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http://clevelandfed.org/research/trends January 1996 Best available copy The Economy in Perspective 0 1 1 the outs ... It has long been conventional in politics to portray oneself as an outsider. At one time, refer-ring to a governnlent official as an insicler was a supreme compliment, but when the public became dissatisfied with government's performance, insiders recognized that they carried too much baggage. Insiders then camchanged. paigned as outsiders, but little act~~ally When the insiders ran government, they never seemed sufficiently botherecl by persistent budget deficits or generational fiscal i~nbalances to endure the short-n~npain required for the long-run gain. They devisecl plans to curb the imbalances, but always schedulecl the pain to occur in the outlying years, beyond the next election. Successive waves of outsiders came to Washington to reverse that result, only to become next year's insiders. In the U.S. fiscal arena, the electorate now seems to have ctevelopecl such an appetite for change that nlany icleas previously regarded as out-of-bounds are finally receiving serious attention. Although a concrete federal budget accord remains elusive, the broacl outlines of an agreeluent are taking shape. In some fashion, the gromith in spending on entitlement progranls will slow clown. The government miill offer fewer services and outsource others. The tax sicle of the equation will not be forgotten. It is far too soon to think that the progressive inconle tax system will be swept away, but alternatives such as the flat tax and consumption tax are no longer clismissed as politically outrageous. In fact, these icleas are likely to receive more serious scrutiny in the next several years than ever before. Even funding Social Security through incliviclually man:lgecl invest111ent accounts, instead of through a government fund invested in Treasury securities, will likely get a hearing. Although congressional refornlers are turning the budget process inside out, they may soon attempt to revise some aspects of monetary policy. Congress a~l~lencled the Federal Reserve Act in 1977 to require the central bank to promote maxinlum employment, stable prices, ancl nloderate long-term interest rates. The following year, through the Full Enlployment and Balanced Growth Act, Congress required the Fed to report semiannually on its projections for economic output, the price level, and the level of unemployment, as well as to announce its plans for the growth of money ancl credit in the year ahead. Although inflation has been trending clownwarcl since the early 1980s, it is not clear how much, if any, of the credit belongs to the legislative framework crafted nearly 20 years ago. At certain tinles during this period, knowledge of the future money supply would not have helped to predict anything. Moreover, many scholars have pointed out that by requiring the Fed si~nultaneouslyto promote several outcomes that nlay conflict, Congress is not providing enough clirection to the monetary authority. A reasonable conclusion is that the Fed's recent outstanding inflation performance has been achieved lal-gely independent of the existing statutes. Now a group of outspolten lawmakers, lecl by Senator Connie iMaclt, proposes to out-andout discard the Full Employment and Balanced Growth Act. As introduced in the Senate last September, the Economic Growth and Price Stability Act of 1995 would direct the Federal Reserve to promote price stability as its primary long-term goal. References to nlaxirnun~ernployment and rnoclerate long-term interest rates are stripped out to enable the Fed to focus more clearly on the price stability objective when it formulates ancl implements monetary policy. The bill also directs the Fed to establish a numerical clefinition of price stability and to report to Congress semiannually on its plans for achieving that objective. It remains to be seen how much support this effort will eventually garner, ancl what changes nlay prove necessary to gain enactment. As the budget battle illustrates, when various interest groups seek to outwit, outflank, and outsell one another, the process can get out of control. But the potential gains fronl a stronger legal manclate for price stability justify the struggle. To prevent inflation from once again becoming out of sight, it is best to keep infeasible objectives out of mincl. http://clevelandfed.org/research/trends January 1996 Best available copy Monetary Policy Percent, weeklv averaaes Percent L." 1994 Percent Percent, weekly averages a. Predicted rates are federal funds futures. SOURCES: Board of Governors of the Federal Reserve System; and Chicago Board of Trade. "Since the last easing of inonetaiy policy in July. inflation has been somewhat 111ore favorable than anticipated. arid this result, along with an associatecl mocleratio~~ in infla'tion espectatiolls, warsants a moctest easing in monet:~r)iconditions." This statement by Federal lieserve Chairrnan Greenspan accompaniecl the r>ecember 19 announcet Federal Open Market ment t l ~ t the Comrnittce (FOMC) had clecicled to lower the intenclecl federal funds rate by 25 basis points, to 5.5%. It now seelns liliely that actual inflation in 1995, as me:lsurecl by the Consumer Price Index, will encl the year below the 3% to 3'/20/0range expected hy the FOMC in J~lly. Although the tinling of the recent policy move may have caught some market participants by surprise, a reduction in the fed funds rate hacl !