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.... http://clevelandfed.org/research/trends February 1997 Best available copy 0 . . The Economy in Perspective The Big Chill...The Soviet Union was officially dissolved on December 26, 1991, one clay after the resignation of Rilikhail Gorbachev. The Cold War was over. Ever since, the countries that nlacle up the former U.S.S.R. have been struggling to govern themselves and to fincl their places in the world. The United States has reacted to these clevelopnlents on two levels. Military bases are closing and spending for national defense is shrinking. New relationships among the United States and the emerging nations are expanding, pronlising greater trade and employment opportunities. These are the more immediate, visible acljustments, but broacler forces are working beneath the surface. The manifest threat of nuclear attack by the Soviet Union brought a high degree of cohesion to U.S. foreign and clefense policies. The vacuum created by the collapse of the "evil empire" is prompting questions that are still largely unanswerecl. Do we have any enemies now, and what d o they want? What are our obligations to protect other nations, ancl how far should we go to fulfill them? By what means can we best achieve our objectives? How much will these efforts cost? In a dangerous world, how much risk should w e bear? There are choices to make, and each comes at a price. In 1979, the United States initiated a hot war against another seenlingly inlplacable foe-inflation. President Carter appointed Paul Volclter to heacl the Federal Reserve, giving hill1 a 11lalldate to eliminate double-digit inflation. This effort relied on a clernonstral~lytight tnonetary policy and the public's willingness to suffer casualties. Inflation hacl become so intolerable that having a numerical goal was unimportant; all that ~nattereclwas reducing it. With support from President Reagan, the Volcker Fed continued using heavy artillery to break inflation's back, reclucing the core rate fro~n11% to 5% by 1953. Uncles the leaclership of Alan Greenspan since 1987, the Fecleral Reserve continued its war against inflation, which it clescribecl as a campaign for price stability. Having reducecl inflation's imlminent threat to economic progress, the Federal Reserve coulcl more gradually squeeze it from the U.S. economy. Initially, the Greenspan Fed followecl a course of li~nitedaggression, 111arkedby an occasional preemptive strike and persistently combative rhetoric. This strategy finally paid off in 1991. As Boris Yeltsin faced clown the tanks in the Kremlin, the U.S. inflation trencl collapsed from 5% to 3%, the spoils of a seven-year siege. Backing its words with action, the Greenspan Fed cut inflation to levels not seen since Sputnik. Once again, howevel-, broader forces startecl working beneath the surface. With inflation lower than it hacl recently been, voices were heard pronouncing it dead. The econotny's pace faltered after the Gulf War, and national attention was focusecl on expansion and employment, not inflation. Whenever Fecleral Reserve to officials spoke about their corn~llit~nent achieving price stability, critics saicl the Fed was fighting the last war. The Soviet Union was imploding, ancl the public was tired of combat. In a sense, people know exactly what they want: peace at no price. But on a very practical level, our nation has no clearer idea about what it wants from the Federal Reserve than from the Pentagon or the State Ilepartn~ent. How does an honorable monetary authority achieve a responsible peace with inflation? A workable conlpromise requires that the public and its central bank understand one another's aspirations ancl limitations. After all, nations create indepenclent central banks to prevent the popular wish for easy money from running amok. An uncluly restrictive monetary policy will eventually lose popular support, but so will policies of appeasement. Although there is a ~ n p l e room for misunderstanding and mischief in the goal-setting process, an honozible monetary authority atte~nptsto be as transparent as possible about its intent ancl operations. Transparency, alas, does not always equal precision. "Price stability" has been described as inflation so low that it cloesn't enter into people's thinking about economic decisions. So defined, this lnonetary policy goal cloes not lencl itself to numerical accountability. Some decry this imprecision as a shortco~l~ing of the current monetary policy regime and argue that it lessens the Fed's credibility. Perhaps so. But if the Federal Reserve's aggressive war against inflation has enclecl, it has been replaced by its own Cold War strategy? designed to attain its goal through less overt means than sustained cornbat. To keep inflation out of econotnic decisions, the at persuaFederal Reserve must be successf~~l sively shaping inflation expectations. Although a clearly articulatecl theoretical framework woulcl enhance its actions, this Fecl's inflation policy is realpolitik. It recognizes that clktente cloes not mean peace. http://clevelandfed.org/research/trends February 1997 Best available copy Monetary Policy Bllllons 01 dollars 420 Billions of dollars CURRENCY 300 t f ~ l t ' t l l t t f l l l l t l l l l l l l l l I 1 ~ * l ~ l ~ ~ t ~ ~ I l 1994 1995 1996 Billions of dollars Billions of dollars 1994 1995 1996 a. Growth rates are percentage rates calculated on a fourth-quarter over fourth-quarter basis b. Adjusted for sweep accounts. NOTE: All data are seasonally adjusted. Last plot is est~matedfor January 1997. Dotted lines represent growth ranges and are for reference only SOURCE: Board of Governors of the Federal Reserve System. Every nzirron rnoney measure e s cept currency fell in January. Currency grew 't.7(H1. which n.as slightly slower than its 1996 average rate of 5.7%. linacljustecl total reserves fell 19.4(%.subst:intiaIly more than last ye:lr's annual percentage loss of 11.4%. 