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The Economy in Perspective
by Mark Sniderman
FRB Cleveland • December 2006
Closing the books…Another year heads into the
barn, bows out, comes full circle, folds its tent, fades
into the sunset. Any way you say it, 2006 will soon
be history. Everyone’s view of the year is colored by
their values, expectations, and vantage point. On
this page, I’d like to reflect on a couple of the issues
that dominated my thoughts about the economy
this year.
Housing may be the biggest story of 2006, especially when you consider its potential for influencing next year’s economy as well. Housing markets
slumped in the second half of the year, dragging
activity levels from boom to bust in just a few
months. Building permits were issued at a seasonally adjusted annual rate of 2.1 million housing units
in the first quarter, declined in each successive
quarter, and stood at 1.5 million units in October.
Builders themselves have suffered to various
degrees, but for the most part seem to be financially
viable after several strong years of profitability.
The pace of new home building in itself will not
be the most pressing issue for the fortunes of the
economy. Yes, the downswing in new home construction will be large enough to show up in the
statistics for national employment and output; it
has already taken its toll this year. But housing
market dynamics can depress consumer spending
in a variety of ways.
Considering that housing constitutes the largest
form of broad-based wealth in the country, consumers have good reason to feel less wealthy now
than they did a year ago. As housing prices appreciated, homeowners pulled out some of their equity
and spent it on other goods and services. When
appreciation petered out, that extra consumption
kicker was gone. Finally, short-term interest rates
have risen considerably since the time when many
homebuyers took out adjustable-rate mortgages
that are only now starting to reset. Rising mortgage
payments, other things being equal, seem likely to
crowd out consumption.
Housing has played a key role in this year’s inflation statistics. One of the largest components in the
Consumer Price Index market basket is owners’
equivalent rent (OER) on primary residences—an
estimate of the rent that homeowners would pay
if they didn’t own their homes. OER accounts for
about 25% of the CPI market basket, enough
for its volatility to show up in the movements of the
total CPI.
Utility prices can obscure the true OER picture, so
they are actually subtracted from the initial calculation. This means that when utility bills fall, as they
have done lately, the OER rises, as indeed it has.
Ironically, this combination of events put upward
pressure on the CPI’s housing component, just
when housing and utility prices were weakening.
OER increased at a rate of about 21/2% in 2004–05,
but is now increasing at a 4% rate. If price movements in the OER component were to decline only
by a percentage point, the effect on the CPI’s rate of
change would be 1/4%—a welcome reduction.
At the moment, the price of energy is playing the
hero’s role in the inflation drama, although it was
the villain during summer stock. The spot price of
crude oil today is the same as it was at the beginning of the year, roughly $53 per barrel. Yet by
mid-August, the price had escalated to nearly $70,
stoking fears of another wave of inflation, just as the
economy began to flag under the weight of declines
in home building and automobile production. The
more recent energy market developments are
providing some breathing room for monetary
policy makers, who have been on the alert for any
signs that inflationary pressures might intensify.
There is one 2006 development that has had
almost no effect on this year’s economy but looms
larger in the picture for 2007, 2008, and beyond.
That development is the reversal in positions of the
two major political parties in the U.S. Congress. The
ascendant party is espousing a different philosophy
on trade, energy, and tax policy (to name just a few
issues) than the party heading to the backbenches.
And yet no party is in a position to dictate to the
other. The parties’ relative strengths will certainly
shape economic performance, but in ways that
have yet to become clear.
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Inflation and Prices
12-month percent change
4.75 CPI AND CPI EXCLUDING FOOD AND ENERGY
4.50
October Price Statistics
Percent change, last:
2005
a
a
a
3 mo. 6 mo. 12 mo. 5 yr. avg.
4.25
a
1 mo.
Consumer Price
Index
CPI
4.00
3.75
All items
–5.8
–2.9
0.7
1.3
2.6
3.6
3.50
Less food
and energy
1.2
2.3
2.8
2.7
2.1
2.2
3.00
Medianb
3.7
3.5
4.0
3.6
2.7
2.5
2.75
16% trimmed
mean
0.9
2.1
2.7
2.7
2.2
2.6
3.25
CPI excluding
food and energy
2.50
Producer Price
Index
2.25
2.00
1.75
All items
–17.9
–10.9 –4.2
–1.6
2.5
5.7
Less food
and energy
–10.1
–2.7
0.6
1.0
1.5
–0.9
1.50
1.25
1.00
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
12-month percent change
4.25 TRIMMED-MEAN CPI INFLATION MEASURES
4.00
3.75
3.50
Median CPI b
12-month percent change
9.00 CPI CORE GOODS AND CPI CORE SERVICES
8.00
CPI core services (1-month
7.00
annualized percent change)
6.00
CPI core services
5.00
3.25
4.00
3.00
3.00
2.00
2.75
1.00
2.50
0
2.25
–1.00
2.00
–2.00
–3.00
1.75
1.50
1.25
16% trimmed-mean CPI b
–4.00
CPI excluding food and energy
1.00
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
CPI core goods
(1-month annualized
percent change)
–5.00
CPI core goods
–6.00
–7.00
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
FRB Cleveland • December 2006
a. Annualized.
b. Calculated by the Federal Reserve Bank of Cleveland.
SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; and Federal Reserve Bank of Cleveland.
The Consumer Price Index (CPI)
declined sharply in October for the
second straight month, falling at a
5.8% annualized rate. However, the
core inflation measures continued to
hold steady, with monthly growth
rates about the same as—or lower
than—their longer-term trends. The
CPI excluding food and energy rose a
moderate 1.2%, while the median CPI
climbed 3.7%.
Longer-term growth trends in the
core retail price measures remained
elevated. Whereas the CPI’s 12month growth rate dropped sharply
(to 1.3%, its four-year low), rates for
the CPI excluding food and energy
and the 16% trimmed-mean CPI
came down only slightly to about
2.7%; both retail price measures remain well above the range generally
associated with price stability.
Deceleration in the core inflation
measures seems to be heavily influenced by recent softness in prices
for core goods (which exclude food
and energy). Core services prices,
however, remain stubbornly high, contributing to the persistently high readings of the Cleveland Fed’s median
CPI. This measure, which examines
the component in the middle of the
monthly price-change distribution,
rose a brisk 3.6% over the 12 months
that ended in October.
The discrepancy in the behavior of
goods versus services prices is clearly
reflected in the monthly price-change
distribution of the CPI components:
Large shares of the consumers’ market basket showed either large price
increases (above 3%) or price softness (below 1%); only a very small
proportion of the CPI components
(continued on next page)
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Inflation and Prices (cont.)
