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Federal Reserve Bank of Cleveland

Economic Trends
January 2007
(Covering December 21, 2006 - January 10, 2007)

In This Issue
Economy in Perspective
Economic Trends in Perspective
Inflation and Prices
Inflation Expectations
Trimmed Mean CPI Inflation
November Price Statistics
Money, Financial Markets, and Monetary Policy
Market Expectations of Policy Rates
Interest Rates, Yields, Outstanding Debt, and Consumer Attitudes
The Yield Curve’s Predictive Power
International
Current Account Sustainability
Economic Activity
Labor Market Conditions
ISM Report on Business Activity
Housing
Labor Turnover
Durable Goods
Revised GDP
Regional Economic Activity
Employment Conditions
State Per Capita Personal Income
The Akron MSA
Banking and Financial Institutions
Banking Conditions

Economic Trends is published by the Research Department of the Federal Reserve Bank of Cleveland.
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ISSN 0748-2922

The Economy in Perspective
01.10.07
by Mark S. Sniderman
Economic Trends in Perspective…The Federal Reserve Bank of Cleveland has been publishing Economic Trends since
1981, and for the past 25 years it has looked more or less the same: Trends has consisted of 20 to 24 pages of material that briefly analyzed a variety of regional, national, and international economic topics and presented a few
graphic images on each page. With this issue, we are breaking new ground—Economic Trends is going fully electronic
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1

Inflation and Prices

Inflation Expectations
01.10.07
by Michael Bryan and Linsey Molloy

CPI Inflation and CPI Inflation Forecasts*
Annualized quarterly percent change
6.0
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
-2.5
-3.0
1995

Top 10
average

Consensus

Bottom 10
average

1997

1999

2001

2003

2005

2007

2009

*Blue Chip panel of economists.
Source: Blue Chip Economic Indicators, January 10, 2007.

Market-Based Inflation Expectations*
Percent, monthly
3.50
Adjusted 10-year TIPS -derived expected inflation a
3.25
3.00
2.75
2.50
2.25

Keeping inflation expectations “contained” seems
to be an important preoccupation for central bankers. This is because the expectation of higher inflation induces changes in economic behavior that
impose costs on the economy, which, over time, are
detrimental to long-term prosperity. For example,
when people anticipate an increase in inflation—
and the corresponding decline in the purchasing
power of their money—they are more likely to
invest their wealth in real assets, such as land or
commodities. This reallocation is a less efficient use
of resources than what may have occured if people
didn’t have to seek this inflation-protected form of
saving. Rising inflation expectations may also help
to perpetuate an otherwise temporary rise in prices,
making the job of maintaining price stability more
difficult to achieve.
To gauge inflation expectations, economists turn to
a number of sources, including surveys of consumers, financial market data, and economists’ predictions. A recent look at each of these sources shows
inflation expectations are running anywhere from 1
to 3-1/2 percent, depending on the source and the
period over which inflation expectations are projected (1 to 10 years).

2.00
1.75
1.50
10-year TIPS-derived expected inflation

1.25
1.00
0.75
1997

1999

2001

2003

2005

2007

*Derived from the yield spread between the 10-year Treasury note and Treasury
inflation-protected securities.
a. Ten-year TIPS-derived expected inflation, adjusted for the liquidity premium on
the market for the 10-year Treasury note.
Sources: Federal Reserve Bank of Cleveland; and Bloomberg Financial
Information Services.

Consumers’ year-ahead inflation expectations were
elevated in the wake of Hurricane Katrina and
geopolitical issues that drove up the price of oil
through last summer but have since tumbled downward. Consumers now anticipate that prices will
rise about 3-1/2 percent over the next year. Longterm inflation expectations—which have been
slightly higher, on average, over the past couple
of years—indicate that consumers anticipate that
prices will rise about 3-1/2 percent over the next 5
to 10 years as well.

2

One source of data from financial markets that can
be used to guage inflation expectations is a comparison of the returns on Treasury inflation-protected
securities (TIPS) and regular (nominal) Treasury
securities (click here for data and an overview and
here for more detail). TIPS-derived inflation expectations have come down a bit in recent months:
Investors now expect prices to rise between 2 and 2
¼ percent over the next 10 years.

Household Inflation Expectations*
12-month percent change
6.0
5.5

One year ahead

5.0
Five to 10 years ahead

4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
1995

1997

1999

2001

2003

2005

2007

*Mean expected change as measured by the University of Michigan’s
Survey of Consumers.
Source: University of Michigan.

Distribution of 2007 CPI Forecasts*
Percent of forecasts
50
45
December 10, 2006
January 10, 2007

40

Meanwhile, the Blue Chip panel of economists
anticipates that quarterly inflation will fall dramatically in the fourth quarter of 2006 and average
about 2-1/2 percent over the next two years. In
light of the relatively sanguine inflation report for
November, the distribution of 2007 forecasts has
shifted downward a bit. In December, the consensus forecast was for a 2.1 percent annual growth
rate in the CPI in 2007, with a majority of forecasters predicting a 2 to 2-1/2 percent rise in the CPI.
In January, the consensus forecast ticked down to 2
percent, with a majority of forecasters predicting a
1-1/2 to 2 percent rise in the CPI in 2007.

35
30
25
20
15
10
5
0
1.0 to 1.5

1.5 to 2.0 2.0 to 2.5 2.5 to 3.0 3.0 to 3.5
Annual percent change, 2006 to 2007

3.5 or
greater

*Blue Chip panel of economists.
Sources: Blue Chip Economic Indicators, December 10, 2006 and January 10, 2007.

3

Inflation and Prices

Trimmed Mean CPI Inflation
CPI Component Price-Change Distribution,
January 1998 to November 2006
Weighted frequency

01.10.07
by Michael Bryan and Linsey Molloy
In a recent speech Governor Kohn of the Federal
Reserve System noted that

50
45
40
35

Average inflation rates
CPI: 2.6%
Core CPI: 2.2%
Median CPI: 2.9%
16% trimmed-mean CPI: 2.3%

30
25
20
15
10
5
0
<0

0 to 1

1 to 2

2 to 3

3 to 4

4 to 5

>5

Average annualized monthly percent change
Source: U.S. Department of Labor, Bureau of Labor Statistics.

Trimmed-Mean CPI
12-month percent change
6.50
CPI
6.00
5.50
5.00

80% trimmedmean CPI
Median CPI

4.50
4.00

60% trimmedmean CPI

3.50
3.00
2.50
2.00

40% trimmedmean CPI

1.50
1.00
1990

1992

1994

1996

20% trimmedmean CPI
1998

2000

2002

2004

2006

Sources: Department of Labor, Bureau of Labor Statistics; and Federal Reserve
Bank of Cleveland.