>eel1 anticipated for months. Incleecl, since last year's first rate cut in July, kc1 funds futures prices have i~nplieclan expectation of additional cuts. Another slight reduction in the intended fed funds rate is anticipated in early 1996. Since February, the sate on one-year Treasuries has been l>elow the fed funds rate. also s ~ ~ g g e s t i nfi~rther g policy actions througho~ltthe coming year. 1)eclining inflation expectations contrib~~tecl to at least part of the overall clrop in interest rates last year. The 30-year Treasu~ybond fell below 6% in the final ctays of December, approaching the cyclical trough recorcleci in October 1993. In the 26 months following that t r o ~ ~ glong-term h, rates rose sharply, incluced both by a strong e c o n o n ~ y that increased the 12te of return o n new business invest~llent ancl by (cotztir~riec/ 017 nextpc~ge) http://clevelandfed.org/research/trends January 1996 Best available copy Monetary Policy (cant.) Billions oi dollars, s a a Billions oi dollars, s.a? Bill~onsoi dollars, s a? Billions oi dollars, s.a? Percent Billions of dollars, s.a." a. Seasonally adjusted. b. Last plot is estimated for December 1995. c. Growth rates are percentage rates calculated on a fourth-quarter over fourth-quarter basis. Annualized growth rate for 1995 is calculated on an estimated 1995:IVQ over 1994:IVQ basis. NOTE: Dotted lines represent growth ranges and are for reference only. SOURCE: Board of Governors of the Federal Reserve System. - % , - - fears that infl:ttior~;~ry pressures miglit 1e;lci to higher trencl inflation. Since the peaks in capit~tlm:trliet mtes just over a ye:lr ago. inflzltion has been steacly ancl 1,usiness investment-\vllile still strong-1x1s mocleratecl. Dan!< loans to corlsuri1er.s mcl husi~lessesgrew r;ipiclly o\.er this periocl. h ~ have ~ t clecelerateci in recent months. 13anlis lor the most part financed their- strong lo211clem;tncl \\.ith noncleposit lial~ilitiesancl l:~rgetime cle- jmsits. As a consequence, pricing of other checkable cleposits (OCDs) ancl money market deposit accounts (h~IMDAs)\\;as not very aggressive. Incleecl. the rate paid on OCIls I~ardlyIxldgecl in the Lice of rising interest sates. Th~rs, OCD opportunity cost (measurecl here as the clifference l~etcveen the 3-month 'I'reasul-1. I ~ i l lyield alicl the effective I-ate ~xticlon OCDs) rose sharply, \i.hich in turn dampecl ho~rseholcl clemancl for OCDs. i\s shor-t rates fell in 1995,s o too clicl the opportclnity cost of OCI>s ancl non-interest-l~earillgttansaction cleposits. Historic:tI relationships suggeslecl that 1r:insaction cleposits \voulcl begin to gro\xi cluring the ye:tr. This dicl not lxtl>pen, largely 1,ecaclse of the \videspreacl implernent:itio~~of sweep arrangements that economize o n hank rescnJes. These ~u-ungcmcnts "sn.eep" escess OClIs, which :ire reser-v;ible, into ivI>fIIAs, which are not reservable. thereby recluci~lg a I~anli'srecl~~irecl reselves. fco~~litlited 012 I Z ~ . Y ~ ~ Y ~ C I http://clevelandfed.org/research/trends January 1996 Best available copy Monetary Policy (cont.) Billions of dollars Billions of dollars 1'300 ITHEM1 AGGREGATEa Billions of doilars I Trillions of doliars a. Last plot is estimated for December 1995. b. Growth rates are percentage rates calculated on a fourth-quarter over fourth-quarter basis. Annualized growth rate for 1995 is calculated on an estimated 1995:IVQ over 1994:IVQ basis for M I . M2, and M3, and on an October over 1994:IVQ basis for domestic nonfinancial debt. NOTE: All data are seasonally adjusted. Dotted lines for M I represent growth ranges and are ior reference only. Dotted lines ior M2, M3, and domestic nonfinancial debt are target ranges. SOURCE: Board of Governors of the Federal Reserve System. It is estimatecl that sweep :LCcounts ;tlone clepressed t~unsaction cleposit gro\vth by :lbout 4!/'% in 1995. I3cc:t~1setmnsaction cleposits are the only reservahle cleposit. the growth Kite of total reserves was restrainccl :ilmost proportionately. The nionetary hase. \\iliich comprises total reserves ancl currency hclcl o~rtsicleIxmlis. was :11so affecteel. Its growth rate, ho\vever. is ciomin:~tecl hy its currency cortiponent. \\,hiell slowed slixrply in the spring. Analysts I>clicve that tliminishccl c~lr- rency gro\vth is related to foreign in\~estors'concerns about the exchangeal~ilityof their current holclings once the newly designecl S100 I7ill is introtlucecl. It is also estimatecl that the &I1 monetary aggregate, u.hicli inclucles both currency ancl tl;~ns:~ctioncleposits! would have gro\vn in 1995 in the absence of sweep acco~~nts. IIespite consiclerable uncertainty about the f'ilt~~re relationships of money ant1 clelx to funclamental polic). ol~jcctives.the FOMC continiles to set growth ranges for M2. M3. :lncl clomestic nonfin:lnci:~l clebt. The I-Iut-riplirey-11:~n~liinsAct of 1978 manclates that the E'edel.al lieserve repor-t these nnges to the U.S. Congress. It is p e r h ~ ~ pironic s that although little :~ttention is paid to these me:isilres. they all enclecl the year within their specifiecl ~ 1 1 g e . &12. -\vhicli inclucles both OClIs ancl MblI>As, \v:ls i r ~ ~ p e l - v i to o ~the ~ s implementation US sn.eep arrangcments. 