Four-quarter percent change
6 UNIT LABOR COSTS, NONFARM WORKERS
Percent of index
50 CPI COMPONENT PRICE CHANGE DISTRIBUTION
45
5
40
4
35
3
30
25
2
20
1
15
0
10
–1
5
–2
0
Less than 0
0 to 1
1 to 2
2 to 3
3 to 4
Monthly annualized percent change
4 to 5
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
More than 5
Annualized quarterly percent change
6.0 CPI INFLATION AND CPI INFLATION FORECASTS b
5.5
Index
1.30 MARGINS a
1.25
5.0
Top 10
average
4.5
1.20
4.0
1.15
3.5
3.0
1.10
2.5
2.0
1.05
Consensus
1.5
1.00
1.0
0.5
0.95
0
0.90
–0.5
-1.0
0.85
Bottom 10 average
–1.5
–2.0
0.80
1958 1963
1968
1973
1978
1983
1988
1993
1998
2003
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
FRB Cleveland • December 2006
a. Ratio of the core CPI to unit labor costs, indexed to the average ratio for the entire period.
b. Blue Chip panel of economists.
SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; and Blue Chip Economic Indicators, November 10, 2006.
(about 5%) showed price increases in
the moderate 1%–3% range.
In a recent speech, Federal Reserve
Chairman Ben Bernanke stated that
“there are substantial uncertainties
about the inflation forecast… One factor that we are watching carefully is
labor costs…[which] have been rising
more quickly of late. Some part of this
acceleration no doubt reflects the
current tightness in labor markets.”
Indeed, in 2006:IIIQ, the four-quarter
growth rate of unit labor costs
was 2.9%, as compensation growth
outpaced decelerating productivity
growth.
Chairman Bernanke suggested
that accelerating growth in unit labor
costs would not affect price inflation
if firms were to absorb rising labor
costs by sacrificing some portion of
their profit margins. Margins, as measured by the ratio of prices to unit
labor costs, do indeed seem unusually high. But what firms’ responses
to rising labor costs would be and
whether firms’ margins are really as
high as this measure would indicate
are highly speculative matters. Chairman Bernanke also suggested that
“the more worrisome possibility is
that tight product markets might
allow firms to pass all or part of their
higher labor costs through to prices,
adding to inflation pressures.”
Despite these concerns, economists don’t anticipate that the recent
acceleration in the growth rate of unit
labor costs will have a lasting impact
on inflation. The consensus estimate
of the Blue Chip panel of economists
is that retail prices will hold steady in
2006:IVQ and will rise between 21/4%
1
and 2 /2% by the end of 2007.
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Monetary Policy
Percent
8 RESERVE MARKET RATES
Percent
6 REAL FEDERAL FUNDS RATE c,d
7
5
Effective federal funds rate a
4
6
Intended federal funds rate
3
5
Primary credit rate b
4
2
3
1
0
2
Discount rate b
–1
1
0
2000
2001
2002
2003
2004
2005
2006
Percent, daily
100 IMPLIED PROBABILITIES OF ALTERNATIVE TARGET FEDERAL
90
FUNDS RATES, DECEMBER MEETING
OUTCOME e
5.25%
–2
1988
1990
1992
1994
11/1: Pending home
sales, ISM mfg,
construction spending
10/18: CPI
70
1998
2000
2002
2004
2006
Percent, daily
100 IMPLIED PROBABILITIES OF ALTERNATIVE TARGET
FEDERAL FUNDS RATES, JANUARY MEETING OUTCOME f
90
10/18: CPI
80
80
1996
9/25: Existing home sales
70
5.25%
60
60
50
50
11/1: Pending home
sales, ISM mfg,
construction spending
9/25: Existing home sales
5.00%
40
40
30
30
5.00%
20
20
5.50%
5.50%
10
10
0
9/22
0
10/01
10/10
10/19
2006
10/28
11/06
11/15
9/22
10/01
10/10
10/19
2006
10/28
11/06
11/15
FRB Cleveland • December 2006
a. Weekly average of daily figures.
b. Daily observations.
c. Defined as the effective federal funds rate deflated by the core PCE.
d. Shaded bars represent periods of recession.
e. Probabilities are calculated using trading-day closing prices from options on December 2006 federal funds futures that trade on the Chicago Board of Trade.
f. Probabilities are calculated using trading-day closing prices from options on January 2007 federal funds futures that trade on the Chicago Board of Trade.
SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; Federal Reserve Board, “Selected Interest Rates,” Federal Reserve Statistical
Releases, H.15; the Chicago Board of Trade; and Institute for Supply Management.
At its October 25 meeting, the Federal Open Market Committee left the
target federal funds rate unchanged
at 5.25% for the third consecutive
time. Likewise, the Board of Governors left the primary credit rate
at 6.25%. The press release that followed the Committee’s meeting
stated, “Going forward, the economy
seems likely to expand at a moderate
pace,” but added, “Nonetheless, the
Committee judges that some inflation risks remain.” The next meeting
is scheduled for December 12.
The real federal funds rate—
defined as the effective federal funds
rate less core inflation in personal
consumption expenditures (PCE)—
has shown signs of leveling off and
now stands at 2.76%. Holding the
effective funds rate constant since
the last meeting, the real funds rate
has gained 6 basis points because
core PCE inflation has slowed slightly.
Participants in the federal funds futures and options market believe that
a continued pause is almost assured.
As of November 20, the implied probability of the federal funds target rate
remaining at 5.25% stood at 95% for
December. The probability that this
will carry over to the January meeting
was down only 10%, to 85%. It is can
be very hard to gauge the impact of
data releases: The September release
on existing home sales came in 1.1%
below consensus expectations, with
the median price down 2.2% on a
year-over-year basis. Market participants may have perceived this as
increasing the likelihood of a “hard
landing” in the housing market,
(continued on next page)
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Monetary Policy (cont.)
Annualized percent change
18 RIKSBANK (SWEDEN): CPI-BASED INFLATION TARGETING
Year-to-year percent change
22 RESERVE BANK OF NEW ZEALAND:
20 CPI-BASED INFLATION TARGETING
16
18
14
1/1/1989: Targeting enacted
16
1/1/1993: Inflation target of 2% enacted
12
14
10
12
8
10
8
6
Target range:
0%–3%
6
4
Target range:
1%–3%
2
Target range: 0%–2%
2
Target range:1%–3%
4
0
0
–2
–2
1976 1979
1982
1985
1988
1991
1994
1997
2000
2003
1980
2006
Year-to-year percent change
14 RESERVE BANK OF AUSTRALIA:
CPI-BASED INFLATION TARGETING
1983
1986
1989
1992
1995
1998
2001
2004
Annualized percent change
10
BANK OF ENGLAND: INFLATION TARGETING
9
12
6/30/1993: Inflation target
range between 2% and 3%
10
10/2003: Switched to CPI target
8
8/1992: Implemented RPIX target
7
8
6
RPIX a
5
6
CPI
Target range: 1.5%–3.5%
4
4
Target
range:
1%–3%
3
2
Target range:1%–4%
2
Target range: 2%–3%
0
1
–2
1980
0
1983
1986
1989
1992
1995
1998
2001
2004
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
FRB Cleveland • December 2006
a. RPIX is the Retail Price Index excluding mortgage interest payments.