“[c]ertainly, the recent data on consumer prices have been encouragingly consistent with the
downward tilt to inflation that the FOMC has
been expecting. However, we need to be cautious about extrapolating trends from a couple
of months of data. The data themselves are
noisy—subject to month-to-month variations
that are unrelated to more-persistent developments. And we need to recognize that some
of the very recent disinflation may represent
one-time influences.”
Separating transitory “noise” from the price data
to reveal the more persistent inflation trend that
the central bank hopes to control is difficult—and
controversial. It is difficult because it is often unclear when a price change is transitory and when it
signals a change in the inflation trend. It’s controversial because ignoring certain price signals may be
interpreted as a selective and perhaps biased interpretation of the data.
The most common approach to reducing the
“noise” in the price data is the so-called Core CPI
measure, which excludes the prices of food and
energy items. This measure certainly eliminates two
of the most volatile, or “noisy” components in the
U.S. retail price data. But this approach does not
address transitory price fluctuations in other components of the retail market basket. And because it
systematically eliminates two components from the
retail market basket, it may also bias the inflation
measure—if there are long-term movements in the
prices of food and energy relative to other goods
and services.
An alternative approach uses “trimmed-mean estimators,” which eliminate any price change above
or below a certain threshold, regardless of what the
component is. In the CPI, for example, one commonly sees a significant portion of the items in the
4

Volatility of One-Month Percent Changes
in the Trimmed-Mean CPI Inflation
Measures, January 1990 to November 2006
Time-series variance
0.055
0.050
0.045
0.040
0.035

market basket with price increases well above or below what the inflation trend ultimately is revealed
to be.
Where the appropriate threshold lies is unclear, as
is the question of which items get excluded from
consideration are unclear. We can exclude the most
extreme, say 5 percent, from each tail of the pricechange distribution, resulting in a “10 percent
trimmed-mean” inflation estimate. Or we could
calculate a more substantial trim—say 49-1/2 percent from each tail to produce the median CPI.

0.030
0.025
0.020
0.015
0.010
0.005
0.000

5

1

10

15

20

25

30

35

40

CPI

45

50a

Core CPI

a. The 50 percent trimmed-mean CPI is equivalent to the Median CPI.
Sources: Department of Labor, Bureau of Labor Statistics; and Federal Reserve
Bank of Cleveland.

Forecast Accuracy of the One-Month
Annualized Percent Change in the
Trimmed-Mean CPI Inflation Measures
in Predicting CPI Inflation over the
Next 12 Months
Root mean-squared error
2.6
2.5
2.4
2.3
2.2
2.1
2.0
1.9
1.8
1.7
1.6
1.5
1.4
1.3
1.2
1.1
1.0

1

CPI

5

10

15

20

25

30

35

40

45

50 a

Core CPI

a. The 50 percent trimmed-mean CPI is equivalent to the Median CPI
Source: U.S. Department of Labor, Bureau of Labor Statistics; and Federal Reserve
Bank of Cleveland.

In December, the 12-month change in the CPI was
2 percent. But the trimmed-mean CPI estimates
showed considerably higher trends, ranging from
about 2-1/2 percent for the 20 percent trimmed
mean, to around 3-1/2 percent for the median
CPI. Each trimmed-mean estimate can give a different read on the underlying inflation trend, so
which one comes closest to measuring the inflation trend that we ultimately see in the data? We
find that once we trim about 8 percent off each
tail of the CPI monthly price-change distribution
(a 16 percent trimmed mean), we have reduced a
substantial amount of the volatility in the monthly
data. More extreme trims of the CPI distribution
result in nearly the same stability, which means it
is hard to distinguish between the relative accuracy
of any trimmed-mean CPI estimator from the 16
percent trimmed-mean to the median CPI. And all
of these trimmed-mean estimates appear to give a
better reading of the inflation trend than the more
traditional “core” approach.
How do we know that these trimmed-mean estimators don’t eliminate some of the inflation “signal?” Well, we don’t, and this is always a risk when
appealing to any “core” inflation measures when
trying to gauge underlying price pressure. Still,
repeated tests in the United States and for other
nations (for example, Australia) indicate that these
trimmed-mean estimators seem to track the future
behavior of the CPI better than either the CPI or
the more traditional Core CPI.
In other words, whatever is being excluded, or
trimmed, from these measures doesn’t seem to be
very helpful in telling us where the inflation trend
is headed.
5

Inflation and Prices

November Price Statistics
12.21.06
by Michael Bryan and Linsey Molloy

November Price Statistics
Percent change, last
12mo.

5yr.a

2005
avg.

1mo.a

3mo.a

6mo.a

All items

0.0

-3.9

-0.2

2.0

2.6

3.6

Less food and energy

0.6

1.6

2.3

2.6

2.0

2.2

Medianb

3.0

3.4

3.8

3.7

2.7

2.5

16 percent trimmed
meanb

1.0

1.5

2.2

2.5

2.2

2.6

Finished goods

26.4

-3.9

-0.6

0.9

2.9

5.7

Less food and energy

16.3

3.9

1.1

1.8

1.2

1.5

Consumer prices

Producer prices

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.

CPI and CPI Excluding Food and Energy
12-month percent change
4.75
4.50
4.25
4.00
3.75
3.50
3.25
3.00
2.75
2.50
2.25
2.00
1.75
1.50
1.25
1.00
1995

CPI

Core CPI

1997

1999

2001

2003

Source: U.S. Department of Labor, Bureau of Labor Statistics.

2005

2007

The Consumer Price Index (CPI) was unchanged
in November following two months of substantial declines. Monthly growth in the core inflation measures showed a marked deceleration from
longer-term trends in November. Like the CPI,
the CPI excluding food and energy was also largely
unchanged (rose at a 0.6 percent annualized rate)
during the month. The 16 percent trimmed-mean
CPI, which eliminates 8 percent of weighted components with both the largest and smallest monthly
price changes, rose a modest 1.0 percent (annualized rate), while monthly growth in the median
CPI has come down a bit to 3.0 percent (annualized rate).
Longer-term inflation trends were still relatively
high in November yet appear to be decelerating
some from their recent peaks. Both the 12-month
growth rate in the CPI excluding food and energy,
as well as the 16 percent trimmed-mean CPI, are
down over 1/4 percentage point since 2006Q2, yet
remain elevated at rates between 2-1/2 and 2-3/4
percent. The longer-term trend of the median CPI,
however, continued to accelerate during the month
to its highest rate since mid-2002.
While the shorter-term trends in the retail price
measures seem to suggest on the surface that inflation rates slowed during the month, the curious
component price distribution makes it difficult to
identify any underlying trend among retail prices.
Indeed, a mere 10 percent of the CPI registered
price increases in the 0 percent to 3 percent
range—the range which most economists consider
to be consistent with the current inflation trend.
The monthly price declines offset the sizeable
monthly price increases: Either prices were falling
(34 percent of the CPI), or rising in excess of 3
percent (about 55 percent).