'l'he strength in PI3 largely reflected lxinlis' tenclency to fin:~nce lo:ln gron.th I,y issuing 1:irge ClIs. 0 5 0 e e . http://clevelandfed.org/research/trends January 1996 Best available copy O Interest Rates Perceni Percent Years to rnalurily Percentage points a. Three-month, six-month, and one-year instruments are quoted from the secondary market on a yield basis; all other instruments are constant-maturity series. b. The yield spread is defined as the 10-year Treasury yield minus the 3-month Treasury yield, and is lagged one year. c. Year-over-year change. SOURCES: Board of Governors of the Federal Reserve System; U.S. Department of the Treasury; and U.S. Department of Commerce, Bureau of Economic Analysis. Interest sates continue to frill. Iiates at all maturities have clroppecl roughly half a point since late June. Long-test11 rates have fallen hy 2 perccnt:ige pointssince their cyclical pe:ilc in i%ovember 1994, anel lllore recently, short-tern rates have also Ileaclecl 1on.e~.The sharp clecline in niecliu111-term sates has not only flatteneel the yield curve. l7~lt has gi\.en it an unch;~r:icteristic shapc: steeper at the long end. e in interpreting Care must l ~ t:tken yield curves. 'nie stancl~irclconstant- maturity clata put out by the Treasu~y I)ep:wt~iient are only an estimate of yielcls, because it is rare to find boncls maturing in exactly seven years, for example. In addition. these ),ielcls are for coupon boncls, inclucling twice-yearly coupons. ?'he yields o n zero-coupon bonds provicle a somewhat cleaner measure, clespite the complications of tax clifferences ancl 1ou.e~n~arketliquidity. The tw.\;o cur\.es :ire similar, although the zerocoujx)n curve is somewhat steeper ancl generally lowel-. Yielcl spreacls. partici~larlyinversions. are often i~seclto forecast r-ecessions. I1lotting the laggecl spread bet\\.een 10-year ancl 3-month Treasuries anci the growth rate of real GI)IJ sho\\~sth;it inversions often d o prececle recessions, but t11:it the re1;itionship is :ilso hroacler. Low spreacls indic:ite low real growth :inel high spl-eads inclicate high real gro\vtli. ?'he relationship is neither one-to-one nor colnpletely precise, however, s o cai~tionin using it is warl.anted. http://clevelandfed.org/research/trends January 1996 Best available copy Inflation and Prices Index 95 November Pri 90 85 mo. 11 mo. Consumer Pric 5 80 75 70 65 60 55 50 45 40 35 Percent change, annual rate 12-month percent change a. Calculated by the Federal Reserve Bank of Cleveland. b. As measured by the KR-CRB composite futures index, all commodities. Data reprinted with permission of the Commodity Research Bureau, a Knight-Ridder Business Information Serv~ce. c. Hor~zontallines represent trends. d. 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. As of July, the stated range (fourth-quarter to fourth-quarter percent change) is 3.125 to 3.375 for 1995 and 2.875 to 3.25 for 1996. SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; the Federal Reserve Bank of Cleveland; Board of Governors of the Federal Reserve System; the Commodity Research Bureau; and the National Associat~onof Purchasing Management. The Cons~imcsI'sice Inclex (CI'I) showecl n o clxinge i r ~November. contsihuting to the me:~suse'slocvest six-montl~gro\\.th sate in nearly 10 years. 'l'he core inflation intleses, which incluclc the CI'I less foocl and energ!. ;inel tlic mcclian C1'1, 1 ~ 1 t h postecl onl!. slight increases for the ;~nnii:llizecl 0.7% :mcl month-an 2.2%. respccti\.ely. As rneasiirccl 1,)- the I,ehac.ior of prodticer prices, the inf1;itiot-i inclic:~tors xceic le45 enco~rl~iglng 111 'do\.cnil>cr -1 he , ~ n n ~ i ~ i l ~one-monrh /ecl ch:lnges in the Proclucer Price Incles (1'I'I) :~ncltlle PPI less foocl arlcl energy n w e 5.8% ancl 5.2%. respecti\.cly. klotor vehicles acco~lnteclfor three-fourths of this increase. Still, clata horn the National Association o f I'urchasing Management suggests that hettes producer price reports rimy be c)n the way. The pcirchasing m:itiagers' price index droppecl from 4:i.j in Novernl~erto 40.8 in 1)ecerntxs-its lo\vest level since J ~ i l y 1001 Or111 10% of those pollecl le1701 tecl f,ic 111ghigl~ersuppl! pl lees, clo\c;n from 16% in November. .