SOURCES: Reserve Bank of New Zealand; Riksbank, Statistics Sweden; Reserve Bank of Australia; and Bank of England, Statistics England.
thereby increasing the implied likelihood of a future cut in the fed funds
target. However, that perception was
short lived, and probabilities started
to rebound the very next day.
When evaluating current U.S.
monetary policy, it is useful to look at
how other countries’ central banks
are working to enhance credibility in
an effort to keep inflation low. Many
countries use inflation targeting as a
means of gaining credibility. In 1989,
the Reserve Bank of New Zealand
became the first central bank to
adopt a formal inflation target and
was quickly followed by Canada, England, Sweden, Australia, and others.
Countries have employed a variety
of methods for promoting price stability. Some countries favor an explicit
target versus a target range when trying to achieve stable prices. Sweden
and England, for example, use an explicit target (currently 2%), whereas
New Zealand and Australia prefer to
target a range of inflation (currently
1%–3% and 2%–3%, respectively).
Even with an explicit target, the Bank
of England will act only if it misses
the target by more than 1 percentage
point on either side; in that case, “the
Governor of the Bank of England
must write an open letter to the
Chancellor explaining the reasons
why inflation has increased or fallen
to such an extent and what the Bank
proposes to do to ensure inflation
comes back to the target.”
How important are these countries’
formal targets for lowering inflation
and keeping it low? Each of them had
substantial disinflation even before
they began inflation targeting; afterward, targeting may have enhanced
their ability to keep inflation low.
Although a country can theoretically
change its inflation target every year,
in practice targets change very little.
For example, New Zealand has
changed its target only three times
since 1989, from a low of 0%–2% to
the current high of 1%–3%.
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Money and Financial Markets
Percent
20
Percent change, seasonally adjusted annual rate
20 FEDERAL FUNDS RATE AND GDP GROWTH a
15
15
Effective federal funds rate
10
10
5
5
0
0
Real GDP growth
–5
–5
–10
–10
–15
–15
1954
1958
1962
1966
1970
1974
1978
Percent deviation from trend
0.2 RESPONSE OF OUTPUT TO A
FEDERAL FUNDS RATE INCREASE
1982
1990
1994
1998
2002
2006
Percent
0.2 RESPONSE OF INFLATION (APR) TO A
FEDERAL FUNDS RATE INCREASE
0
0.1
–0.2
0
–0.4
–0.1
Funds rate increase
Funds rate increase
–0.6
0
1986
–0.2
5
10
Quarters
15
20
0
5
10
Quarters
15
20
FRB Cleveland • December 2006
a. Quarterly data.
SOURCES: Federal Reserve Board; U.S. Department of Commerce, Bureau of Economic Analysis; and Lawrence J. Christiano, Martin Eichenbaum, and
Charles L. Evans, “Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy,” Journal of Political Economy 1 (2005): 6-7.
We know that correlation does not
necessarily imply causation. Nonetheless, the association between recessions and hikes in the federal funds
rate suggests that increasing the
funds rate can indeed cause recessions. But the sheer variety of shocks
buffeting the economy implies that
the correlation between the funds
rate and output growth is quite small.
Econometricians are left with the
difficult task of isolating the effect of a
funds rate increase on variables such
as output and inflation.
Vector autoregressions (VARs) try
to disentangle these factors and show
the impact of an exogenous funds rate
increase on output and inflation. The
ability to disentangle the various
shocks that affect these variables requires the assumption that output
and inflation do not respond instantaneously to an interest rate shock.
VAR evidence suggests that an increase in the interest rate temporarily
lowers output and reduces inflation.
However, the impact on these two
variables is not symmetric; increases
in interest rates affect output much
sooner than they do prices. Inflation
does not respond significantly until a
year after an interest rate increase,
and there may be a lag of 10 quarters
before the peak response occurs.
Output reaches its trough roughly
five quarters after the rate increase.
The lags between interest rate
increases and output (and, eventually, rate increases and inflation)
make it difficult for the Federal Open
Market Committee (FOMC) to determine when tighter monetary policy is
tight enough. The wording of the
FOMC’s recent statements suggests
(continued on next page)
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Money and Financial Markets (cont.)
Percent
8 EVOLUTION OF OUTPUT AND INFLATION
Percent
8 EVOLUTION OF OUTPUT AND INFLATION
WITH A RATE INCREASE
7
7
11/18/06
6
11/18/06
6
Interest rates tightening
Interest rates baseline
5
5
4
4
3
3
2
2
Inflation baseline
Inflation tightening
1
1
0
0
Output growth tightening
Output growth baseline
–1
2004
–1
2005
2006
2007
2008
2009
2010
2004
2005
2006
2007
2008
2009
2010
Percent
8 EVOLUTION OF OUTPUT
Percent
3.5 EVOLUTION OF INFLATION
7
3.0
11/18/06
6
2.5
Output growth tightening
5
2.0
4
Inflation baseline
3
1.5
2
1.0
11/18/06
1
Inflation tightening
Output growth baseline
0.5
0
0
2004
2005
2006
2007
2008
2009
2010
–1
2004
2005
2006
2007
2008
2009
2010
FRB Cleveland • December 2006
NOTE: All charts assume there are only monetary shocks.
SOURCES: Author’s calculations; and Lawrence J. Christiano, Martin Eichenbaum, and Charles L. Evans, “Nominal Rigidities and the Dynamic Effects of a
Shock to Monetary Policy,” Journal of Political Economy 1 (2005): 6-7.
that the recent string of interest rate
increases—from a low of 1% to the
current 5.25% level—is adversely affecting GDP: “Economic growth has
moderated…partly reflecting…the
lagged effects of increases in interest
rates.” Similarly, the FOMC has reaffirmed its belief that, even without
any more policy moves, inflation will
eventually moderate: “Readings on
core inflation have been elevated in
recent months…However, inflation
pressures seem likely to moderate
over time, reflecting…the cumulative
effects of monetary policy actions.”
How much have the cumulative
effects of past monetary policy tightening curtailed output growth? What
about inflation? Should we expect a
significant moderation in inflation
without further rate hikes? We answer this question, given the VAR evidence above, by assuming that the
only shocks to hit the economy over
the past 30 months are monetary. We
also assume that the funds rate
remains at 5.25% for four quarters
before slowly declining to its longrun average of 4%.