6

CPI and Trimmed-Mean CPI Measures*
12-month percent change

CPI Component Price Change Distribution
Weighted frequency

4.25

50

4.00

45

3.75

Median CPI

3.50
3.25

40
35

3.00

Motor fuel, fuel oil, and other fuels

2.75

30

2.50

25

Owner’s equivalent rent of
primary residence

2.25
20

2.00
1.75
1.50

16% trimmed-mean CPI
10

Core CPI

1.25
1.00
1995

Gas (piped)
and
electricity

15

5
1997

1999

2001

2003

2005

2007

*The Median CPI and the 16% trimmed mean CPI are alculated by the Federal Reserve
Bank of Cleveland.
Sources: U.S. Department of Labor, Bureau of Labor Statistics; and Federal Reserve
Bank of Cleveland.

0
<0

0 to 1

1 to 2
2 to 3
3 to 4
4 to 5
Annualized monthly percent change

>5

Source: U.S. Department of Labor, Bureau of Labor Statistics.

Money, Financial Markets, and Monetary Policy

Market Expectations of Policy Rates
01.04.07
by Bruce Champ and Bethany Tinlin

Reserve Market Rates
Percent
8
Effective federal funds rate

7

a

6
5

Primary credit rate

b

4
3
2
1

Discount rate b

0
2000

2001

Intended federal funds rate b
2002

2003

2004

2005

2006

a. Weekly average of daily figures.
b. Daily observations.
Source: Board of Governors of the Federal Reserve System, “Selected Interest Rates,”
Federal Reserve Statistical Releases, H.15.

On December 12, the Federal Open Market
Committee (FOMC) decided to leave the federal
funds rate unchanged at 5.25 percent. In its statement, the FOMC noted that economic growth
had slowed, primarily because of a weak housing
market. However, the committee also remarked
that “the economy seems likely to expand at a moderate pace on balance over coming quarters.” The
FOMC expressed some concern about recent data
on core inflation but felt that “inflation pressures
seem likely to moderate over time.” It left open the
possibility of additional policy tightening in order
to curb potential “inflation risks.” Richmond Fed
President Jeffrey M. Lacker dissented from the
committee’s decision, preferring a rate hike of 25
basis points.
Looking ahead, participants in the federal funds
options market currently expect the FOMC to
keep the funds rate at 5.25 percent over the next
7

Implied Probabilities of
Alternative Target Federal Funds Rates,
January Meeting Outcome*
Implied probability
1.0
5.25%

0.9
0.8
0.7

GDP release

0.6

New home sales

0.5

Existing home sales

0.4

FOMC meeting

5.50%

0.3
0.2

5.00%

0.1
0.0
09/22 10/02 10/12 10/22 11/01 11/11 11/21 12/01 12/11 12/21 12/31
*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: Chicago Board of Trade; and Bloomberg Financial Services.

Implied Probabilities of
Alternative Target Federal Funds Rates,
March Meeting Outcome*
Implied probability
1.0

GDP release

0.9

New home sales

0.8

Existing home sales

0.7

FOMC meeting

0.6
5.25%
0.5
0.4
0.3
0.2

5.00%
5.50%

0.1

4.75%
0.0
11/01 11/07 11/13 11/19 11/25 12/01 12/07 12/13 12/19 12/25 12/31
*Probabilities are calculated using trading-day closing prices from options on
March 2007 federal funds futures that trade on the Chicago Board of Trade.
Sources: Chicago Board of Trade; and Bloomberg Financial Services.

two meetings. These expectations were moderately
reinforced by the December 12 decision. Key data
releases, such as revisions in third-quarter GDP
and data on home sales, had only minor impact on
expectations regarding the future course of monetary policy. The minutes of the December meeting,
released on January 3, seemed to jar recent investor
optimism. Market participants focused on the extent of the FOMC’s concern regarding the housing
market slowdown, and the minutes’ release prompted a sharp decline in the stock market. However,
the release of the minutes had little impact on
expectations regarding future monetary policy.
Currently, participants place more than a 95
percent probability on the committee keeping the
funds rate at 5.25 percent at the January meeting.
Looking further ahead toward the FOMC’s March
meeting, participants overwhelmingly expect no
change in policy, although a 13 percent probability
is placed on a cut of 25 basis points in the funds
rate at that meeting. Participants in the federal
funds futures markets also see the possibility
Eurodollar futures, which provide a longer-run
perspective on the expected course of monetary
policy, similarly point policy change over the coming months. Participants in this market expect the
FOMC to lower rates throughout 2007; however,
they also expect a fairly quick round of policy easing, with rate hikes in 2008.
During the last round of policy tightening, from
June 2004 to June 2006, the real federal funds rate,
defined as the effective nominal federal funds rate
less core PCE inflation, rose more than 370 basis
points. Currently, the nominal funds rate stands
near the upper end of the range suggested by the
Taylor rule, with a target inflation rate of between
one and three percent. The Taylor rule views the
federal funds rate as a reaction to a weighted average of inflation, target inflation, and economic
growth.

8

Implied Yields on
Federal Funds Futures*

Real Federal Funds Rate*
Percent

Percent
6.0

5.30

5.0
5.25
Dec 29, 2006
5.20

4.0
3.0

a
Sep 22, 2006

5.15

a
Oct 26, 2006

2.0
1.0

a
Dec 14, 2006

5.10

0.0
5.05

-1.0

5.00
Sep Oct
2006

Nov Dec

Jan Feb
2007

Mar

Apr

May

Jun

Jul

-2.0
1987 1989 1991 1993 1995 1997 1999 2001 2003 2005
*Defined as the effective federal funds rate deflated by the core PCE. Shaded bars
represent periods of recession.
Sources: U.S. Department of Commerce, Bureau of Economic Analysis; Board of
Governors of the Federal Reserve System, “Selected Interest Rates,” Federal
Reserve Statistical Releases, H.15; Federal Reserve Bank of Philadelphia;
and Bloomberg Financial Information Services.