[.he recent 12-month trend in the CPI stood at only 2.6?4, iclentical to the relatively lo\v inflation recorcled i t 1 1994. I-lo\~e~.es, as measureel by the riieclian C1'1, inflation reachecl 3.2% over the 1:1st 1 2 months, prompting the question: "Which is the 'true' inflation sate?" h1e:isuring monet;u-y inflatior~represents a n enorinous challenge to econorilists. Some of the ciifficulty \ten)\ frorrl [he l,ict that transrent l c o i ~ ~ ~ t ~ ol ttl c17extp~igr~c) cl e e o e http://clevelandfed.org/research/trends January 1996 Best available copy e Inflation and Prices (cont.) Percentage points, squared 12-month percent chanqe Coefi~cientof kurtosis Coeffic~eniof skewness 8 inn 6 4 2 0 -2 -4 -6 -8 -1 0 1988 1989 1990 1991 1992 1993 1994 1995 a. Calculated by the Federal Reserve Bank of Cleveland. SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; and the Federal Reserve Bank of Cleveland events. such 21s a clrought that recluces the si~ppl\.of crops, can tell~lx)ra~-il;,slien. the p i c e data ;~nclsubstantiall;. alter :I \\;eighteel-avei';tge inclex iilw the CI'I. Sclcli price-incles tnovemcnts are genelxlly not considered ',inflation:1ry," :I phenomenon most economists attribute to monetary c;iLlses. For :i time, then, the price aggreg:ite ma!- k~lselyinclic;~tea c1i;knge in inflation as it reacts to a tl-ansitory sllock: t1i;~t is. a majority of price movements will Ile markecll\~a l ~ o v e o ~ I>elo\\. . the ~.:lte recorclecl 1,y the CI'I. One methocl of eliminating the influence of these transitory events is to trim the outlying portions of the o n tlie cross-sectional d i s t r i l ~ ~ ~ t iof CI'I's components. What remains is the center of the price change clistrilx.~tion, o r the tlleclian change. Incleecl, rese:~rch at the Fecleral Resel-\-e I3:lnli o f Clevelancl inclicates that n k e n the trend in the CPI is t)eloxv the trenci in the mec1i:in CI'I (3s it tl;ls heen over the past sevel-al c ~ i r ; u t e r ~-1x.e . woulcl genesally espect the CPI to rise rather than the mccli:m to fall. Slie\vness is one of se\~eralme:lsuses that can help LIS j ~ ~ d gn.l~ether e the CI'I is being influenceel hy any c ~ n ~ ~ s uprice al clisturbances. Another. CI'I \.;~riance,measures the clispersion of constimer price changes :lncl liirrtosis. which is a n inclicator of 1101~-"pealieel" the clistril~~rtion of price ch:inges is. Neither of these measures suggests any L I I I L I S L I : ~ unclerlying ~ beha\.ior in the recent price d;lt:l: CI'I vari;uice is slightly rial-ro\ver, ancl clistrihirtion is slightly less peakecl, that1 their eigllt-year :iver-:iges. http://clevelandfed.org/research/trends January 1996 Best available copy Percent of forecasts Real GDP and Components, 19953111Q (Advance estimate, ~.a.a.r.~) chanae. billio& of 1987 $ Real GDP Consumer spending Durables Nondurables Services Business fixed investment Equipment Structures Residential investment Government spending National defense Net exports Exports Imports Change in business inventories '"" I DlSTRlBUTlON OF ECONOMISTS' REAL GDP FORECASTS I Percent change, last: Quarter quarters 56.8 26.8 15.6 0.2 11.O 4.2 2.9 11.7 0.1 2.2 3.3 15.3 14.0 1.4 5.8 7.0 1.1 0.9 18.3 17.5 8.3 9.7 3.5 10.9 3.1 2.1 10.6 8.6 14.6 16.3 8.7 -1.4 -0.4 -7.3 10.4 10.0 1.O - - - I 7.7 1.8 2.8 Annual percent change Billions oi dollars. seasonallv adiusted Index January 1990 = 100 inn a. Seasonally adjusted annual rate. SOURCES: Blue Ch~pEconomic Indicators, December 10, 1995; and U.S. Department of Commerce, Bureau of Economic Analysis and Bureau of the Census. Accorcling to the rillle Chip p:tnel of economists. I:.S. economic acti\.ity is liliel). to slo\v this yeas from :In anticip:ttecl 3.3%~incre:lse i11 1995. Gro\\.th forcc:tsts for 1996 center o n a Ltnge of 2.5(%> to 2.7?4, I)i~texhii)it ;I f;lisl).niclc clispersion. 'l'he slo\ves grow111 forec;~st is I>asecl largely o n a n espectecl softening in the consumes sector, which accounls 1'0s appsosim:ttel). t~vo-thirclsof' tot:tl output. 1)espite sIi:u.1> increase in the preliminar-y cl;tt:t 1;)s Soveml)er, retail sales appear to h:l\.e clropped off in recent motlths. 'I'otal retail sales 1ia1.e :tdvz~ncecla t a 2.9% :tnnual I-ate since last ~\I;iy.co~npztreclwith 6.5% over t l ~ cp r e v i o ~ ~12 s months. Early (z111cl slietchy) evide~lcesuggests that Decemher's holicl;~y spending was we:lker tli;t11 xnticipatecl. In assessing h o ~ ~ s e h o lspencling d pattern^ :;"i;~lysts frequently cite consumers' sentiment a h o ~ l tImth 21 the o v e ~ l l economy l :lntl f11tilt.ejol) prc)spec~sEr'cli n1e;tx~esllon-eel a getleral cleterioration over 1995. I x ~ t I>oth telltl to hc lather vol:ttile. Actu;il elnployment g r o t i ~ l islo\vecl. but the ernploy~iient-to-~~c~~~i~~:ttion ratio se11i;tinecl ne:u. its recoscl peal<. hlIost o f the recent concern a b o i ~ t consumers h:is locusetl o n their clel>t I~ul~clens-partic~~larlythat porti(-)~i ;iss~ci;~tedwith credit Icor~~iitrrc~~l oil r~extpqqc~) http://clevelandfed.org/research/trends January 1996 Best available copy Economic Activig (cont.) Index. 1987 = 1 00 Percent risina Index, February 1966 = 100 Percenta a. Percent of respondents expecting improvement less percent expecting worsening, plus 100. SOURCES: Board of Governors of the Federal Reserve System; National Association of Purchasing Management; U.S. Department of Commerce, Bureau of Economic Analysis; and the University of Michigan. - Wa C carcls. Altlloiigh tlie ratio of consumer inst:~llment debt to clisposable income has picltecl tip since late 1992. there is little eviclence that co~lsuniers' licliliclity is constraineel. The clelincl~~ency rate o n consumer installment cleht has risen, hut it remains extremely low by historic stancl:trcls. The inciiistrial sector also shows some signs of softening. Imt n o eviclence of :tn o v e ~ l l ldecline. Inclustrial pl.ocluction, while generally up for the year, has remained flat in repotential is strengthening. 