This experiment suggests that
even without any additional policy
firming, output growth should be
near its trough, while inflation should
be near its peak. Going forward, output growth should pick up and
inflation should moderate, in accord
with the FOMC’s recent statements.
If the funds rate had increased
another 25 basis points in August, inflation would have moderated even
further. But because of the long lags
between rate increases and inflation,
the latter will not moderate significantly until it drops below 1.5%, its
assumed long-run average.
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The Currency Composition of International Reserves
Trillions of dollars
5.0 TOTAL FOREIGN EXCHANGE HOLDINGS a
Trillions of dollars
5.0 CURRENCY COMPOSITION OF RESERVE HOLDINGS a
4.5
4.5
4.0
Industrialized countries
3.5
3.5
3.0
3.0
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Trillions of dollars
2.0 DEVELOPING COUNTRIES' RESERVE HOLDINGS a,b
Billions of dollars
1,000 FOREIGN EXCHANGE RESERVES
900
1.8
1.4
Known
0
0
1.6
Unknown
4.0
Developing countries
U.S. dollars
U.K. pounds
Euros
Japanese yen
800
Japan
700
Other
1.2
600
1.0
500
0.8
400
0.6
300
0.4
200
0.2
100
0
0
China
Russia
Korea
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
India
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
FRB Cleveland • December 2006
a. Preliminary estimate, 2006:IIQ.
b. Includes only those holdings whose currency composition is known.
SOURCE: International Monetary Fund.
The U.S. dollar is the world’s key
international reserve currency. Many
countries—particularly developing
and oil-exporting nations—have
amassed huge foreign-exchange
portfolios. Some, notably China and
Japan, have done so through efforts
to prevent their currencies from
appreciating against the dollar. Others, adversely affected by global
currency crises in 1997–98, have
built buffers against banking turmoil
and rapid financial outflows. Reflecting the comparative advantage of
the U.S. in providing broad, liquid,
transparent financial markets, the
lion’s share of these reserves is in
dollar-denominated assets.
However, some commentators fear
that the era of the dollar may be coming to a close. Current global imbalances, they contend, suggest that the
dollar must depreciate quite substantially, and the prospect of capital
losses creates a strong incentive to
diversify out of dollars.
No country publicizes the currency
compositions of its own reserves, but
many allow the International Monetary Fund (IMF) to aggregate the data.
The IMF knows or can allocate the currency composition of only two-thirds
of total foreign currency reserves, and
that proportion has been shrinking.
All of the action is in developing
countries, which began trimming
their dollar shares in 1997 and accelerated the pace after 2001. In that year,
U.S. dollars made up 70% of the
reserves whose currency composition
is known; by 2002:IIQ, their share was
down to 60%. Developing countries
seem to be shifting into euros (up
9 percentage points to 30% of the
total) and British pounds (up 2 percentage points to 5%).
9
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Latin America’s Economic Prospects
Real GDP Growth
Inflation
Percent
Average, Average,
1988–97 1988–2005 2006a
Percent
Average, Average,
1988–97 1988–2005 2006a
a
2007
2007a
Western Hemisphere
2.9
2.4
4.8
4.2
Western Hemisphere
162.8
7.9
5.6
5.2
Argentina
3.2
1.4
8.0
6.0
Argentina
159.4
6.4
12.3
11.4
Bolivia
4.1
2.9
4.1
3.9
Bolivia
12.5
3.8
4.1
4.0
Brazil
2.0
2.0
3.6
4.0
Brazil
576.3
7.3
4.5
4.1
Chile
7.9
3.3
5.2
5.5
Chile
13.9
3.2
3.5
3.1
Colombia
4.0
2.1
4.8
4.0
Colombia
24.5
8.9
4.7
4.2
Ecuador
3.7
3.0
4.4
3.2
Ecuador
42.7
30.9
3.2
3.0
Paraguay
3.7
1.2
3.5
4.0
Paraguay
19.3
8.8
8.9
4.9
Peru
0.6
3.0
6.0
5.0
Peru
267.1
3.1
2.4
2.5
Uruguay
3.3
0.8
4.6
4.2
Uruguay
59.0
9.1
5.9
4.3
Venezuela
2.6
1.5
7.5
3.7
Venezuela
51.4
22.4
12.1
15.4
Average percent change in GDP
3.0 FISCAL SITUATION
GROSS PUBLIC DEBT
2002
2005
2.5
2.0
Primary balance
Revenue
Non-interest expenditure
Argentina
Brazil
1.5
Bolivia
Uruguay
1.0
Colombia
0.5
Ecuador
0
Peru
–0.5
Venezuela
–1.0
Chile
–1.5
1990–92
1995–97
2002–04
2004–06
0
50
100
Percent of GDP
150
200
FRB Cleveland • December 2006
a. International Monetary Fund projections.
SOURCES: International Monetary Fund, World Economic and Financial Surveys, Western Hemisphere, November 2006, and World Economic Outlook,
September 2006.
The economic outlook for developing
countries in the Western Hemisphere
is one of the brightest in decades.
According to the International Monetary Fund, the region is likely to post
real economic growth of around
4.8% this year and 4.2% in 2007, with a
regional inflation rate moderating to
about 5% in 2007. That said, public
debt remains relatively high, and fiscal
spending has recently accelerated
despite the stepped-up pace of economic activity.
Latin American countries owe
much of their improved growth to a
strong demand for fuel and nonfuel
commodities. Colombia, Ecuador, and
Venezuela, for example, benefited
from the sharp rise in oil prices, while
Chile and Peru benefited from a jump
in metals prices. In consequence,
private domestic consumption and
investment are poised to propel Latin
America’s economic activity next year.
Even with higher commodity
prices, most countries in the region
have made big strides in lowering their
inflation rates. Many of them, notably
Brazil, Chile, Colombia, and Peru, have
implemented formal inflation targeting regimes and have allowed their
exchange rates greater flexibility.
Notable outliers in the inflation fight
are Argentina and Venezuela, where
inflation continues to breach doubledigit levels.
Primary fiscal surpluses are shrinking. Although revenues—particularly
commodity-based revenues—keep
growing, government outlays, a high
proportion of which are mandated,
are rising rapidly. Stronger fiscal
positions, faster economic growth,
exchange rate appreciation, lower interest rates, and debt restructuring
have all contributed to a healthy drop
in many countries’ public debt ratios.