'I'he monetary lmse cleclinecl 5.3% ~lf'tei-rising 3.8% in 1996. 7'he 4.5% clr-op in un~icljustetlM 1 is in line with last year's 4.7%)clccrease. Both M1 anel tot:ll reserves were Ixginning to ~noclerateat the end of 1996, convincing some analysts that sweep accounts were becoming saturatecl. These accounts, irlitiatecl in late 1903 as a way for banks to economize on their reserves, "sweep" excess housel~olcl checka l ~ l ecleposits, which are resewable, into money market deposit accounts. which are not. Su.eep accounts :ire I>elieveclto be responsible for the shar-p cleclines in M1 and - >i11 recent years; howtot. 1 rtscrves ever, even when these measures are atljusted for sweeps, they still shocv anemic groxvth. The usefulness of available sweep account c1at:i is limited, hecause clepositories arc not recluiretl to clisclose the size of their pmgums. This rlleans that sweep account activity can be estim:itecl orlly by tising the daily-average effect o f new sweep programs on the rnonthly avelage > . (cotititilrcd 071 12~.xtpugc?) http://clevelandfed.org/research/trends February 1997 Best available copy Monetary Policy (cont.) Percent weekly averages 65 RESERVE MARKET RATES Percent I [ TREASURY BILL YIELDS Percent Percent 7.0 6.5 6.0 5.5 50 4.5 4.0 3.5 3.0 1994 Dec Jan. Feb. March Aoril Contract month Mav June a. Predicted rates are federal funds futures. SOURCES: Board of Governors of the Federal Reserve System; and the Chicago Board of Trade. level of other checlial~lecleposits. The Fecleral Open Market Cornmittee (FOI\IC) reconvened in early Febrrial~;lncl reporteclly tooli n o action on the federal f~inclsrate. A full year has passeci since policymaliers approved a recluction (25 basis points). Since that time, the economy lias contin~iecl to growT \;at a mocler;~te price ancl infl:~tion:iry pressures 1i:lve k c - n kept in check. Altho~igli tlie funcls rate has re- mainecl constant, yielcis on shortterm 'I'reasury securities have tapered off in recent months. Current T-l~illyielcls are 5.0% on the threemonth I ~ i l l ancl 5.2% on the six~nonth.Although short-term yielcls are l,elow their historical averages, they are ahout 2% above 1993 levels. Federal Reserve Chairman Alan Greenspan :~ppeareclsatisfiecl with the current state of the economy when lie testified before tlie Senate 13uclget Co~nmitteein January, but lie obser\;ecl that if the U.S. labor ~ilarlietcontinc~esin its current state, workers :Ire liliely to start demancting higher wages. The fecleral funds futures ~narlcet,which reflects participants' expectations of fi~tureFOMC actions, seems to concur with the Chairm:~n.ancl has built a moderate increase into the funcls rate by late in the seconcl quarter of 1997.This is a clistinct change fro111last Decemher. when marlict participants were (contiu~re~l on 17extp~~~ye) http://clevelandfed.org/research/trends February 1997 Best available copy Monetary Policy (cont.) Percent Inflat~onrate percent I 20 lBUNEMPLOYMENTAND NFwTloN, 1960-1996 lnilat~onrate CHANGE IN UNEMPLOYMENTVERSUS INFLATION, 1960-1 9% h -1 0 -05 0.0 05 1 .O 15 Change in unemployment, percentage points Actual mlnus expected inflation percentage po~nts 5 CHANGE IN UNEMPLOYMENT VERSUS UNANTICIPATED 1 -1 0 -0 5 00 05 10 Inflationrate, percenl I 20 Change ~nunemployment rate percentage po~nts Unemployment rate, percent a. Unanticipated inflation is the difference between actual inflation and its expected value, where expected inflation is based on past inflation rates. SOURCES: U.S. Department of Commerce. Bureau of Economic Analysis; U.S. Department of Labol; Bureau of Labor Statistics; and the Federal Reserve Bank of Cleveland. expecting policy Lo remain ne~ltral until May. The unemployment Ixte is curwell Ixlon; what rn:iny rently 5.40/0. analysts consicler consistent with low inflation. They contenel that rising unemployment leads to lower inflation ancl killing unemployment le:lcls to higher inf1:ltion. Although this relationship (c:lllecl the "f'hillips curve") is thought to b e o n e ol' the rnost re1i:lhle in 11iacroeco11011li~~. tile c11rre11tprolongeel pcriocl o f lo\v inflation ancl low^ unenl~ployment raises douhts a l x x ~ its t valiclity. Incleed, in examining the clata, one might at first I ~ l i e v ethat a slight pc~sitiverelationship exists. a view that is confirmed when one plots the inflation rate against the ch:ulge in the uncmpIo)11nent rate. Analysts generally resolve the apparent conflict between the Phillips cuIve :Inel the cl:ita by focusing on the change in unemploytnent ancl the cleviation of inf1:ition from the level espectecl I,y the market. With this ~noclification, the clata Inore reaclilp reveal a neg:ltive correlation hetween price changes ancl unemployment. Clearly, the relationship betwecn unemploynient and inflation SIIC)LIICI be regarclecl with some skepticism. After all, a negative correlation is one thing, but a stable relationship is quite another. Eviclence shows that simple estimates of the I-'hillips cur-ve basecl on :ivailable clata may shift over time. Thus, although the Phillips curve I-emains :i foc;~lpoint for policy cliscussions, :I cautious application seems xvarmntecl. 