13usiness fixecl investment as :I s1ia1.e o f GDI' cent months. The purchasing manreached recorcl levels in 1994 a n d agers' incles c a l ~ ~ine at just uncler 50% l:lst year, implying about eclual 1995. :tnd productivity g r o ~ v t his p r o p ~ r t i o n sof managers reporting al,o\;c trend. The Stantlard & l'oor's growth ancl declines. The indilstrial 500 acl\iancecl more than 30% in sector accounts for only about 20% 1995, compareel with :tn average inof n~ltionaloutput, but it is a pivotal crease of 3.4% over the previous component of the business cycle. two years. 'l'hese strong g:~ins-k~r Despite the chance for some in excess of the inflation ratenear-term slowi~lgin U.S. econolllic imply that the market may I,e saisactivity, evidence increasingly s ~ ~ g - ing its espect;~tionsfor f~1t~ir.e real gests that our long-range growth earnings ancl economic jirowth. http://clevelandfed.org/research/trends January 1996 Best available copy The Eeld Curve Percentage poin!s GDP growth, percent ," -5 -4 -3 -2 -1 0 1 2 3 4 Interest-ratespreads, percentage points a. Month following cyclical peak to cyclical trough, as determined by the National Bureau of Economic Research. b. Average percentage-point spread between 10-year Treasury constant maturity and effective federal funds rate for 12 months prior to recession. c. Number of months between first inversion and onset of recession. d. Difference between 10-year Treasury constant maturity and effective federal funds rate. NOTE: Shaded bars indicate recessions. SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; Board of Governors of the Federal Reserve System; and National Bureau of Economic Research. The yiclcl cur\;e o n 'I'reasilry securities-\vIlicli clescril,cs rates of return at cliffercnt m:it~iriticsin 21scencling orclcr-hiis flatteneel drnmatic:llly since tllc' ~liirclquarter of 1994.At the enci of Ileccmber, the cliffesence 11etn.een the 10-year Treas~~r-y yielcl :incl the effc.cti\.e kclera1 ft~nclsrate XIS less than 20 Ix~sis points (a ixlsis point represents 1/100 of a perc.ent;ige point). 7'0 psoviclc somc perspecti\.c o n this cliffercncc, tllc spre:lcl il:is aver;lgccl nearly- 100 basis points in nonrecession ) - e m since 1354. 13:isecl o n past experience. this clecline in the rate spread between short-terrn :ind long-term interest rates has 13ised some concern about the prospectsfor the U.S. economy o\.cr the coming year: Kearly all [x)stt-19SOs recessions were prececlccl hy significant declines in the cliifrcnce Ixtween, for instance, the lO-~.c:u.7're;~suryrate and the federal f ~ ~ n cIxte. l s I11 all hut one instance, this sprc:~ci was actually rrcgatii~e prior to the clownturn. Thus, although the magnitude and timing of so-callecl yielcl-c~iiveinversions have cliffered before the onset of recessions, conventional wisclorn liolcls that negative, or very low, interestsate spreacls are harbingers of tough economic times. Changes in long-ter~nless shortterm interest rates depend, of course, o n the heh:rvior of rates at each ruaturity. Before becoming too (corztirllrcd O N ~zextpcige) http://clevelandfed.org/research/trends January 1996 Best available copy The EeId Curve (cont.) Percent Percentage points Percent 22 Percentage points 20 18 16 14 12 10 8 6 4 2 May Sept. 1972 Jan May 1973 Sept. Jan. Percent May 1974 Sept Jan 1975 O~an. Percentage points Percent May Sept 1980 Jan May Sept. 1981 Jan May Sept. 1982 Percentage points a. Vertical line represents business cycle peak. SOURCES: Board of Governors of the Federal Reserve System; and National Bureau of Economic Research alar~lieclat tlie niessages reacl from yield-curve tea 1eax.e~.it is instructive to examine the components of rate spreacls more closely. The recessions of 1973-75 ancl 3981-82 are typical o f most clo\c-nturns in the past 35 yexrs. In 11otli of tliese cpisocles. the 10-year 'I'reasu~)-/ fi~nds-satespreacl fell precipitously ;ttlcl invertecl sollie ~nonths1,efol.e tlie reccssion l>esin.These cleclines occurrecl even though long-term rates v\cr.c steacly or rising. The sinking r:ite spreacls. therefore, were largely I: result of filirly steep increases in the fecleral f~lnclsrate. A simil:~rpattern can be foiuncl before the 1960-61, 1970, zuncl 1980 contractions. A notable exception w;ls the 19C)O-91recession. Not only \\,as tlie yielcl inversion smaller in magnitucle ancl longer in lead ti~ile th;m clilr~ngearlier episocies, but the n e s t i v e 10-year/fi1ncIs-rate spreacls h : ~ lclisappeared six months lxfore the clo\v\;nturnbegan. Wltli tlie p o s h l e exception of this latest contraction, the current kill in rate spre;lcls is unlike the cleclines tlizit preceded earlier reces- sions. In cont~kstto constant or rising 10-year yielcls co~iibineclwith a rising fclncls sate. last year witnesseel a slightly killing funcls r:lte com1,inecl with significant declines in