*All yields are from constant-maturity series.
a. One day after FOMC meeting.
Source: Bloomberg Financial Information Services.

Implied Yields on Eurodollar Futures
Percent

Taylor Rule*
Percent

8.0

5.8

7.0

5.6

a

a
Inflation target: 1%

6.0

Oct 26, 2006

5.4

5.0

5.2

4.0

Dec 29, 2006
Dec 14, 2006

a

3.0

5.0

2.0
Inflation target: 3% b

4.8
4.6

1.0
Effective federal funds rate

a
Sept 22, 2006

4.4
2005

0.0
-1.0

2007

2009

2011

a. One day after FOMC meeting.
Source: Bloomberg Financial Information Services.

2013

2015

1999

2000

2001

2002

2003

2004

2005

2006

*The formula for the implied funds rate is taken from the Federal Reserve Bank of
St. Louis, Monetary Trends, January 2002, which is adapted from John B. Taylor,
“Discretion versus Policy Rules in Practice,” Carnegie–Rochester Conference
Series on Public Policy, vol. 39 (1993), pp. 195–214.
a. This line assumes an interest rate of 2.5 percent and an inflation target of 1 percent.
b. This line assumes an interest rate of 1.5 percent and an inflation target of 3 percent.
Sources: U.S. Department of Commerce, Bureau of Economic Analysis; Board of
Governors of the Federal Reserve System, “Selected Interest Rates,” Federal Reserve
Statistical Releases, H.15; Federal Reserve Bank of Philadelphia; and Bloomberg
Financial Information Services.

9

Money, Financial Markets, and Monetary Policy

Interest Rates, Yields,
Outstanding Debt, and Consumer Attitudes
01.02.07
by Bruce Champ and Bethany Tinlin

Yield Curve

The yield curve remained inverted in December,
with the yield on 10-year Treasury securities nearly
40 basis points below that on the 1-year Treasury
bill. An inverted yield curve has been a feature of
the data throughout the summer and fall months
of 2006. Historically, inverted yield curves have
often preceded recessions. However, an inverted
yield curve can also be consistent with the Federal
Reserve’s ability to contain long-run inflationary expectations. For an analysis of the predictive power
of the yield curve, see “The Yield Curve’s Predictive
Power.”

Percent, weekly average
5.3
5.2
5.1
5.0

Aug 11, 2006 a

4.9
4.8

Oct 27, 2006

4.7

Sept 22, 2006

a
a

Dec 22, 2006

4.6

Dec 15, 2006

4.5

a

4.4
0

5

10
Years to maturity

15

a. Friday after the FOMC meeting.
Sources: Board of Governors of the Federal Reserve System, “Selected Interest
Rates,” Federal Reserve Statistical Releases, H.15; and Bloomberg Financial
Information Services.

Short-term Interest Rates
Percent, weekly
7
6

Target federal funds rate

5
4
3

Three -month Treasury bill

a

One-year
Treasury bill

a

2
1

Six-month Treasury bill

a

0
1997

1999

2001

2003

2005

a. Yields from constant-maturity series.
Sources: Board of Governors of the Federal Reserve System, “Selected Interest
Rates,” Federal Reserve Statistical Releases, H.15; and Bloomberg Financial
Information Services.

20

Short-term interest rates increased step in step with
the federal funds rate during the last round of tightening by the Federal Open Market Committee.
Over the two-year round of policy tightening, the
90-day Treasury bill rate increased more than 350
basis points.
Nominal yields on long-term Treasury securities
have trended downward since policy tightening
ended in late June. Since that point in time, the
yield on 10-year Treasury notes has fallen nearly
70 basis points, resulting in the strongly inverted
yield curve we observe today. The decline in longterm Treasury rates has been mimicked by a nearly
identical fall in conventional mortgage rates over
the same period.
Due to strong and liquid corporate balance sheets,
risk premiums on corporate debt remain at historically low levels. Since January 2004, the spread
between yields on AA-rated debt and the 10-year
Treasury rate have varied little, averaging slightly
over one basis point. However, risk premiums on
lower-rated corporate debt have been higher and
more volatile over that period.
Home mortgage debt continued to rise at doubledigit rates in the third quarter of 2006, albeit at
10

Long-term Interest Rates
Percent, weekly
10
9
8
Conventional mortgage

7
6
5
4

20-year Treasury bond

a

3

10-year Treasury note

a

2
1
0
1997

1999

2001

2003

2005

a. Yields from constant-maturity series.
Sources: Board of Governors of the Federal Reserve System, “Selected
Interest Rates,” Federal Reserve Statistical Releases, H.15; and Bloomberg
Financial Information Services.

Yield Spreads: Corporate Bonds
Minus the Ten-Year Treasury Note*
Percent, weekly
12
10
High yield
8
6

more modest rates than those observed earlier in
the year. Nonrevolving consumer credit growth
continued to slow. Much of this slowdown is attributed to a decline in vehicle sales. Monthly data
demonstrate a marked slowdown in consumer
credit outstanding during October. Nonetheless,
levels of consumer debt remain at historically high
levels. However, despite high levels of consumer
debt, delinquency rates on consumer loans remain
subdued.
The Conference Board’s Index of Consumer Confidence rose markedly in December, after falling
modestly in October and November. December’s
increase placed the index at its highest level since
April. Both the present conditions and expectations component of the index registered increases.
Consumer perceptions of conditions in the labor
market improved, according to the survey.
In contrast, the University of Michigan Consumer
Sentiment Index fell slightly in December. After
reaching its highest level since July 2005 in the
October survey, the index has fallen modestly during the last two months. The expectations component of the index fell two points from November
to December. However, the current conditions
component of the index actually rose in December.
Lower gasoline prices appear to be an important
factor improving consumers’ views about their current conditions. According to the Michigan survey,
household inflation expectations fell slightly in December, with the one-year ahead inflation expectation at 2.9 percent.

4
BBB
2
AA
0
1998

2000

2002

2004

2006

*Merrill Lynch AA, BBB, and High Yield Master II indexes, each minus the yield
on the 10-year Treasury note.
Sources: Board of Governors of the Federal Reserve System,
“Selected Interest Rates,” Federal Reserve Statistical Releases, H.15; and
Bloomberg Financial Information Services.