2.0 http://clevelandfed.org/research/trends February 1997 Best available copy Percent 75 YIELD CURVES ON JANUARY 31,1997') Percent, weekly averages 70 - 65 - 60 - 55 I 50 - 453-mo 6-mo. I-yr 2-yr 3-yr. 5-yr. 7-yr. 10-yr 30-yr. 3-mo I 6-mo I I-yr I 2yr I 3-yr I 5-yr I 7-yr I 10-yr Percent a. All instruments are constant-maturity series. b. The coupon yield is a weekly average and the zero-coupon yield is a daily number. c. The real interest rate and expected inflation rate are calculated from the Survey of Professional Forecasters using the 30-day T-bill rate SOURCES: Board of Governors of the Federal Reserve System; the Federal Reserve Bank of Philadelphia; and The Wall Street Journal, various issues R $ 3 A -i: -.%. 4 % Interest rates have movecl up since last month, ancl the yielcl curve has steepened. 'rhe yield on 30-year I~oncls11:~sincreaseel 31 basis points. (to 6.89(%); the .?-year, 3-month spreacl stancls at 99 basis points, a n d the 10-year, .?-month spreacl is at 144. The yielcls on zero-coupon I~oncls continc~eto closely tl.acli the yields on coupon 1,oncls. This month. however. the yielcls on 2-, 3-, 5-, ancl 7-year notes exceecl that of s:ulne-maturity zeroes. This is sur[>rising. IIecause the shorter clura- tion of the notes usually leads to a lower yield. It also serves as a remincler that other factors, such as nnarliet licluiclity, d o matter. Nominal interest rates clepend 1,oth on espectecl inflation and on real (inflation-adjusted) rates; uncertainty :IISO has an effect. Prior to maturity, a bo~lcl'spielct can be adjusteel for expected inflation, giving an estimate of the real interest rate. In the l,ottom ch:irt, which slnom~ssuch a hreaIiclo\~~nfor the 30-clay T-bill rate. several relationships stand out. From 1990 to late 1995, expected in- flation Utes cleclinecl fairly steaclily. Since then. espectecl inflation 1n:ts inchecl higher for 14 consecutive months. Expected inflation does not account for nnost of the variation in nominal rates, Inowever, at least since the micl-1980s. Clnanges in the ~~nderlping real sate have been more ilnpc)rt;tnt. Careful obsen~ersnnay note that tile real rate and espectecl inflation do not aclcl up to tlne nominal rate: the clifference is the risk premium that investors clemand for I2earing uncertainty ahout inflation. http://clevelandfed.org/research/trends February 1997 Best available copy Inflation and Prices Perceni of forecasis I 80 DISTRIBUTION OF JANUARY BLUE CHIP CPI FORECASTSa 1 8-2 2 23-2 7 2 8-3 2 3.3-3 7 Annual perceni change ] 12-monih percent change I TRENDS IN THE CPI I 3 8-4.2 December Price Statistics Annualized percent change, last: I mo. 6 mo. 12 mo. 5 yr. 1995 avg. Consumer Prices All items 3.1 3.0 3.2 2.8 2.6 Less food and energy 1.4 2.4 2.6 3.0 3.0 MedianC 2.1 2.8 2.9 2.9 3.2 Finished goods 6.5 3.7 3.0 1.8 2.1 Less food and energy 1.7 0.6 0.6 1.5 2.6 3.0 -5.6 -0.7 2.9 5.4 Producer Prices Commodity futures pricesd a. Forecast of the Blue Chip panel of economists. b. 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. c. Calculated by the Federal Reserve Bank of Cleveland. d. As measured by the KR-CRB composite futures index, all commodities. Data reprinted with permission of the Commodity Research Bureau, a Knight-Ridder Business Information Service. SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; the Federal Reserve Bank of Cleveland; the Commodity Research Bureau; and Blue Ch~p Econorn~cIndicators, January 10. 1997. Economists' 1907 projections for retail price inflation are narron.ly clistributecl. Xearly 70(!,6ol those pollee1 in Januai-y's Blue Chip s~lr\-eyexpected the Consumer Price Inclex (CPI) to rise l>et\\-een2.S'Xi ~iancl3.2% this year. vet-), close to its :ia\.crage increase for the p a t five ye:irs (2.8%,).b~iorct1i:tn 60% of tile I3lue Chip economists cspcctecl tlie CI'I to rern:~in in this narrotv I.;inge in 1998, ancl less than lo?%sarv inklatlon f:llling l>clo\\ 2 3"i1 or I rslng above 3 7(!h After trending beneath the central retail prices seems centered in only tencletlcy projection of the Fecleral :I hanclful o f components, particuOpen I\/I;irket Committee (FOblC) 1:irly fc>ocl ant1 energy items-two di~ring most of 1996, tile Ct'I's areas that hacl a moclerating inflitgrowth sate \\;as pushed to the proence on the CI'I for 111ost of tlie past jection's extreme upper limit (3.2%) five years. If we exclucle these com13y a surge in consumer prices at ponents, the CI'I appears to have year's end. In fact, the CPI's 12heen trending clon.nward over the month gro\vth rate 112s been trendpast year or so: After reaching al~out ing i~p\v:iarcl ever since reaching its 3% in micl-1995, its 12-month growth recent lo\v of ahout 2.6% at tile encl rate fell to only 2.5(Hj l ~ ythe encl of of 1995. 