Ion,cycr-term r:ltes. Being cloomecl to repeat histol-y cloes imply that histo~yrepeats itself. A cleeper look into the recent yielclcurve cleciines suggests that the source of similar behavior in the p:~st-l)ch:lvior that clicl not illtimately 1,ocle \veil for short-term cco1io111icgro\\.th-may he absent in the curl-ent environment. - http://clevelandfed.org/research/trends January 1996 Best available copy Labor Markets Change, thousands of workersa 350 -100 Jan. Feb Mar Apr May June July Aug Sept Oct. Nov. - 3 - 2 - 1 0 1 2 3 4 5 6 Percent change a. Seasonally adjusted. b. December data not included. c. Finance, insurance, and real estate. SOURCE: U.S. Department of Labor, Bureau of Labor Statistics. I,al~orn~:irkets \Yere solicl 1x1~ not spect:~c~il;lr in 1995. as the nxtion postecl a ye:lrlong eml>loyment gain of 1.5 million jotxi. Although Deceml~crcl;~ta;ire not incluclecl in thc tally, this figlire 11~11s1:lst ).ear's net job cre:ltio11 at roiighly 11:llf the 1994 tot:11 (5.5 nill lion). E~nl>loynlenttooli a turn for the worse in the goocls-proclucii~gsector, sheelcling 102.000 ~vorlierscom11:u-eel to p i n of 696.000in 1994. Onc significant lactor in this loss n x s the hlc:~liemployment situation in man~ i k ~ c t ~ i r i where ng, a number of incl~istries, notably tra~lspor~ation ecluipn~entand fabricated metals, espcricncccl consistent cutbacks. h4ost se~~ice-producing categories aclclccl fewer worlcers in 1995 than in 1994. One exception was the conlp ~ i t u: ~ n ddata processing inelustry, u.hic11 170sted a 10% employnlcllt gain over the course of the year. 'l'ilis translatecl into 98,000 new jolx :iclclccl to the economy. ?'hc ~nonthlyunemploytnent figures fliict~i:lted cluite a hit during 1995. hut the average for the year (5.6"/o)c:une in kir I ~ e l o ~the v 1994 rate of 0.1%).At the regional le\.el. the c~nploymentnelvs IVZIS mixeel. Mountain states like Nevacl;~,I;tah. :~ndKc\\. Mexico exhihitecl strong gro\vtli. while inclustrial hubs (incliiding Ohio) finishecl in the miclclle of the p;lc1;. In adelition. a rising niiml~cro f st:ltes postecl net employment cleclincs comparecl to 1994. 0 0 . 0 b e http://clevelandfed.org/research/trends January 1996 Best available copy e Labor Market Trends Percent oi total employment 90 Percent 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 Percent Percent SOURCE: U.S. Department of Labor, Bureau of Labor Statistics The U.S. worliforce has unclergone c1rarn:ltic changes since Wi~rld\%r 11. The share of \i~orliersemployecl in the goods-producing sector has steadily declinecl, from 40%)in 1950 to 21% in 1993. The shifts I,et\veen manufacturing (the most cyc1ic:llly sensitive inc1ust1-y in the goodsproducing sector) and services have been the most prono~lncecl. The jobless sate in the gooclsproducing sector typically exceecis that of the service-producing sector. While unemployment in the service inelustries clenlonstrates a strong cyclical pattern, its cyclical variability is less than that of the gooclsproclucing sector. A second f~rnclamentallal~ormarket shift has occurred in the participation ~.atesof males and females. O\.er the last 45 years, the share of n,omen in the worl~forcehas risen from approxirnately 33% to about SO%!, while the fsaction of Inen has killen roughly 12 percentage points. 11~1r.ingthe 1960s 11ncl 1970s. as the P:KC ;it wllich \vomen enterecl the labor force quickenecl, the jot)less sate for women rose abo\.e t1l:it for- nlen. If this was p:irt of a n :icljustrncnt process, it seems to have enclecl. Since the early 1980s-as in tile 1950s ancl early 1960s-the two series have tsacltecl much more closely. http://clevelandfed.org/research/trends January 1996 Best available copy The FeFederal Budget Percent 1980 Percent 1985 1990 1995 2000 B ~ l l ~ o noisdollars 200i" Billions of dollars 1995 1996 1997 1998 1999 2000 2001 2002 Bllllons of dollars a. Dotted lines represent CBO baseline projections. b. "Other" includes net interest and offsetting receipts NOTE: All data are for fiscal years. SOURCE: Congressional Budget Office. National clelx cloilblecl from ~kbout 35% o f gross domestic product in 1980 to more than 70(yn in 1995. Although the Congression:ll 13uclget Office (CEO) preclicts the 1995 federal cleficit \?;illcome in at onl). 2.3% of G111'-the loxvest since 1979C130 projections l>:lsecl on current policy show that it \\rill rise to 4.0% of GI)P 1)); 2005. Rapicl increases in projectecl retiretilent 2nd liealth henefits for the I~al>y-hoom generations :ire eslxctecl to push these ratios still higher in the first tnn clecacles of the next century. Moreover, the Meclicare program is projectecl to be bankrupt by 2002 under current rules. This scenario has proved alarming enough to warrant agreement between Congress and the actministration on the neecl to achieve a 1,alanced buclget by that year. Despite such goodwill, however, issues about the nature of expenditilre cuts and possible tax recluctions remain unresolved. Congress \i~ishes to enact significant cuts in cliscretionary spending; reduce Medicare gro\\.th I,y increasing premiums and enco~~laging the use of HMOs; pare ivleclicaid spetlcling and shift the primzkry responsibility for this program to tlie states; and shrink outlays o n government research, food stamps, ecluc~ltion,and other mielfare programs. 