10
•
•
•
•
•
•
•
Economic Activity
Percentage points
2.5 CONTRIBUTION TO PERCENT CHANGE IN REAL GDP c
a,b
Real GDP and Components, 2006:IIIQ
(Preliminary estimate)
Annualized
percent change
Current
Four
quarter
quarters
Change,
billions
of 2000 $
Real GDP
62.4
Personal consumption 57.0
Durables
17.3
Nondurables
6.6
Services
35.3
Business fixed
investment
31.3
Equipment
18.4
Structures
10.7
Residential investment –29.1
Government spending 10.9
National defense
–1.3
Net exports
–5.2
Exports
19.8
Imports
25.0
Change in business
inventories
4.3
2.2
2.9
5.9
1.1
3.1
3.0
2.7
2.7
3.1
2.6
10.0
7.3
16.7
–18.0
2.2
–1.1
__
6.3
5.3
8.3
5.9
14.4
–7.9
1.7
–1.2
__
9.0
7.2
__
__
Last four quarters
2006:IIQ
2006:IIIQ
2.0
Personal
consumption
1.5
Exports
1.0
Government
spending
0.5
Residential
investment
0
Change in
inventories
Business fixed
investment
–0.5
–1.0
Imports
–1.5
Percent of GDP
14 FIXED INVESTMENT
Annualized quarterly percent change
6 REAL GDP AND BLUE CHIP FORECAST c,d
13
Final estimate
Advance estimate
Preliminary estimate
Blue Chip forecast
5
12
Nonresidential
11
4
30-year average
10
9
3
8
2
7
Residential
6
1
5
0
IIIQ
IVQ
2005
IQ
IIQ
IIIQ
IVQ
2006
IQ
IIQ
2007
IIIQ
4
1996 1997 1998 1999 2000
2001 2002 2003 2004 2005 2006
FRB Cleveland • December 2006
a. Chain-weighted data in billions of 2000 dollars.
b. Components of real GDP need not sum to the total because the total and all components are deflated using independent chain-weighted price indexes.
c. Data are seasonally adjusted and annualized.
d. Blue Chip panel of economists.
SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; U.S. Department of Energy, Energy Information Administration; and Blue Chip
Economic Indicators, November 10, 2006.
Real GDP increased at an annual rate
of 2.2% in 2006:IIIQ, according to the
Commerce Department’s preliminary estimate. This upward revision
of 0.6% was largely unanticipated, the
consensus growth estimate having
been 1.8%. The largest revision was
to inventories: They were estimated
to have increased $4.3 billion from
2006:IIQ, compared with the advance estimate, which showed a $3.0
billion decrease. There was also a
substantial revision to net exports
(up $10 billion); this was largely the
result of the change in imports, where
the increase was revised from 7.8%
to 5.6%.
Despite the upward revision, real
GDP growth continues its slowdown
from the beginning of the year
and is nearly a full percentage point
below the 30-year average of 3.17%.
Contributions to the percent change
in real GDP reveal that personal consumption, business fixed investment,
imports (less negative), and government spending have outpaced their
four-quarter averages; on the other
hand, residential investment, change
in inventories, and exports are all less
than their four-quarter averages.
In their October 10 report, the Blue
Chip panel of economists forecasted
that annualized real GDP growth for
2006:IIIQ would be 2.3%. Although
they were off by 0.7% according to the
advance estimate, the preliminary
estimate finds them off by only 0.1%.
The panel forecasts an upward trend
in each of the next three quarters
(2.3%, 2.6%, and 2.7%).
(continued on next page)
11
•
•
•
•
•
•
•
Economic Activity (cont.)
Index: 2002 = 100
120 INDUSTRIAL PRODUCTION a
Percent
1.50 RATIO OF INVENTORY TO SALES a
115
Manufacturing: Durable goods
Total
1.40
110
Retail trade
Manufacturing
105
1.30
100
Manufacturing: Nondurable goods
95
1.20
Mining
Utilities
90
85
1.10
1/04
7/04
1/05
7/05
1/06
1999
7/06
Percent of capacity
100 CAPACITY UTILIZATION a
2000
2001
2002
2003
2004
2005
2006
Year to year percent change
6 PRODUCTIVITY AND COMPENSATION a,b
5
95
Output per hour
Utilities
Mining
4
90
3
85
2
80
1
Total
Manufacturing
75
Real compensation per hour
0
70
1999
2000
2001
2002
2003
2004
2005
2006
–1
1996
1998
2000
2002
2004
2006
FRB Cleveland • December 2006
a. Seasonally adjusted
b. Data series is from the nonfarm business sector.
SOURCE: U.S. Department of Commerce, Bureau of the Census and Bureau of Economic Analysis; and the Federal Reserve Board.
Business fixed investment, though
nowhere near its late-2000 high, has
steadily increased since 2004:IIIQ
and is now 10.6% of GDP. In contrast,
investment in residential structures
has been trending down since 2005
and stands at 5.6% of GDP. Although
the recent housing market downturn
has received considerable attention,
residential investment still accounts
for a relatively high share of GDP.
Another gauge of the general business climate is the inventory-to-sales
ratio. Nondurable goods inventories
have been slowly creeping up since
2005. However, the inventory ratios
for both durable goods and retail
trade have been relatively flat.
Reflecting the economy’s overall
slowdown, industrial production fell
slightly from a high of 114.0 in August
to 113.7 in October. Because its
volatility is largely determined by the
weather, the utilities industry’s performance must be viewed over a
longer period; it appears to have
leveled off in the last couple of years.
Mining has recovered completely
from the severe drop in oil and gas
extraction caused by Hurricanes Rita
and Katrina. Capacity utilization rates
have eased slightly overall and for
manufacturing; mining’s utilization
rate, in contrast, is the highest since
May 2001.
Worker productivity and compensation affect the economic climate as
well. Real compensation was up more
than 3% at an annual rate in the
second and third quarters, far outstripping productivity gains. Were this
situation to continue, it could lead to
higher inflation if firms tried to raise
prices in an attempt to recoup their
costs. At this point, considering that
real compensation has trailed productivity gains for most of the last five
years, the more likely interpretation is
that compensation is merely catching
up with past productivity gains.
12
•
•
•
•
•
•
•
Labor Markets
Change, thousands of workers
450 AVERAGE MONTHLY NONFARM EMPLOYMENT CHANGE
Labor Market Conditions
400
Average monthly change
(thousands of employees, NAICS)
Revised
Preliminary estimate
350
300
Payroll employment
250
Goods producing
Construction
Manufacturing
Durable goods
Nondurable goods
200
150
Service providing
Retail trade
Financial activitiesa
PBSb
Temporary help svcs.
Education & health svcs.
Leisure & hospitality
Government
100
50
0
–50
2003
9
2004
175
2005
165
Jan.–
Oct.
2006
151
Nov.