1996. This matches 1994's record :IS Much of the lecent a c c e l e ~ ~ ~ t1i11o n ( c o n t r i l ~ ~ e01 ~2/ I~.Y/ f~crigc) http://clevelandfed.org/research/trends February 1997 Best available copy Inflation and Prices (cont.) Dollars oer barrel 12-month percent change PPI less food and energy 1993 1994 1995 Index, 1982-84 = 100 115 1996 Percent l 6 ENERGY EXPENDITURES AS A SHARE OF GDP 1 a. West Texas intermediate. b. As measured by the KR-CRB composite futures index. Data reprinted with permission of the Commodity Research Bureau, a Knight-Ridder Business lnformation Service. c. Ratio of barrels of oil to dollars of real GDP SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; U.S. Department of Commerce, Bureau of Economic Analysis; the Commodity Research e Expenditure Report. Bureau; DRI/McGraw-Hill; and U.S. Energy Information Administration, State Energy P ~ c and the smallest annii;tl increase in the inclex for more than 30 years. Wicle swings in food and energy prices were also major contributors to last yeas's ju~llp in proclucer prices. The I'roclucer Price Index for fitinishecl goocls (1'1'1) increaseel 3% o v e r the 12 months encling in I>ecernber, a l ~ o u ta percentage point higlier than in 1995 and the strongest rise in six years. Nonetheless, after adjusting for changes in food ancl energy prices, the 11' 1' ~ 2 s a substantial two percentage points l o n e r in 1996 than in 1995, ancl ne:trly one percentage point below its five-year average increase. The 1996 rise in energy prices l>rolie a string of generally moclerate increases for this important commodity dating back to the Gulf \Var. Several factors, inclucling severe winter weather in Europe, contribi~tedto the price siirge and accelerateel the clo~vnwarcltrend in U.S. crucle oil stoclis t1i:lt began in 1990. Comrnoci- ity marliet palticipants apparently clo not expect these effects to linger very long. A reading of oil futures si~ggeststhat oil prices could come clown by the enel of spring. Moreover; improvecl energy efficiency appears to have reclucecl the role of oil in the economy. Expenclitures on petroleuru accoi~nteclfor less than 4% of GDI' in 1993nearly full percentage point less than in 1970. 1 http://clevelandfed.org/research/trends February 1997 Best available copy Percent of forecasts 45 IDISTRIBUTION OF ECONOMISTS'REAL GDP FORECASTS Real GDP and Components, 1996:IVQ (Advance estimate) Change, billions of 1992 $ Real GDP Consumer spendlng Durables Nondurables Services Business f~xedinvestment Equipment Structures Res~dentialinvestment Government spending National defense Net exports Exports Imports Change In business ~nventor~es Percent change, last: Quarter Four quarters 80.3 38.8 8.1 6.0 24.6 8.0 -2.5 9.9 -0.9 2.2 -1.4 36.7 47.7 11.0 4.7 3.3 5.4 1.7 3.8 4.2 -1.7 22.7 -1.3 0.7 -1.8 3.4 2.7 5.5 1.8 2.5 9.1 9.4 8.4 4.0 2.3 1.5 - - 25.5 4.7 7.6 8.6 -2.6 - Annual percent change Percent Billions of 1992 chain-weighted dollars NOTE: All data are in chain-weighted 1992 dollars, seasonally adjusted annual rate. SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; and Blue Chip Economic Indicators, January 10, 1997. I n l i k ~n l c ~ t ~olit b . like ci lio~z.According to advance estimates. real GDP grew \:ill exceptionally kist 4.7% in 1906:11TQ.\vith :::tins in exports and personal consulnption expendit u r e s leading the way. Inventory accumulation slo\vecl slightly. Last c1u:lrter's gro\vtli rate compares with 2.1% in 1996:IIIQ, 4.7% in 1096:IIQ. ancl 2.0041 in 1996:IQ. The fourth-quarter figure. hon.ever, is su1,ject to revision as more cornplete clata hecome a\.ailat~le. In tlie sixth year of the current business expansion, outpiit grew 2.5(%. up f r o ~ n2.0% in 1995 and \\jell a l ~ o v elast winter's pessimistic projections of 2.0%. Future prospects also seem good. On average. economists participating in the January Blue Chip s u r \ ~ e j ~ which , prececled the laelease of the most recent GIII-' nurnl~ers,forec:~st real economic growth of 2.3% in 1997 and 2.1% in 1998. 'The recent GDP release highlights the gro\\;ing importance of tracle to the U.S. economy. Exports anel imports together no\\^ ecl~lalapproxinlately 26% of GDI), up from 9% in the early 1960s. Last cluarter's export gi1i11~ acco~lnteclfor 59% ($47.7 billion) of the rise in total output. Although the data are incomplete, this sharp increase in exports seems to have come primarily from shipments of computers, aircraft, serniconcluctors, ancl telecommunications eclui11rnent. Imports increasecl $11 billion, ( C ~ I I I I ' I Z L I0~11~ I)?ex/pagd I . . e B m B e http://clevelandfed.org/research/trends February 1997 Best available copy e Economic Activig (cont.) Index, March 1973=100 Ratio index, 1973=100 I110 95 [TRADE-WEIGHTED DOLLAR AND RELATIVE ECONOMIC Percent Percent change from corresponding month oi previous year 8 89 [INDUSTRIAL PRODUCTIONAND CAPACITY UTILIZATION* I Percent change from corresponding month of previous year 7 Percent rising 65 60 55 50 45 40 35 1990 1991 a. b. c. d. December data, except for 1997, which covers only January. 