'The aclministration, Iiowevel; prefers to retain the tnlo health-care progr~unsin their current form and to expanel expenditures on education. pro\~idemore for en\-'. , I I o11111ental protection, and boost outlays on go\,crnment research. http://clevelandfed.org/research/trends January 1996 Best available copy International Saving Trends Percent of GDP 40 30 20 10 0 U.S. Japan Germany France Italy U.K. Canada US Japan Germany France Italy U.K Canada Percent 24.0 Percent of GDF US. U.S. Japan Japan Germany Germany France France Italy Italy U.K U K. Canada Canada Percent 79.5 23.5 78.0 23.0 76.5 22 5 75.0 22.0 73.5 21.5 72.0 21.0 70.5 20.5 69.0 20.0 67 5 19.5 1960 1965 1970 1975 1980 1985 1990 66.0 1995 SOURCES: Organisation for Economic Co-operation and Development; International Monetary Fund; Bank of England; National Income and Product Accounts; and Deputies of the Group of 10 Countries. Measurecl real interest r:ltes hi11.e increasecl in clevelopecl countries over the last 30 years. Among the se\.en largest de\;eloped n:ltions, the upticks rime steepest in France (210 basis ponts) ancl the Ii.S. (200 I~asis points). 'I'his trencl m:1y I>eattributeel to a longterm decli~lein s:l\.ing in 11ic)stcleveloped economies. Incleecl, f~otlis:~\.ing211nclinvestlllellt 111oved clistinctly lo\ver clrlsing this pcriocl. Aggregate saving is con\;ention:dly sep:~rateclinto pu1,lic saving (the government's l>~lclgetsurplus) anel private sxving (saving out of personal clisposable income, or national income less net taxes). Uncler this methocl, contributions for social insurance :Ire inclucled in direct taxes, not in clispos;~bleincome. Because these contrihutio~lsare clepositecl in a trl~stfuncl ancl are associatecl with expected f ~ ~ t ubenefits, re indivicl~~:~ls may consicler them part of their ou-n saving, arlcl their existence may affect sa\.ing out of clisposable income. Whether such contributions shoulcl I)e cl:~ssifiecluncler public or pri\.;lte s:~\.ingis, therefore, deb:lt;lhle. The conventional methocl of cleter~niningaggregate saving suggests th:~t greater fiscal cleficits are the main cause o f 1on.e~saving :inel higher interest rates. In the I-.S.. ho\\.ever, changes since the 1960s in private ancl government consumption espencliti~sesas a share of national o u t p ~ point ~t to the opposite conclc~sion:The steep increase in private consumption is primarily resaving sponsible for low nr~tio~lal rates in the 1930s. e e a e http://clevelandfed.org/research/trends January 1996 Best available copy e Banking Conditions Percent Percent Billions of dollars 4 75 Net interest rnargln Percent Percent a. Includes credit card lines, home equity lines, commitments for construction loans, loans secured by commercial real estate, and unused commitments to originate or purchase loans. b. Troubled assets include noncurrent loans and leases plus other real estate owned. NOTE: All data are for FDIC-insured commercial banks. 1995 data are for the first three quarters of the year and are annualized where appropriate. SOURCE: Federal Deposit Insurance Corporation. Conunerci:ll h:~nlic:trnings so:u-eel to a recorcl high of S13.S t~illionin the thircl clu:irter, sp~lrreclby strong l(xun gro\vth, stalde net interest margins, ancl recl~lcetltleposit insuwnce prem i ~ ~ m 13~111i s. eart~illgshave no\v surpassed $10 tillion for 11 consec~ltiveC J L I ; I S ~ ~ S S . The inclust~j.'~ return o n assets rose to a recorcl 1.32%)in 199S:IIIQ. I>ringing the :I\.el.age for the first three quarters of the year to I . 19(% --more than t\\.ice the le\.el seen onl). four years ago. Although the net interest margin has cleclined from its 1994 average, it has not klllen since the first quarter of 1995 ancl rem:~insa l ~ o v epre-1992 levels. Hanks have increased the fraction of loans in their portfolios, allowing higher returns even though the net interest tn:u.gin has remained flat. Gro\vth of unusecl loan conlmitments continues to outpace the rise in Imnk loans. This suggests t h : ~ lencling stanclarcls are relati\,cly re- l:~sed 2nd th:it changes in clemancl m:ky I>e the prevailing factor for ch:lnges in creclit. ,. I he clu:~lit)~ of commercial hanl< assets rern;~ineclstrong in 1995:IIIQ, as the satio of trouhlecl assets to total assets continueel to clecline. Net charge-offs as a share of loans ancl leases increased slightly in the JuIy-to-Septe~~~l>er periocl, b ~ l tthe a v e n g e for the first three quarters of I995 remained helow 1994's e 0 . 