2006
132
–42
10
–51
–32
–19
28
26
0
9
–9
22
25
–6
1
–7
8
7
–4
2
–6
–40
–29
–15
–13
–2
51
–4
7
23
12
30
19
–4
147
17
8
40
13
33
26
13
143
13
12
41
14
31
21
14
144
–9
14
32
–4
38
28
23
172
20
11
43
5
41
31
28
Average for period (percent)
–100
Civilian unemployment
rate
–150
2002 2003 2004 2005
IVQ
2005
IQ
6.0
5.5
5.1
4.7
4.5
IIQ
IIIQ Sept. Oct. Nov.
2006
2006
Percent
65.0 LABOR MARKET INDICATORS
Percent
6.5
Percent
12 UNIT LABOR COSTS
Preliminary estimate
Revised
10
Employment-to-population ratio
64.5
6.0
64.0
5.5
63.5
5.0
8
6
4
2
0
63.0
4.5
–2
–4
62.5
4.0
–6
Civilian unemployment rate
–8
3.5
62.0
1995
1997
1999
2001
2003
2005
–10
2005:IVQ 2006:IQ 2006:IIQ 2006:IIIQ 2005:IVQ 2006:IQ 2006:IIQ 2006:IIIQ
Nonfarm businesses
Manufacturing
FRB Cleveland • December 2006
a. Financial activities include the finance, insurance, and real estate sector and the rental and leasing sector.
b. Professional and business services include professional, scientific, and technical services; management of companies and enterprises; administrative and
support; and waste management and remediation services.
SOURCE: U.S. Department of Labor, Bureau of Labor Statistics.
Nonfarm payrolls grew by 132,000 in
November. This moderate increase
was accompanied by the Labor Department’s net upward revision of
84,000 jobs for the previous two
months. November’s increase was
above expectations but slightly below
the three-month average of 138,000.
Service-providing industries added
the most jobs (172,000), led by professional and business services (43,000).
Educational and health services
(41,000) and leisure and hospitality
(31,000) were also buoyant. Goodsproducing industry payrolls continued to sink, losing 40,000 jobs in
November. Weakness in the homebuilding and remodeling sectors
drained jobs from the construction
industry (–29,000). Manufacturing
was also weak; its 15,000 payroll
reduction occurred mainly in the
durables sector (–13,000).
The civilian unemployment rate
edged up from 4.4% in October to
4.5% in November, which is still
below the first nine months of the
year, when the rate ranged from 4.6%
to 4.8%. The labor force participation
rate was largely unchanged at 66.3%
and the employment-to-population
ratio held at 63.3%.
Unit labor costs hinted at inflationary pressure in the labor market early
in the year, but the recent dramatic
revisions do not. Nonfarm business
costs fell a net 9.3% in the last two
quarters, with the most severe adjustment (from 5.4% to –2.4%) in
2006:IIQ. Manufacturing costs fell a
net 10.7% in the last two quarters,
most dramatically (from 1.2% to
–8.3%) in 2006:IIQ. The revised data
suggest that the labor market will
exert less pressure on inflation than
previously was thought.
13
•
•
•
•
•
•
•
Labor Costs
Four-quarter percent change
16 UNIT LABOR COSTS AND CORE CPI
Four-quarter percent change
6 MEASURES OF EMPLOYEE COMPENSATION
14
5
Employment Cost Index
Average hourly earnings
12
4
10
3
CPI excluding food and energy
8
6
2
4
1
Unit labor costs
2
0
Unit labor costs
0
–1
–2
–4
–2
1992
1994
1996
1998
2000
2002
2004
1966
2006
1971
1976
1981
1986
1991
1996
Four-quarter percent change
12 AVERAGE HOURLY EARNINGS, ECI,
UNIT LABOR COSTS, AND CORE CPI
Percent
80 EMPLOYEE COMPENSATION AND CORPORATE
PROFITS AS SHARES OF NATIONAL INCOME a
10
70
CPI excluding food and energy
8
2001
2006
Employee compensation
60
Employment Cost Index
6
50
Average hourly earnings
4
40
2
30
0
20
Corporate profits
Unit labor costs
10
–2
–4
1983
1988
1993
1998
2003
0
1992
1994
1996
1998
2000
2002
2004
2006
FRB Cleveland • December 2006
NOTE: Data are seasonally adjusted.
a. Corporate profits, adjusted for inventory valuation (IVA) and capital consumption (CCA).
SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; and U.S. Department of Commerce, Bureau of Economic Analysis.
Unit labor costs, relatively stagnant
since 2002, are showing signs of an
upward trend. Since the beginning
of this year alone, unit labor costs,
a productivity-adjusted measure of
compensation, have risen nearly 2%,
the highest growth rate since 2001.
Other measures of compensation
include average hourly earnings and
the Employment Cost Index. The percent change in average hourly earnings decreased from 4.1% to 1.8% between 2000 and 2004; it has since
rebounded and now hovers around
4%. Meanwhile, the ECI, which takes
into account not only wages and
salaries but also benefits costs, fell less
than either unit labor costs or average
hourly earnings; however, it has not
rebounded like the other two series.
Its annualized growth rate is 3.3%,
down from to 4.4% in 2000.
Some economists argue that rising
labor costs can increase inflation over
the long run. This theory seemed to
be substantiated in the 1970s, when
the core Consumer Price Index was
highly correlated with unit labor costs.
This correlation, however, has broken
down over the last two decades, and
unit labor costs are no longer a good
predictor of inflation. In fact, neither
average hourly earnings nor the
Employment Cost Index is strongly
correlated with the core Consumer
Price Index.
Employee compensation as a share
of national income has remained relatively flat, but corporate profits have
been trending upward since 2002.
How will firms react if wages continue
to rise? Should higher wages cause inflation concerns? Although current
data do not answer these questions,
they do show that labor costs are poor
inflation predictors.
14
•
•
•
•
•
•
•
Fourth District Employment
Percent
8.5 UNEMPLOYMENT RATES a
UNEMPLOYMENT RATES, OCTOBER 2006 b
8.0
U.S. average = 4.4%
7.5
7.0
6.5
6.0
U.S.
5.5
Lower than U.S. average
5.0
About the same as U.S. average
(4.3% to 4.5%)
4.5
Higher than U.S. average
Fourth District b
More than double U.S. average
4.0
3.5
1990
1993
1996
1999
2002
2005
Payroll Employment by Metropolitan Statistical Area
12-month percent change, October 2006
Cleveland Columbus Cincinnati Dayton
Total nonfarm
Goods-producing
Manufacturing
Natural resources, mining,
and construction
Service-providing
Trade, transportation, and utilities
Information
Financial activities
Professional and business
services
Education and health services
Leisure and hospitality
Other services
Government
October unemployment rate (percent)
Toledo Pittsburgh Lexington
U.S.