1996 and 1997 data are based on The Economist poll of forecasters. Chain-weighted data in 1992 dollars, seasonally adjusted annual rate. Seasonally adjusted. SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; Board of Governors of the Federal Reserve System; International Monetary Fund, International FinancialStatistics; the National Assoc~ationof Purchasing Management; and The Economist, January 18-24, 1997. substantially off the pace that prevailed e;ulier this yc:lr. Despite the Sourtli-cluartw imS net expc~rt provements. ~ L I ovel.;llI position \vorsenecl in 1996. This foll o w s a tre~ldtow:~rcl growing trade deficits that l ~ e g a nin 1990. I h r i n g the currcnt l~usinessespansion, U.S. output growtl~has esceeclecl that of most of our m:ljos t~lclingpartners. In atitlition, tile cloll:lr's eschange rate incles-:~tijustecI for inklati011 clifferentials anlong countries-has ;lppreciiatetl 10.4% since 1990. These relative growth and exchange rate patterns seem lilcely to persist througho~~t 1997, suggesting that our net expclrt position will not improve hefore 1998. Appmxin~atelyhalf of the 1996:lYQ rise in real GDP stem~necl from stronger consumer spending, much of it for lionautomotive durable goods. Real disposable personal income rose 2.8% in Decemt~esfrom 12 months earlier, anct real personal consumption expentiituses increased 2.2%). Although consumer debt 1,~sclens have gone L I in ~ recent years, the current level is actually 11elo~v that of 1989. Industrial procl~~ctionincreaseel ,, :t.3(%on a year-over-year basis in Ilecemher, and capacity utilization rose to S3.5?41.The National Association of I'urchasing lvk1nagcment's incles inclicates that 52% of man:tgers are r e p o ~ - t i growth ~ ~ g in their firr-ns. http://clevelandfed.org/research/trends February 1997 Best available copy Labor Markets Change thousands o i bvorkersn 600 [AVERAGE MONTHLY NONFARM EMPLOYMENTGROWTH I Labor Market Conditionsa Average monthly change (thousands of employees) Year 1996 IVQ Nov. Dec. 1997 Jan. Payroll employment 218 Goods-producing 17 Manufacturing -8 Construction 25 Service-producing 202 102 Services Business services 30 Retail trade 50 234 181 34 35 12 8 23 27 200 146 91 71 18 -7 76 54 261 40 14 28 221 100 36 73 271 32 18 14 239 167 70 19 Average for period (percent) Civilian unemployment rate 5.4 5.3 5.3 5.3 5.4 Employment/ population ratio 63.2 63.4 63.4 63.4 63.6 Labor force participation rate 66.8 66.9 66.9 67.0 67.2 1990 1991 1992 1993 1991 1995 1996 IVQ Nov Dec. Jan 1996 1997 Percent Percent Percent change, year over year 1 INFLATIONAND EARNINGS I a. Seasonally adjusted. b. Vertical line indicates break in data series due to survey redesign. SOURCE: U.S. Department of Labor, Bureau of Labor Statistics. Nonfarm payrolls gre\v 13). 271.000 in January, continuing the fourth q u : ~ t e r ' s string o f vigoroils increases. 7'he g:lin was l>roacl-/>aseel, with every major sector of the economy adding to its pxyrolls. Services contini~eclto espancl as :L ~ I C tion o f total eiiiploynlent. \vhilc rnanuklcti~ring acl\.ancecl :I solitl 2.1% o n a n ~ ~ n n u aI~asis. l Strong growth in t2usiness sel-vices \\;as led by contini~eclespa~lsionol'the n:~tion's tempolxry help agencies. Although overall employment rose. the jobless rate increaseel slightly for the month, from 5.3% to 5.4%, a statistically insignific;lnt ch311ge. The source of this app:lrcnt conflict can l ~ tracecl e to the increasing number of people looking for \\.orli w h o previously were neither cmployecl nor searching for a jol,. While an influx of people into the 1:117or marliet is expcctecl \\-hen employment prospects are goocl, the current I~usiness expansion has yielded p:lrtic~~larlylarge inflo~vs. Both the e ~ ~ i p l o y ~ i ~ e ~ ~ t - t ~ ) - ~ ) o ~ ~ i ~ l : ~ t i o n t i o :lncl the lal~orforce particip:ltion Ixte stancl at recorcl higlis. A\.erage \\.eelily earnings increasecl moclerately in 1996. 1111 3.2% over 1995's lei-el :111d only slightly above the 1996 inflation w e . The Janiiary nilmhers clicl not I~reakwit11 this pattern, 21s aver:lge hourly p:ly rose only 1 cent, to $12.06. http://clevelandfed.org/research/trends February 1997 Best available copy Employment Cost Index Four-quarter percent change 7 6 5 4 3 2 1 1986 1988 1990 1992 1994 1996 ECI Wage and Salary Growth ECI Wage and Salary Growth by Industry, 1 9 9 6 ~ by Occupation and Region, 1996 Average annual percent change, last: Average annual percent change, last: Occupation Professional specialty/ technical Executive Administrativesupport Serviceoccupations Blue-collar occupations Region Northeast South Midwest West 1 yr. 3 yr. 6 yr. 3.57 3.77 3.12 3.40 3.04 3.04 3.44 3.14 3.14 3.01 3.42 3.45 3.50 3.25 3.1 6 3.32 3.76 3.32 3.10 2.96 3.16 3.20 3.11 3.24 3.28 3.45 3.34 1 yr. 3 yr. 6 yr. Manufacturing Construction 3.30 2.90 3.15 2.91 3.48 2.75 Transportation and public utilities 2.67 3.35 3.57 Wholesale and retail trade 3.84 3.35 3.38 3.21 3.57 4.67 2.34 3.40 2.75 3.04 4.15 2.39 3.56 2.77 3.42 3.52 3.30 3.57 FIRE^ Services Business Health Educational a. Private industry workers. b. Finance. Insurance,and real estate. SOURCE: U.S. Deparlment of Labor, Bureau of Labor Statistics - i - - T h e Emplo)/ment Cost Incles (ECI) is t h e best rneasure of compensation (wages ;uncl l~enef'its)gro\i:th available to labor analysts. Like