11

Outstanding Debt

Consumer Attitudes
Percent of income

Ratio

Four-quarter percent change
25

150

120

140

114

20
130

Revolving consumer credit
15
10
5
Home mortgages

0

Nonrevolving consumer credit
-5

a
108

120

102

110

96

100

90

90

84

80

78

70

72

60

66

Consumer confidence, Conference Board

50

-10
1991

Consumer sentiment, University of Michigan

1993

1995

1997

1999

2001

2003

2005

Source: Board of Governors of the Federal Reserve System.

60

2000

2001

2002

2003

2004

2005

2006

a. Data are not seasonally adjusted.
Sources: University of Michigan; and the Conference Board.

Money, Financial Markets, and Monetary Policy

The Yield Curve’s Predictive Power
Yield Spread and Real GDP Growth*
Percent
12
10
8

Real GDP growth
(year-over-year)

6
4
2
0
-2

Yield spread:
10-year Treasury - 3-month Treasury

-4
1953 1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005
*Shaded areas represent recessions.
Sources: Department of Commerce, Bureau of Economic Analysis;
Board of Governors of the Federal Reserve System.

12.21.06
by Joseph G. Haubrich and Brent Meyer
The slope of the yield curve has achieved some notoriety as a simple forecaster of economic growth.
The rule of thumb is that an inverted yield curve
(short rates above long rates) indicates a recession
in about a year, and yield curve inversions have
preceded each of the last six recessions (as defined
by the NBER). Very flat yield curves preceded the
previous two, and there have been two notable
false positives: an inversion in late 1966 and a very
flat curve in late 1998. More generally, though, a
flat curve indicates weak growth, and conversely, a
steep curve indicates strong growth. One measure
of slope, the spread between 10-year bonds and
3-month T-bills, bears out this relation, particularly
when real GDP growth is lagged a year to line up
growth with the spread that predicts it.
Lately, the yield curve has some forecasters worried.
One reason for concern is that the spread is currently negative: with 10-year rate at 4.56 percent
12

and the 3-month rate at 4.93 percent (both for the
week ending December 15), the spread stands at
a negative 37 basis points, and indeed has been in
the negative range since August. Projecting forward
using past values of the spread and GDP growth
suggests that real GDP will grow at about a 1.4
percent rate over the next year.

Yield Spread and Lagged GDP Growth
Percent
12
10
Real GDP growth (year-over-year) lagged one year
8
6

While such an approach predicts when growth is
above or below average, it does not do so well in
predicting the actual number, especially in the case
of recessions. Thus, it is sometimes preferable to
focus on using the yield curve to predict a discrete
event: whether or not the economy is in recession.
Looking at that relationship, the expected chance of
a recession in the next year is 44 percent.

4
2
0
-2
Yield spread: 10-year Treasury bonds - 3-month Treasury notes
-4
1953 1958 1962 1967 1972 1977 1981 1986 1991 1996 2001 2005
Sources: Department of Commerce, Bureau of Economic Analysis; Board of
Governors of the Federal Reserve System.

For an extended discussion of using the yield curve
to predict output and recessions, see the Commentary, “Does the Yield Curve Signal Recession?”

Yield Spread and
Predicted GDP Growth

Probability of Recession
Based on the Yield Spread*

Percent
Probability
100

6
5

90
80

Predicted real GDP growth (year-over-year)

Probability of a recession
4

70
60

Forecast

50

3
2

40
30

1

20

0

Forecast

10
0

Yield spread: 10-year Treasury - 3-month Treasury
-1
60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06

*Estimated using probit model.
Sources: Department of Commerce, Bureau of Economic Analysis;
Board of Governors of the Federal Reserve System.

3/01

8/02

7/03

7/04

6/05

5/06

5/07

Sources: Department of Commerce, Bureau of Economic Analysis;
Board of Governors of the Federal Reserve System.

13

International Markets

Current Account Sustainability
01.03.07
by Owen F. Humpage and Michael Shenk

Foreign Exchange Indexes*
Index
160
140

Broad Dollar Index

120
100
80
Major Currency Index

60
40
20
1973

1978

1983

1988

1993

1998

2003

*The Major Currency Index includes large industrialized countries; the Broad
Dollar Index includes these plus the important developing countries.
Source: Board of Governors of the Federal Reserve System, “Foreign Exchange Rates,” Federal Reserve Statistical Releases, H.10.

Foreign Exchange Rates*
Index, 1/2/2006 =100

The dollar has softened a bit since early October,
largely because of changing beliefs about the probable course of monetary policies here and abroad.
Market participants seem to believe that the Federal
Reserve will move to lower the federal funds target
sometime this year and that the European Central
Bank and the Bank of Japan are likely to raise their
target rates.
Leveraging the impact of changing beliefs about
monetary policy, however, is the longer-held expectation that the dollar must depreciate to correct what has become an unsustainable U.S. balance-of-payments pattern. The United States has
financed a nearly unbroken twenty-year string of
current account deficits by issuing financial claims
in unprecedented amounts. Many observers fear
that the market is becoming saturated with dollardenominated assets. They warn of portfolio diversification accompanied by sharp dollar depreciation
and higher U.S. interest rates. Projections of a hard
landing have been around for a number of years
now, but so far the landing has been nothing if not
soft. Current account deficits are likely to persist for
the foreseeable future, and their financial burden
will set the general tone for the dollar.

104
102
Japanese yen
100
98
96

Euro

94
92
90
88

British pound

86
84
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
*Foreign currency units per dollar.
Source: Bloomberg Financial Information Services.

The United States has run a current account deficit every year save one since 1982; this is likely to
continue for the foreseeable future. Although the
current account incorporates more than trade in
goods and services, our propensity to import more
goods than we export largely explains the current
account deficit.
The United States pays for its surfeit of imports by
issuing financial claims (for example, stocks, bonds,
Treasury securities, and bank accounts) to the rest
of the world. Private individuals and organizations
hold most of these claims, but foreign governments,
their central banks, and international agencies own
a significant share. Governments such as China,
Japan, and the oil-producing nations often add a
14

substantial portion of these claims to their official
foreign exchange reserves.

Current Account Balance*
Percent of GDP

Billions of dollars
100

1

0

0

-100

-1

-200

-2

-300

-3

-400

-4

-500

-5

-600

-6

-700

-7

-800

-8

-900

-9

-1000

Since 1986, foreigners have held more financial
claims against the United States than U.S. residents
have held against them, giving us a negative net
international investment position. In 2005, the
last year for which we have complete information,
foreigners’ net claims against the United States
equaled approximately $2.7 trillion, mostly held by
the private sector in a relatively liquid form. Official reserves, for example, amount to 17 percent of
foreign financial claims on the United States, and
direct investments, which presumably are relatively
illiquid, amount to 15 percent of these claims.

