inclicate that relative inflation sates ancl exchange-rate movements have a cornl~inecleffect o n the U.S. competitive position relative to Germany :il~dJapan. Both strength in the clollar ancl higher 1J.S. inflation ~ x t e swealien the IJ.S. posilion. The Gerlrlan marli has helcl its gro~rncl ~ig:rinstthe clollar since 1992, despite higher i~lflatiollrates in ~rnifieclGermany. Over the same periocl. the yen has gelierally giinecl against tile dollar, with lower Japzrnese inflation sates. 'I'hus, C.S. parity :igaitrst Germany has impso\.ecl relative to o u r position against Jap:i11. Since 1995, both the mark :ind the yen have n~ealieneclagainst the clollar. Although U.S. inflation rates have I x e n higher. the relative strength of the American economy makes the clollar an attractive invest~nent. (cot?/ir~lred0 1 2 1ze.xtp~~gc~1 b e e s e e e International Developments (cont.) http://clevelandfed.org/research/trends August 1996 Best available copy Percent change froni corresponding quarter oi previous year Percent change iron^ corresponding month o i previous year 30 Percent [LONG-TERM INTEREST RATES a. Seasonally adjusted. NOTE: Prior to January 1991, German data represent West German figures. SOURCES: DRIIMcGraw-Hill: and Board of Governors of the Federal Reserve System Long- anel short-I-LI~ mo\.emcnts in exch:lnge rates, in~erest~ t c s ancl , inflation rates ma). be conncctccl through the rnech:tnisn1 of monetary policy. I-Iigher r:ltes o f money growth tencl to prodilce higher infl:ltion, ancl the expectation of grc:lter inflation incre;ises long-term interest rates ;is Icnclers clcm;incl colnpensation for lost purchasing power. News that a central b;lnli m a y tighten tcncls to l>oost tile v;~l~le of' a nation's ciwrcncy 21s people anticipare higher sllorl-term interest rates. Since r~nific~ition. C;errn;iny 11:~s hacl higher sates of' Inonel. gron-th th:un both Ja17;~nancl the U.S., yet l ~ y may tighten in response to strong 1994 Gertllan econonlic gro\vth hael first-cluarter g r o \ \ ~ hhas s ~ ~ p p o r t e d recoveretl t o near the U.S. rate. And the yen, while Germany's ongoing while Japanese money gro\vth has sluggishness has lecl to talk of loosbeen only slightly belotv that of the ening ;lncl has \vealieneti the marl<. L.S., Jap;m's long-term interest rates Efforts by centlxl I~;unlisto stimulate 1x11.e been much lower. These patgrowth 13); manipulating short-term terns may 1,e related to u~lanticipatecl interest rates are cluiclily reflected in cle~.eloi>~nents in output. Gerirlatl lower currency \.slues if they are GIII-' d s o p ~ x dsharply after unificaperceiveel as an acceptance of higher tion, 1 ~ 1then t reboundect. Japanese inflation. Accostling to this vien., the economic gro~vthfinally began to re1on.e~interest Kites in Japan might cover in late 1995 from problems be cli~et o that nzltion's \villingness to causecl 11y Ixld assets at many of the hold the line against inflation clespite counL~-!.'sfinancial institutions. 21 fen- !.cars of less-than-stellar ecoSpeculation that the Banli ofJ~ipan norllic gro~vth.