–0.1
–0.3
0.3
0.5
0.2
–0.1
0.9
–0.2
–0.8
–0.3
–0.1
–1.6
0.5
1.3
1.6
0.5
–1.2
–2.9
1.0
–0.2
–1.7
1.4
0.7
–0.2
–2.2
0.0
–0.9
0.5
–0.4
0.9
0.5
–0.1
0.5
–1.2
1.1
1.1
0.0
–0.6
0.5
5.1
–0.3
–3.6
–0.9
–1.1
0.6
0.3
–0.2
0.0
3.7
1.6
0.8
–0.7
–4.5
0.3
3.8
1.3
1.5
–2.2
–0.9
2.1
1.6
0.4
0.0
1.9
0.1
2.0
0.2
–0.5
–1.5
0.9
2.8
0.6
1.6
–0.1
2.6
2.5
2.2
1.4
–0.5
1.9
0.0
0.8
1.8
0.2
–2.3
1.8
2.7
–2.0
–0.4
1.0
1.8
2.5
–0.3
1.5
1.3
0.0
2.7
–1.0
2.8
2.7
2.4
2.6
1.0
1.1
4.9
4.5
4.7
5.6
5.7
4.3
4.0
4.4
FRB Cleveland • December 2006
a. Shaded bars represent recessions.
b. Seasonally adjusted using the Census Bureau’s X-11 procedure.
SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; Kentucky Office of Employment and Training, Workforce Kentucky; Ohio Department of Job
and Family Services, Bureau of Labor Market Information; Pennsylvania Department of Labor and Industry, Center for Workforce Information and Analysis; and
West Virginia Bureau of Employment Programs, Workforce West Virginia.
The Fourth District’s unemployment
rate was 5.0% in October, down
0.3 percentage point (pp) from the
previous month and 0.7 pp from the
previous year. From September to
October, employment increased 0.3%,
unemployment decreased 3.6%, and
the labor force increased 1.8%. By
comparison, the U.S. unemployment
rate was 4.4% in October, down 0.2 pp
from the previous month.
Among the District’s counties, 137
out of 169 had unemployment rates
higher than the national average in
October; seven of them were more
than double the U.S. rate. However,
there has been recent improvement:
Rates in 122 counties dropped over
the month, and rates in almost all
counties (163) fell during the previous
two months. Similarly, unemployment
rates declined over the month in most
of the District’s major metropolitan
areas. Pittsburgh’s rate fell below the
national average, joining Lexington.
Several other metro areas came close
to the U.S. average.
Over the past year, the nation has
increased employment by 1.4%; however, none of the District’s metro
areas have kept up, partly because
they have trailed U.S. growth in
both goods-producing and serviceproviding industries. In fact, although
the nation increased goods-producing
employment 0.7% over the year,
Cleveland, Cincinnati, Dayton, Pittsburgh, and Lexington all lost jobs in
that sector. The leisure and hospitality
industry, however, experienced positive growth in all of the District’s
metro areas, and, in several of them,
outpaced U.S. growth.
15
•
•
•
•
•
•
•
The Youngstown Metropolitan Statistical Area
LOCATION QUOTIENTS, 2005, YOUNGSTOWN MSA/U.S. a
Percent
30 SHARE OF EMPLOYMENT IN MANUFACTURING
Natural resources, mining, and construction
Manufacturing
25
Trade, transportation, and utilities
Information
Youngstown MSA
Financial activities
20
Professional and business services
Education and health services
U.S.
Leisure and hospitality
15
Other services
Government
0
0.5
1.0
1.5
10
1990
Index, March 2001 = 100
110 PAYROLL EMPLOYMENT SINCE MARCH 2001 b
1992
1994
1996
1998
2000
2002
PAYROLL EMPLOYMENT GROWTH
Youngstown MSA
U.S.
Total nonfarm
105
2004
Goods-producing
Non-manufacturing, U.S.
Manufacturing
100
Natural resources,
mining, and construction
Non-manufacturing, Youngstown MSA
Service-providing
95
Trade, transportation, and utilities
Information
90
Financial activities
Manufacturing, U.S.
Professional and business services
85
Education and
health services
Leisure and hospitality
80
Other services
Manufacturing, Youngstown MSA
Government
75
2001
2002
2003
2004
2005
2006
–6
–3
0
3
12-month percent change, October 2006
6
FRB Cleveland • December 2006
NOTE: The Youngstown-Warren-Boardman, OH-PA Metropolitan Statistical Area consists of Trumbull and Mahoning counties in Ohio and Mercer County
in Pennsylvania.
a. The location quotient is the simple ratio between two locations of a given industry’s employment share.
b. Seasonally adjusted.
SOURCE: U.S. Department of Labor, Bureau of Labor Statistics.
The Youngstown metropolitan statistical area, home to more than half
a million people, comprises three
counties in Northern Ohio and Pennsylvania. Youngstown is traditionally
thought of as an area heavily invested
in manufacturing. Indeed, more than
40,000 people—or 16.7% of total
employment—work in that sector,
compared to 10.7% for the U.S.
Conversely, several industries, such
as information and financial activities,
have much smaller employment
shares than the nation.
Although manufacturing’s share of
total employment is higher in the
metro area than in the U.S., the area’s
reliance on the sector has decreased
significantly. In 1990, 25.0% of the
metro area’s total employment was
concentrated in manufacturing, but
by 2005, that percentage had fallen
to 16.7%. This drop changed manufacturing from Youngstown’s largest
industry in 1990 to its third largest in
2005, behind the trade, transportation, and utilities industry (21.0% of
total employment) and the education
and health services industry (17.5%).
Since the last business cycle peak
in March 2001, Youngstown’s manufacturing sector has shed 21.5% of its
jobs, compared with the U.S. decline
of 16.3%. Growth in non-manufacturing employment also trailed the
nation’s.
The area’s manufacturing employment remained fairly stable in 2005
(continued on next page)
16
•
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•
•
•
•
The Youngstown Metropolitan Statistical Area (cont.)
Percent
13 UNEMPLOYMENT RATES a,b
Selected Demographics, 2005
Youngstown MSA
Ohio
U.S.
0.6
11.2
288.4
White
88.3
85.7
76.3
Black
11.2
12.3
12.8
Other
0.6
2.0
10.9
0 to 19
25.3
27.0
27.8
20 to 34
17.0
19.3
20.1
35 to 64
41.4
40.8
40.0
65 or older
16.4
12.8
12.1
Total population
(millions)
11
Percent by race
Youngstown MSA
9
Percent by age
7
Ohio
5
U.S.
3
1990
1992
1994
1996
1998
2000
2002
2004
Percent with bachelor’s
degree or higher
17.3
23.3
27.2
Median age
41.4
37.6
36.4
2006
Thousands of dollars
35 PER CAPITA PERSONAL INCOME
Year-over-year percent change
2 POPULATION GROWTH
U.S.