the Consumer Price Incles (CI'I), it relies on a fisecl Ixtsliet o l items-in this case, occilpations. This pre\ients shifts in the occupational cornposition of the \vorliforce from appearing as LGuge gains. as they clo in average hourly earnings c1:tt:u. Recause the ECI inclucles overtilne payments as a fixed i~lcrelnentto wages, shortterm increases in overtilne will not alter the incles. A long period of low unemploynlent sates has lecl many analysts to seek eviclence of "excessive" \\age increases. but wage growth has remainecl moderate; it has I x e n further offset by slower growth in henefit costs over the last two years. For most groups of workers (occilpations, industries, or regions), 1996 wage growth was con~para1,leto tile rates of the ~ ~ 1several st years. Although the ECI ancl the CPI have shown similar gro\i~thpatterns in recent years, the clirection of causality is ~lnclear.Firms coulcl Ile ;~cljustingwages to lteep pace with inflation or acljusting prices to lteep 1111 with wage growth. Both exp1:lnations are consistent li~iththe correlation hetween the CI'I and the ECI. http://clevelandfed.org/research/trends February 1997 Best available copy Employment Trends Percent "" 1 Percent I EMPLOYED PERSONS AS A SHARE '- EMPLOYED PERSONS AS A SHARE OF POPULATION, AGE 16-19 VERSUS 20-24 70 - 65 - 60 - 55 - 50 - 45 - 40 - 16-19 11 351940 1950 1960 1970 1980 1990 Perceni Percent SOURCE: U.S. Department of Labor, Bureau of Labor Statistics. Despite perioclic fluctu;ltions in the pace of U.S. economic activity, the percentage of \\-orking-age Arnericans w h o are ernployeel has risen steadily since the early 1970s ancl now stancls at a recorcl 63.4%. Because er-nployment changes play an important role in cletermining overall economic growth, it is usefill to explore the source of the employment rate increase to see \vlletlier this trericl may continue. The rise in the employment-top o p ~ ~ l a t i o ratio n since the e:lrly 1970s reflects a subst:~ntialincre:ise in wctmen's employment rates, a trellcl which began much earlier. The overall employment ratio rose, clespite a sul>stantial clecline in the employment rates for inen ancl people 55 and over. (Early-retirement programs, initiated in the 1970s, contsibutecl to this decline.) Teenagers' employment rate was roughly unclizunged over the perioci. It I'ollo\vs that the c1ram:ltic increase in overall employment rates was clriven by an even Inore elmmatic rise in the ernploylnent sates of psime-age miorkers (25 to 54). Gro\vth ~vit11i11this group resulted exclusively from the increase in \\.omen's employxnent. It is u~llikelythat the employment of prime-age women will keep rising at the same rate over the next clecacle. If substantial growth in the overall employme~ltpercent:lges is into continue, it will liltely recl~~ire creases in the employment mtes o f men ancl people over 54.However. a more liliely scenario is that growth in the percentage of Americans \\rho are employeel will s l o ~ vgreatly in the coming years. . @ . I 0 , http://clevelandfed.org/research/trends February 1997 Best available copy e Structural Changes in US.Fiscal Policy Percent of GDP Percent 01 GDP " Percent of GDP 12 I STATE AND LOCALTAXES AND EXPENDITURES Index, 40-year-old male = 1 I Index, 40-vear-old male = 1 10 8 6 A SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis and Bureau of the Census; and University of Michigan, Survey Research Center. b s. A -4 Feclelal spencling has cot~sistently outpaceel fec1er;ll revenues since the 1970s. Although the opposite is true for the sum of st;lte :~ncllocal budgets, the total national clel2t (both nominal ancl inflation-adjustecl) has m~~shroomecl over the last 25 ye:trs. Many analysts vie~vthe higher level of esplicit clel~tas 2111 indication of ho\\- fils the 1,urclen o f paying for current government spencling has b e e n shifted onto future genemtions. Some suggest that the level of explicit ciebt :tlone i~nclerestirnates t h e extent of such 1,urclen-shifting, citing the government's implicit So- cia1 Security and Medicare liaf>ilities :tlso snakes Social Security, i\leclic;ue, to current generations, which f ~ ~ t ~ i r Meclicaicl, e ancl \velfare tztnsfers. generations of workers will have to A glance at the components of aggregate taxes ancl tmnsfers is suffipay. Ho\vever, the paylnent burclen on fi~turegenerations has itlcreasecl cient to convince anyone of the sigin a thircl \?ray---through struct~lral 11ific:lnt structural changes in postwar changes in fiscal policy. [J.S. fiscal policy. As a share of GI)I', The government has man), fiscal lal>orinconle taxes xncl pa)7roll taxes instn~mentsat its disposal. It obtains (which also fall on \vorltel.s) have revenue through taxes on labor ant1 trenclecl upwarel. Because ).ounger capital income, payroll tases. ancl ingenerations \\'.ark more than retirees, clirect (sales and escise) taxes, their taxes have incre:~sedsnore. 