0 B 69 http://clevelandfed.org/research/trends January 1996 Best available copy P) Banking Conditions (cont.) B ~ l l ~ o n01sdollars B~llionsof dollars la lila 1991 IQ IIIQ 1992 la ills 1993 la ilia 1994 la IIIQ 1995 NOTE: All data are for FDIC-insured commercial banks. SOURCE: Federal Deposit Insurance Corporation. level. The banking inclust~y'sretnrn o n equity set a new secosci of 16.30% in the third cluarter. l'he preset in vious higl~-1G.13°/o--was the thircl quarter of 1993. The ratio of equity capital t o assets continued to fir111 cluring the first nine months of t h e year, with ;I 10.4%)increase in equity capital overshaclowing a 7.8% rise in assets. T h e quality of com~nercialI ~ a n k loans remaineel strong in the thircl quarter, although clelincluency and net charge-off rates pickecl LIP slightly. More than half of the $57.4 billion increase in loans was traceaide to real estate loans and loans to consumers. Loans to conl~rlercial anel inclustrial (C&I) borrowers showecl theis smallest quarterly rise in two years. Noncurrent loans (those 90 days or Illore past due) continuecl to ciecline. At the enci of the thircl quarter, noncurrent loans stood at $31.5 million, $1.9 t,illion below the year-ago level. However, clelinquent lo;ins (those 30 to 89 clays past clue) increasecl cluring the thircl quarter, possibly suggesting higher future levels of noncurrent loans. Despite sluggish thircl-quarter gro\vth. C&I borron;ing in September was up 12.5% over year-ago levels, with strong loan growth in every region of the country. Only four states saw a clecrease in these types of loans. 18 e e e e e http://clevelandfed.org/research/trends January 1996 Best available copy . The German Economy Percent Percent chanae from fourth quarter of orevious yeara J M M J S N J M M J S N J M M J S N 1993 Percent change from corresponding month of previous year 1994 1995 Percent change from corresponding quarter of previous year a. Annualized and seasonally adjusted. b. Horizontal llnes represent the Bundesbank's M3 target for 1993, 1994, and 1995. Each target's base period is the fourth quarter of the previous year. SOURCES: Deutsche Bundesbank; and DRIIMcGraw-Hill. When the R~~nclesl)anii cut official interest rates on 1)eceml)er 14, other European centl-al banlis cl~~ickly followecl suit. Observers, noting helo%\.-targetGerman money grot\~th ancl IOLV irlfl;itior~.a11tici~:itefl~~rther (;errran interest-rate c ~ ~ t s . 'The BunclesI,anl<Act recl~~ires the German centlxl 11:lnli to rnaintain the "sta1)ility of the currcnc~.."7he mons seer11 etary a ~ ~ t h o r i t i etl.;iciitionally to interpret an inflation rate helow 2% as being consistent with this inzinclate. Germany's inflation rate, which rose sharply following unification, clroppecl below 2% early this year ancl has continued to mocler.ate. In November, consumer prices were LIP1.7% over year-ago levels. Ileal German GDP growth slo\vetl over the first three quarters of '1995. but remained fairly strong. Many economists, ho\vever, fear that real eronomic activity will stall or possi- hly c o n t ~ i c in t 1995:IVQ. Real man~ ~ f a c t ~ ~ rorclers i n g fell sharply in October, ancl industrial production h~tsbeen weali. Ilecember's disruptions in shipments -stemming frorn French rail strilies-fi~rther darlienecl the b~lsinessoutlook. Business conficlence has ebbed, suggesting that capital spenclirlg may slow. A suhst;intial \vealieni~lg in German economic zictivity coulcl clampen growth througho~~t Europe. http://clevelandfed.org/research/trends January 1996 Best available copy The Mexican Economy Pesos oer U S dollar Perceni chanae, annual raie 85 80 75 70 65 60 55 50 45 40 35 30 N D J F M A M J J A S O N D J Percent change from corresponding rnon!h of previous year B ~ l l ~ o nofsU S dollars 20 10 0 - 10 - 20 - 30 - 40 iva IIIO la iia 1994 IIIQ ivoa 1995 a. Current account data are not ava~lable.International reserves data are through October 1995. SOURCES: DRllMcGraw-Hill; International Monetaty Fund; and Board of Governors of the Federal Reserve System. year a!'ter l'lesico's clis;tstrous peso cleprwiation. the n-orst of' the 1~1:ltter 11i:t). I>e ox-er. htIcsico's ~wosl7ects-pa1~tic11~:11-i~its access Lo international capital m:trl\ers-\\.ill clelxr~clon tlie go\-ernme~it's c:tpacit)' to sclst:lin a stal~iliz:ktionprogr:um in the lace o f \veal< economic acti\.ity ancl :k shak). financial sector. 12inancial niarliet jitters in Octohcs anel Noveml>cr (11-hicll h a w since c:llrnecl) cl~licl\rl).sent h'lesican inte1.cst rates Ilighes ancl the peso 1on.c.r. Mesico's <;1>1' has coiit~tctecl \f sharply since 1994:IVQ. More moclemte cleclines in real economic :kc:i\.ity since 1995:111Q, couplecl nith impsot-cments in the nation's espoi-t inclustr).. offer soille hope th:tt the secession has hit bottom. Severtheless. the prospects for a rapicl recovery this year remain few. .i,h e peso's clepreciatioll :tncl the recession ha!^ eliminatecl Mesico's current ;tccorlnt cleficit. 111October. imports stoocl 6.7% below year-ago le\.els, lvhile esports \\;ere 35.7% higher. The current account shifteel from a SZ9 hillion (a1111~1:tlrate) cleficit in 1994:IVQ t o :I $2 h i l l i o ~ ~ surl'l~~sin 1995:IIIQ. International reser\.es, \\-liich fell to $6.3 I~illion1)). the encl of 199.-i.Il:t\.e sincc risen to S l"t.5 l~illion.although largel). flum inf1ou.s of of'ici:~lfilncls. hIcsico prol>:tl~l).xvill not sustain :I current :~ccoitnts u r p l ~ ~ once s the recent crisis h:ls passecl. C o ~ ~ n t r i e s importing Soreign capital f i ~ rclc\-elopnlent typic;tlly 1.~111 C L I I - S ~ I I ~:ICcount cleficits.
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