-10
1980

1985

1990

1995

2000

Because these ultimately are claims on future U.S.
output, we typically gauge their size relative to
GDP. In 2005, the net stock of outstanding foreign
claims against the United States amounted to 22
percent of GDP. Given projections for this year’s
current account deficit, our negative net international investment position could reach $3.5 trillion
(approximately 27 percent of GDP) this year.

2005

*Data for 2006 are quarterly data shown at an annual rate.
Source: U.S. Department of Commerce, Bureau of Economic Analysis.

Components of Current Account*
Billions of dollars
200

Income

Services trade
0

Unilateral transfers
-200

Current account

-400

Goods trade

-600

-800

-1000
1980

1985

1990

1995

2000

*Data for 2006 are authors' estimates.
Source: U.S. Department of Commerce, Bureau of Economic Analysis.

2005

The ratio has increased sharply since 1999, but
it cannot rise indefinitely. As foreign portfolios
become saturated with dollar-denominated assets,
global investors will become increasingly reluctant
to hold additional dollar-denominated assets without compensation for the risk of doing so. They
may eventually begin to diversify their portfolios
out of dollars. Should we reach this point, the dollar will depreciate and U.S. interest rates will rise.
The dollar depreciation will help reduce the current
account deficit by raising the dollar price of foreign
goods, lowering the foreign-currency price of U.S.
goods, and shifting worldwide demand towards
U.S. markets. The rise in interest rates will reduce
investment in the United States and encourage saving.
Economists are fairly certain about the nature of
these adjustments. Nevertheless, no one knows
when they might commence, how long they might
take, or how disruptive they may be.
15

A change in investment and savings patterns is a
necessary, but often forgotten, aspect of the adjustment pattern. A country’s savings and investment
pattern corresponds to its current account position.
A nation, like the United States, that maintains a
current account deficit also invests more than it
saves. Foreign savings, channeled into the country
when foreigners buy U.S. financial instruments,
makes up the difference between domestic investment and savings.

Net Financial Flows*
Billions of dollars
900
800

Official
All other

700
600
500
400
300
200
100
0
-100
1980

1985

1990

1995

2000

2005

*Data for 2006 are authors' estimates.
Source: U.S. Department of Commerce, Bureau of Economic Analysis.

Net International Investment Position*
Trillions of dollars

Percent of GDP

1

15

0.5

10

0

5

-0.5

0
-5

-1
-1.5

-10

-2

-15

-2.5

-20

-3

-25

-3.5

-30

-4

-35
1980

1985

1990

1995

2000

The pattern of investment and savings in a deficit
country often has implications for the sustainability
of its negative net international investment position. Throughout most of the 1990s, for example,
foreign savings went to support an investment
boom in the United States. Both investment and
savings rose as a share of GDP. The added capital
seemed to boost the pace of our long-term economic growth, making it easier—in terms of foregone
domestic consumption—to service and repay
foreign financial claims on the United States. Since
2000, however, investment has fallen along with
domestic savings. Inflows of foreign savings have
financed consumption spending—notably government spending—in the United States. This pattern
is not likely to foster the economic growth necessary to repay our foreign obligations without a drop
in private domestic consumption.

Composition of Foreign Claims
Other

Official

2005

*Data for 2006 are authors' estimates.
Source: U.S. Department of Commerce, Bureau of Economic Analysis.

Direct

Source: U.S. Department of Commerce, Bureau of Economic Analysis.

16

Net Savings and Investment

Net Savings: Private and Government

Percent of GDP

Percent of GDP
14

12

12
10
10

Investment
Private savings

8

8

6
6

4
Total savings

2

Savings

4
0
-2

2

-4

Government savings

-6
1980

1985

1990

1995

2000

2005

Source: U.S. Department of Commerce, Bureau of Economic Analysis.

0
1980

1985

1990

1995

2000

2005

Source: U.S. Department of Commerce, Bureau of Economic Analysis.

Economic Activity and Labor Markets

Revisions to Real GDP
12.22.06
by David E. Altig and Brent Meyer

Revisions to Real GDP: 2006:IIIQ

There will be another revision in July 2007—as
there is every year— but until then the final word
from the Bureau of Economic Analysis is that real
Gross Domestic Product grew at an annualized rate
of just under 2 percent in the third quarter. This
is slightly below the preliminary estimate issued in
November, but still above the growth rate estimate
in October’s advance report.

Annualized percent change
5
Advance
Preliminary
Final
4
3
2
1
Gross private
investment
0

GDP

PCE

Net exports

-1
-2
-3

Sources: U.S. Department of Commerce, Bureau of Economic Analysis.

Government
consumption

There is both unpleasant and (maybe) not-so-unpleasant news buried in the details of the latest revision. The single largest reason for the decline in the
growth estimate from the preliminary report was a
downgrading of private investment spending.
The unpleasantness came by way of the fact that
part of the decline in the investment estimate was
a reflection of the ongoing weakness in residential
investment. But the largest factor was a revision in
the estimated pace at which businesses accumulated
inventories over the quarter.

17

That’s the maybe not-so-unpleasant news. To the
extent that an accumulation of inventories is either
unwanted or intended to build desired ratios relative to sales, a slower pace of inventory build-up
would be consistent with one less potential drag on
production going forward, small though it may be.

Contributions to Revisions in
Contributions to Real GDP, 2006:IIIQ
Annualized percent change
0.2
Change from preliminary to final

0.1

0.0
Net exports

PCE
-0.1

Government
consumption

-0.2

Gross private
investment

GDP
-0.3

Sources: U.S. Department of Commerce, Bureau of Economic Analysis.

Economic Activity and Labor Markets

Durable Goods Orders and
Personal Income and Consumption Reports
12.27.06
by Ed Nosal and Michael Shenk

Durable Goods Orders
Billions of dollars

Billions of dollars
250

160
Durable goods
140

Durable goods ex
transportation

200

120
150

100
80

100
Transportation
(secondary axis)

60
40

50

20
0
1996

0
1998

2000

2002

2004

Source: U.S. Department of Commerce, Bureau of the Census.