011 the other hand, taxes or1 capital inamong others. Apart from spending to purchase goods and services for come have declinecl over this period, reducing the t:lses of older generaits own operation and to provicle puhlic goocls like national defense, it (cot2titzzred orz tze.xip~/ge) http://clevelandfed.org/research/trends February 1997 Best available copy Structural Changes in US.Fiscal Policy (cont.) Index 65-year-old male = 1 Percent of GDP IL ISOCIAL SECURITY AND HWLTH CARE TRANSFERS Perceniof GDP I Index 40-year-old male = 1 36 1 RELATIVE PROFILES OF MEDICARE AND SOCIAL lndex 40-year-old-male= 1 IRELATIVE PROFILES OF WELFARE BENEFITS BY AGE SOURCES: U.S. Department of Commerce. Bureau of Economic Analysis and Bureau of the Census; Social Security Administration; and Mark McClellan and Jonathan Skinner, "The Distribution of Medicare Benefits: A Lifetime Perspective," Stanford University, unpublished manuscript. April 1996. tions, who o\vn most of' the economy's physical capital. Fu~-thecSocial Security anel health care tmnsfers have risen ~;tpicllyas a share of GDI? i~nplyinga clecline in the net tax burelens of oltler generations, w h o ~nalceup a significant ~najorityof recipients. However; the increase in these tl-ansfers implies a s ~ n a l l e rdecline in the net hurclens of younger ancl unhorn genemtions, who ~villreceive them in the c1ist:mt f ~ ~ t u r and c , then only after malcing substantial payroll contril,~itions while worlting. The sh:tre of \velf;u.e ments may not much affect overall transfers that accrue mainly to revenue and spencling numl~ersthat is. annual cleficits Inay remain young, poor indivicluals-single mothers a11d the une~nployecl-has ~~nch;lngecl. It m:ty nevertheless sig;tiso increaseel, but at a IIILIC~I slo\ver nificantly alter the generational clispace than Social Security ancl health tril>~itionof net payment hurclens. care transfers. I3ecause cliffere~ltgenerations have clissimilar saving patterns and incliThe government's choice of a parnations to participate in the workticular nix of taxes, spending, anel force (clepencling on their age), transfers cleter~ninesthe clistrihution changes in this clistril,~ttionare likely of net p:iyment burclens (taxes net of transfer receipts) alllong current to affect the nation's overall ecoanel f~1t~ir.e generations. A str~~ct~ir.;tl nomic performance. ch:lnge in the mix of these instru- http://clevelandfed.org/research/trends February 1997 Best available copy Housing Finance Index, March 16, 1990=1 Percent *'1 MORTGAGE APPLICATION VOLUME MORTGAGE RATES 90 J M M J S N J M M 1995 J S N J 1996 1997 Billions of dollars [MORTGAGE ORIGINATIONS BY TYPE OF LENDER I J F M A M J J A S O N D J F M A M J 1995 1996 SOURCES: U.S. Department oi Housing and Urban Development; Federal Home Loan Mortgage Corporation; Office oiThrifi Supervision; Mortgage Bankers Association of America; and Bank Rate Monitor. After cleclining stezkclily sincc September 1996, 30-year fisecl mostgage rates ha1.e ji~mpecl -40 1):tsis points from 1)eceml~er's l o ~ v of 7.38%. Fifteen-year fisecl sates have follo\\;ecl a similar pattern. n~hile one-year :~clj~istal~le Utes have risen some\\-h;lt less. Nonetheless. analysts generally Llgree tl1:kt tl~isrecent ~ ~ p n ' ; ~trencl rd n-ill not c o n t i n i ~ e inclefinitel>- if economic gro\vth rer~llainsrel:~ti\.elystahle ancl inflation moclelates. A l t h o ~ ~ gthese h rates are still low compared to those of the last 20 yezkrs, the 1993 refi~lanci~lg I,oom the boomlet at the entl of 1995 left many mortgage holclers wit11 even lower rates than those prevailS, the volume ing toc1:lp. T ~ L I while of home-1~urchaseapplications has continued to grow steaclily, refin~uncingactivity is less p r o n o i ~ n e d . Nevertheless. mortgage originations rernainecl strong through the first 11:1lf of 1996. The recli~ceclrefinzlncing clernancl ;klso helps to explain why the share of acljust;~l,le-rate mortgage originations is o n c e again moving in ta~ltlem\vith the spread I,et\veen fixecl- ancl acljustal>le-ratemortgages. IVhen long-term rates were at historically l o ~ vlevels in 1993%m:lny I~orro\verslocliecl in those fa\.oraide ter111s. even thoiigh the spre:lcl Ixtween fixed anci acljustable rxtes \\;as i~ni~sii:~lly \vide. I http://clevelandfed.org/research/trends February 1997 Best available copy Household Debt and Delinquencies Percent loo HOUSEHOLD DEBT BURDENS Percent Percent 180 Filings per 100,000 U.S. adults Percent 1,700 /BANKRUPTCYAND CREDIT CARD CHARGE-OFF FATES Percent 30 IHOUSEHOLD DEBT/FINANCIAL ASSETS 6 I I SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; Board of Governors of the Federal Reserve System; American Bankruptcy Institute; and FDIC Statistics Branch. Over the last few years, the mtio of householcl clelx to clisposable personal incorile has reachecl historically high levels, raising concerns about the financial stability of I1.S. ho~~seholcls. The recorcl n~imberof personal I,anl<nlptcyfilings (1996:IIIQ alone saw more than 290,0001, along byit11 increases in credit card charge-offs (\vi~ichreachecl 4.49% of total cr-eclit care1 debt outstancling in 1996:IIQ). has further heighteneel this concern. A better indicator of ho~~seholcls' true financial health is the proportion of clisposable perso~lalincome that must be used to service this cleht. After all, the general cleclinc in interest rates during the '1990s has made it much easier for householcls to manage greater clebt levels. As a fraction of clisposable personal income, estimated debt-selvice payments have been rising over the 1:ist few years, but their level is still consistent with that of the late 1980s ancl is \veil below its 17.6'Yo high of 1989:IVQ. 7'0 understancl householcts' financial r\:\;ell-being, it is also important to notice that the composition of householcl cleht has been changing since the mid-1970s. with home mortgages acco~lntingfor a larger share of total householcl liabilities ancl collsurner cleht becoming relatively less in~portant. In contrast, tliere has been a relative increase in (cotztin~redor? 