30
U.S.
1
Ohio
U.S. metropolitan areas
25
0
20
Youngstown MSA
Youngstown MSA
–1
15
10
–2
1980
1985
1990
1995
2000
2005
1980
1985
1990
1995
2000
2005
FRB Cleveland • December 2006
NOTE: The Youngstown-Warren-Boardman, OH-PA Metropolitan Statistical Area consists of Trumbull and Mahoning counties in Ohio and Mercer County in
Pennsylvania.
a. Shaded bars indicate recession.
b. Seasonally adjusted.
SOURCES: U.S. Department of Commerce, Bureau of the Census and Bureau of Economic Analysis; and U.S. Department of Labor, Bureau of Labor Statistics.
but has fallen more recently. Over the
last year, Youngstown has shed 4.6%
of its jobs in that sector. Information
and the professional and business
services industries, however, create a
bright spot: Employment in information increased 3.1% over the year,
compared to almost no change for the
nation, and employment in professional and business services increased
5.7%, compared to a 2.7% gain for the
nation.
Another labor market measure—
the unemployment rate—shows that
Youngstown’s employment performance has been weaker than both
the state’s and the nation’s. However,
the area’s unemployment rate has
recently closed in on Ohio’s, trailing
it by 0.8 pp in October.
Besides a heavy dependence on
manufacturing, relatively low education levels may also be responsible
for Youngstown’s slower economic
performance. In 2005, 17.3% of the
area’s residents aged 25 and older
held a bachelor’s degree, compared
to 23.3% for the state and 27.2% for
the nation. Youngstown’s lower education levels are probably a factor in
its below-average per capita income.
Youngstown’s population growth
has trailed the nation’s by an average
of 1.5% since 1980; and 2004 was the
first year the metro area increased its
population since 1993.
17
•
•
•
•
•
•
•
Credit Unions
Thousands
12
Billions of U.S. dollars
750 STRUCTURE a
Millions
90 MEMBERSHIP a
85
Number of institutions
650
11
80
Assets
550
10
75
70
450
9
350
8
250
7
65
60
55
50
45
150
6
40
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Percent
32 LOANS a
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Billions of U.S. dollars
500
450
28
Percent
27 SHARES a
Billions of U.S. dollars
650
600
24
Shares
Loans
24
400
20
350
16
300
21
550
18
500
15
450
12
Loan growth b
Shares growth b
400
250
12
9
350
6
300
250
8
200
4
150
3
100
0
0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
200
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
FRB Cleveland • December 2006
NOTE: Data are for federally insured credit unions.
a. All values for 2006 are through the second quarter.
b. Growth rate is for 12 months.
SOURCE: National Credit Union Administration, Quarterly Data, June 2006.
Credit unions are mutually organized depository institutions that
provide financial services to their
members. Like banks and savings
associations, the credit union industry continues to consolidate. The
number of credit unions fell steadily
from 11,392 in 1996 to 8,540 by
2006:IIQ. Over the same period,
however, their total assets more than
doubled from $326.9 billion to $697
billion. The number of credit union
members also increased steadily
from 69.2 million to 85.4 million.
Growth in credit unions’ assets
has been fueled by positive loan
growth, although growth in both
assets and loans has tapered off in recent years. From the end of 1996 to
the middle of 2006, loans increased
from $213.8 billion to $476.4 billion;
loans as a share of assets grew modestly from 65.4% to 68.4%. Year-overyear loan growth has varied between
5.8% and 11.3% over the past 10 years,
with an average annual growth rate
of 7.5%.
Federally insured credit union
shares have also risen steadily since
1996, totaling $594 billion in 2006.
Shares, which are analogous to
deposits in banks and savings associations, are the primary source of
credit unions’ funds, accounting for
roughly 85% of the total. The annual
shares growth in 2006 (3.6%) was the
lowest in 10 years, slowing dramatically from a 15.3% pace in 2001.
Shares grew at a 6.8% annual rate
during this period but, like loans, are
following a tapering trend.
Credit unions continued to accumulate capital, which more than
(continued on next page)
18
•
•
•
•
•
•
•
Credit Unions (cont.)
Percent
16 CAPITAL
Billions of U.S. dollars
80
15
75
14
70
Percent
12 EARNINGS
Percent
1.2
1.1
11
Capital
13
65
12
60
11
Capital growth
Return on assets
Return on equity
10
1.0
9
0.9
8
0.8
7
0.7
6
0.6
5
0.5
55
10
50
9
45
8
40
7
35
6
30
25
5
Percent
4.0 EXPENSES
0.4
4
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Percent
3.50
Percent
0.70 CREDIT UNION HEALTH
Percent
12.0
Delinquent loans to assets
3.45
0.65
3.40
0.60
11.0
3.35
0.55
10.5
2.0
3.30
0.50
10.0
1.5
3.25
0.45
9.5
1.0
3.20
0.40
9.0
0.5
3.15
0.35
8.5
3.10
0.30
3.5
Capital to assets
Cost of funds/assets
3.0
2.5
Operating
expenses/assets
0
11.5
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
8.0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
FRB Cleveland • December 2006
NOTE: Data are for federally insured credit unions.
a. All values for 2006 are through the second quarter.
b. Growth rate is for 12 months.
c. Return on assets is on average assets; return on equity is on average equity.
d. All ratios are for average total assets.
SOURCE: National Credit Union Administration, Quarterly Data, June 2006.
doubled from $35.3 billion at the end
of 1996 to $77.8 billion by 2006:IIQ.
Because retained earnings are credit
unions’ only source of capital, the
pace of capital accumulation mirrors
the general downward trend in return on assets (ROA) and return on
equity (ROE) since 1996. ROA fell
from a high of 1.1% in 1996 to a low of
0.85% in 2005, then reached a plateau
at 0.86% in 2006. ROE followed a similar pattern over the 10-year period,
evening out at 7.7%.
The decline in credit unions’ profitability over the second half of the
1990s resulted partly from the steady
increase in operating expenses per
dollar of assets and the relatively high
cost of funds. After constant improvement in operating efficiency between
2000 and 2004, operating expenses as
a percent of assets increased to 3.3%.
In the low-interest-rate environment
of 2000–2004, the cost of funds
declined; since then, it has risen in
response to higher interest rates.
Overall, the health of the credit
union industry appears sound. Capital
as a share of assets stood at 11.2% by
2006:IIQ. Delinquent loans as a share
of assets fell to a 10-year low, from
0.66% in 1996 to 0.40% in 2006. Moreover, credit unions held nearly $28.21
of capital for every $1 of delinquent
loans by the end of that period. In
short, credit unions remain a viable
alternative to commercial banks and
savings associations for such basic
depository institution services as
checking accounts, consumer loans,
and savings accounts.
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