2006

Durable goods orders rose 1.9 percent in November, reversing October’s decline of 8.2 percent.
However, if transportation is excluded, total durable goods orders fell 1.1 percent. Analysts often
exclude transportation to discern the underlying
trend in orders. Aircraft, which are part of transportation, are very expensive. If large numbers are
ordered, as sometimes happens, the industry can
dominate the series. For example, the October
number was big and negative, primarily because of
hefty aircraft orders in September. The figure below
illustrates aircraft’s effect on total durables.
It shows durable goods excluding transportation
orders (the dark blue line) as a smoothed version of
total durable goods orders. The red line represents
transportation orders alone.

18

Growth in GDP and Personal Income
Percent of GDP
88

Personal income, which rose 0.3 percent in November, and consumption, which increased 0.5 percent,
are used as inputs in constructing the GDP series.
Over the past five years, personal income as a fraction of GDP has fallen fairly steadily from a high of
nearly 87 percent to slightly over 82 percent.

87
86
85
84
Personal income
83

This decline is consistent with observed increases in
corporate profits as a share of GDP. Although personal income accounts for a huge fraction of GDP,
the quarterly growth rates for personal income and
the GDP series behave quite differently.

82
81
80
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

The personal income series seems more volatile
than the GDP series. The chart above suggests the
need for caution when using monthly personal
income data to estimate quarterly GDP growth.

Source: U.S. Department of Commerce, Bureau of Economic Analysis.

Personal Income as a Share of GDP
Annualized percent change, quarterly
16
14
Personal income
12
10

GDP

8
6
4
2
0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Source: U.S. Department of Commerce, Bureau of Economic Analysis.

19

Economic Activity and Labor Markets

Labor Turnover
12.29.06
by Murat Tasci and Laura Kleinhenz

Labor Turnover

One of the more useful recent additions to the
menu of government statistics available to economic analysts is the Bureau of Labor Statistics’ Job
Openings and Turnover Survey, commonly referred
to as JOLTS. The survey, begun in 2001, provides
data on employment, job openings, hires, quits,
layoffs, discharges, and other separations from
employment.

Percent
4.5

4

Hires rate

3.5

Separations rate

3

2.5

Openings rate

2

1.5
Dec00

Jun01

Dec01

Jun02

Dec02

Jun03

Dec03

Jun04

Dec04

Jun05

Dec05

Jun06

Source: U.S. Department of Labor, Bureau of Labor Statistics,
Job Openings and Labor Turnover Survey, November 2006.

Average Net Hires Rate by Industry,
2004 – October 2006
Percent
Hires

Separations

Net
hires

Job
openings

Total private

4.0

3.8

0.24

2.8

Mining

3.4

2.9

0.46

1.8

Construction

5.5

5.3

0.19

1.8

Manufacturing

2.5

2.6

-0.07

1.9

TPUa

4.0

3.8

0.13

2.3

Information

2.4

2.5

-0.08

3.1

FIREb

2.4

2.3

0.11

2.8

PBSc

5.2

4.6

0.57

3.7

Education and health
services

2.7

2.4

0.31

3.4

a. Transportation and public utilities.
b. Finance, insurance, and real estate.
c. Professional and business services.
Source: U.S. Department of Labor, Bureau of Labor Statistics, Job Openings
and Labor Turnover Survey, November 2006.

The net hires rate—the difference between the hires
rate and the rate of job separations of all sorts—has
been positive since September 2005, consistent
with the employment growth evident from the
usual payroll and household surveys released on
the first Friday of every month. The detail available
from JOLTS makes it clear that a big part of the
story behind the employment picture this year has
been the recent decline in separations rate. At 3.2
percent, this is the lowest separations rate since January 2004. Furthermore, the job openings rate—a
measure of job availability—has been increasing
steadily, implying a growing demand for labor.
Most of the employment growth in the past two
years was driven by professional and business services, with an average net hire rate of 0.57 percent.
Although the rate of net hires in the information
sector has been negative since 2004, there is clear
evidence of unmet demand for labor in this area, as
indicated by the sector’s higher-than-average rate of
job openings.
Since 2004, most of the monthly growth in net
hires occurred in the South, accounting for 48 percent of U.S. employment growth. The other three
regions of the country shared the remaining 52
percent of growth almost equally. As for job openings, the South accounted for 39 percent of the
total since 2004, followed by the West at 23 percent, the Midwest at 20 percent, and the Northeast
at 18 percent.

20

Regional Shares in Job Openings and Labor
Turnover,
2004 – October 2006

Percent
Hires

Separations

Job openings

Net hires

Northeast

0.17

0.17

0.18

0.18

South

0.38

0.38

0.39

0.48

.22

0.22

0.20

0.16

0.23

0.23

0.23

0.18

Midwest 0
West

Source: U.S. Department of Labor, Bureau of Labor Statistics, Job Openings and
Labor Turnover Survey, November 2006.

Economic Activity and Labor Markets

Housing
01.02.07
by David E. Altig and Brent Meyer

Single-Family Home Sales

It is never a good idea to read too much into a few
months worth of data, but some signs that we may
have seen the worst of the downturn in the residential housing market are providing a few straws
for the optimistic to grasp. Both new and existing
home sales for November exceeded expectations,
and year-over-year growth rates are, arguably, showing signs of having bottomed out.

Year-over-year percent change

50
40
30

New

20
10
0
-10

Furthermore, inventories of unsold homes, though
still on the high side, appear to be retreating.

Existing

-20
-30
2002

2003

2004

2005

Sources: U.S. Department of Commerce, Bureau of the Census;
National Association of Realtors.

2006

If you are operating on the theory that the real
problem resides in falling housing values (and what
that might mean for consumers’ balance sheets
and spending behavior), it is clear that rapid appreciation of the previous four years is done. But
the actual amount of price depreciation has been
relatively modest compared to the 25 percent to 30
percent appreciation enjoyed from 2002 through
2005.

21

Those bits of light notwithstanding, there is still of
plenty to keep the pessimists in bad humor. Housing starts and permits—the latter being a component of the Conference Board’s index of leading
indicators—are still signaling weakness, despite the
recent uptick in starts:

Housing Starts and Permits
Year-over-year percent change

40
30

Permits

20
10

You may keep your brow furrowed, if you wish.

0
-10

Starts

-20
-30
-40
-50
1995

1997

1999

2001

2003

2005

Sources: U.S. Department of Commerce, Bureau of the Census.