17extpagc) http://clevelandfed.org/research/trends February 1997 Best available copy http://clevelandfed.org/research/trends February 1997 Best available copy Monetary Policy and Global Competition Yen per U S dollar I I5O [ NOMINAL EXCHANGE RATE Yen per U S dollar 152 REAL EXCHANGE RATEa 150 - 148 - 146 - 144 - 142 - 140 - 138 - 1991 Percent change from corresponding quarter oi previous year 7 1992 1993 1994 1995 1996 Percent change from corresponding quarter of previous year ( " JAPANESE REAL GDP a. The real exchange rate is calculated using consumer prices for both the U.S. and Japan. The base period is November 1991 SOURCES: Bank of Japan; and the Statistics Bureau of the Japanese Prime Minister's Office. The clollar's recent sh:irp rise against the yen has intensifiecl long-held concerns a l ~ oJapanese ~~t man~~hcturers' competitive edge in U.S. marItets. Since M:irch 1995, the clollar has :~ppreciatecla l ~ o u t35% xgainst the yen, ancl many analysts anticiac1v;lnces this year. pate ~LII-ther When one also weighs the persistent inflation clifferentials Ixtween the two c o ~ ~ n t r i ethe s , competitive implications of the clol1;~r's rise seem rnore challenging. On a real i~asis.tlie clollar has :lppreciatecl nearly 13% against tile yen since 1990. Can policy moves 11i:ilie :i difference? Foreign exchange inter\.ention can sencl ripples through the market. Much like a rock tossed into ): snift river, however, inten~entionofl with fers 110 f ~ ~ n d a m e n t aforce which to alter a marltet's current. Because success clepencls on cli~inging traclers' perceptions ancl espectations of events, rather than clirectly changing fiindamentals, intervention's infl~lenceis at best fleeting. i\lternatively, the Federal Reserve co~llcle:ise monetary policy when tlie 13ank of J:lpan tightenecl its money supply. This ~ ; o u l dpromote 21 clollar clepreci:ltion at the expense of higher inflation in the U.S.;Inel cleflation in Japan. Since exchange rates often responcl Illore quickly than prices, our competitive position might s h o ~ v;I temporary improvement that ~voulcl last only until prices responded f~illyto monetary ~ I ~ ~ S S L I SUltimately, ~S. countries cannot imixove their competiti\.e posih policy. tion t h r o ~ ~ gmonetar)~ 1 * O O e ? l O Q http://clevelandfed.org/research/trends February 1997 Best available copy Q Monetaly Policy and Economic Growth Inflation, oercent 100 Short-run Growth of Money and Output MONEY GROWTH AND INFLATIONa - (Correlation, year-over-year percent change) M2 lagged one year M2 lagged two years -0.1 7 -0.1 1 France 0.1 7 0.06 Germany 0.74 -0.13 Italy 0.62 0.42 Japan 0.72 0.51 U.K. 0.1 8 U.S. 0.35 Canada m Correiat~on 0 99 - rn - eba - %a a= -0.19 7 0.16 0 0 10 20 I 30 0 10 20 30 I I I GO 40 50 M2 growth, percent 70 80 90 100 40 50 GO Inflation, percent 70 80 90 100 I I I Real GDP growth, percent 10 8 4 2 0 -2 -4 -6 -8 -1 0 0 10 20 30 40 50 GO M2 growth, percent 70 80 90 100 a. Average annual percent change. NOTE: The sample includes 45 countries. All have at least 15 years of available data, and most have 35 years. See GeogeT. McCandless, Jr. and Warren E. Weber, "Some Monetary Facts," Federal Reserve Bank of Minneapolis, Quarterly Review, Summer 1995, pp. 2-11. SOURCE: International Monetary Fund, International Financfal Statistics. Although most economists n.ill concede that nlonetary policy can affect real economic gro\vth over the short run. many caution against attempting to manage i>i~siness cycles through policy minipulation. Indeecl, in most large industrial countries, faster money growth seems to prececle Lister economic gro\vth by one year. E. --2 - - - - A causal connection I>et\veen money ;me1 growth, ho.r\.e\-er, req ~ ~ i rthat e s information :il)out policyinclucecl price changes bc imperkct. This m:tp happen if so~lnesectors of the economy have embeclclecl outdatecl price expectations in Elinding co~ltmcts,if certain groups have better access to cu~-rentprice information t h ~ mothers, or if people generally have good infor~llational~outthe wages they earn ancl the prices they charge, hilt not about other prices. In the long rim, when information is complete and contracts can adjust, faster money growth increases neither outpilt nor employment. As crosscountry correlations reveal, faster money gro~vthcontributes only to inflation. Sollle economists warn that higher inflation may slo\v groxvth. If the p~ll>liccluestions the stability of a currency's purchasing power, they will expend more time and energy protecting their financial \vealth from inflation. Society will clevote Illore resources to fiillatlcial services allel to the prompt acljustment of prices. \vhile fewer resources will g o towarcl capital accumi~lationanci investments that enhance protluctivity.