Month’s Supply of Single-Family Homes

Median Prices: Single-Family
New and Existing Homes

Ratio
9

Year-to-date percent change
Total U.S. new = –4.64%
Total U.S. existing = –1.99%

8
Existing
7

New = –5.9322%
Existing = –4.69%
New = 5.33%
Existing = 2.17%

New = 2.70%
Existing = –2.28%

6

5

4
New = –4.30%
Existing = –2.03%

New
3
1995

1997

1999

2001

2003

2005

Sources: U.S. Department of Commerce, Bureau of the Census;
National Association of Realtors.
Sources: U.S. Department of Commerce, Bureau of the Census;
National Association of Realtors.

22

Economic Activity and Labor Markets

ISM Report on Business Activity
01.04.07
By Tim Dunne and Bethany Tinlin

ISM Manufactures and Services
Diffusion Indexes
Index, SA (50+ = Economic expansion)

70

Nonmanufacturing Business Activity Index

65
60
55
50
45
40

Manufacturing PMI Index

35
1999

2000

2001

2002

2003

2004

2005

2006

Source: Institute for Supply Management.

Looking at the details of the reports, the new orders
and production components in manufacturing
showed improvement in December compared to
Novembe, with both indexes moving from below
50 to above 50. For nonmanufacturing industries,
new orders also continued to grow but at a slower
rate than in November. The growth in new export
orders slowed in manufacturing but accelerated for
nonmanufacturers.

New Orders Index
Index, SA (50+ = Economic expansion)

75
Manufacturing New Orders Index

70
65
60
55
50
45

Nonmanufacturing New Orders Index

40
35
1999

2000

2001

2002

Source: Institute for Supply Management.

2003

2004

According to the latest release of the Institute for
Supply Management (ISM) surveys, both the manufacturing and nonmanufacturing sectors expanded
as they closed out 2006. The ISM composite index
for manufacturing registered a rebound in December, finishing out the year at a level of 51.4. The
ISM uses a diffusion index, and a level above 50
indicates that the sector is expanding, while a value
below 50 indicates contraction. The manufacturing
index has trended downward over 2006, showing a
general slowing in growth in manufacturing. As has
been the case all year, the nonmanufacturing index
has showed considerably more strength than manufacturing, closing out the year at 57.1—slightly
down from November’s reading of 58.9.

2005

2006

The employment picture differed across the two
sectors as 2006 finished up. The manufacturing
employment index remained slightly below 50 in
December, indicating little change in employment
in manufacturing. This index has hovered around
50 since September. Alternatively, the employment
index for nonmanufacturing industries increased
moderately in December to 53.3, suggesting continued expansion in nonmanufacturing payrolls.
The ISM also surveys producers on the prices
they pay for supplies and services. For 2006, both
manufacturers and nonmanufacturers reported a
general slowing in the growth in prices over the
year. However, the December surveys paint a mixed
picture on the growth in prices at the end of the
year. The manufacturing price index fell sharply to
23

below 50, indicating decreasing supply prices. The
manufacturing price index is now well below the
average values observed earlier in 2006. In the nonmanufacturer sector, the index rebounded from the
November reading to 59.1, showing some strengthening in supply prices in the last month of the year.
Even with this increase, the nonmanufacturing
index ended the year significantly less than its peak
level in 2006 of 77.5 and well below the average
index values in 2004 and 2005.

Production Index
Index, SA (50+ = Economic expansion)

75
70
65
60
55
50
Manufacturing Production Index

45
40
35
1999

2000

2001

2002

2003

2004

2005

2006

What’s in store for 2007? Producers are relatively
optimistic looking forward to 2007. The December
ISM Semiannual Economic Forecast indicates that
supply executives expect, on average, to increase
production capacity by 5 percent to 6 percent in
2007. If this expected growth is achieved, it would
represent an acceleration in capacity growth compared to 2006, when survey respondents reported
increases in capacity of about 3 percent. Both
sectors expect capital expenditures to increase in
nominal terms by roughly 8 percent next year, and
this is in line with the growth in capital expenditures observed in 2006. On the employment front,
manufacturers see little expansion in payrolls while
nonmanufactures forecast an increase of 1.6 percent.

Source: Institute for Supply Management.

ISM Export Diffusion Indexes
Index (50+ = Economic expansion)

70
65

Nonmanufacturing New Export Orders Index a

60
55
50
45
40
1999

Manufacturing New Export Orders Index

2000

2001

2002

a. Not seasonally adjusted.
b. Seasonally adjusted.
Source: Institute for Supply Management.

2003

2004

b

2005

Overall, the ISM surveys offer a picture of an
economy that at the end of 2006 continues to grow
moderately, with some evidence of a reduction in
the price pressures observed earlier in the year.

2006

The supply executives differ in their forecasts of
supply price growth in 2007. Manufacturing supply
executives think the price growth they saw in 2006
will abate and forecast supply prices to increase,
on average, by only 1.1 percent in the upcoming
year. Alternatively, nonmanufacturers see continued
price pressures expecting supply price increases of
4 percent in 2007—a roughly 1.5 percentage point
rise in expected supply price inflation compared to
2006.

24

ISM Price Diffusion Indexes

ISM Employment Diffusion Indexes

Index, NSA (50+ = Economic expansion)

Index, SA (50+ = Economic expansion)

100

65

Manufacturing Prices Index

60

Nonmanufacturing Employment Index

90

55

80

50

70

45

60

40

50

35

40

Nonmanufacturing Prices Index

30
1999

Manufacturing Employment Index

2000

2001

2002

2003

2004

2005

30
1999 2000 2001 2002 2003 2004 2005 2006

2006

Source: Institute for Supply Management.

Source: Institute for Supply Management.

ISM Forecasts for 2007
Manufacturing
forecast
(percent)

Nonmanufacturing
forecast
(percent)

Growth in production capacity

+5.4

+6.2

Growth in nominal capital expenditures

+8.5

+8.2

Employment growth

+0.1

+1.6

Growth in supply prices

+1.1

+4.0

Source: Institute of Supply Management.

25

Economic Activity and Labor Markets

Labor Market Conditions
01.10.07
by Peter Rupert and Cara Stepanczuk

Average Monthly
Nonfarm Employment Change

The December employment data showed far more
job growth than most had predicted. The Bureau of
Labor Statistics (BLS) reported that nonfarm payroll employment increased by 167,000 that month
(preliminary estimate), building on November’s
unexpectedly strong upward revision of +154,000
jobs.

Change, thousands of workers
250
225
200
175
150
125
100
75
50
25
0
IQ

IIQ

IIIQ

IVQ

Aug

Sep

Oct

Nov

Dec

2006
Source: Department of Labor, Bureau of Labor Statistics.

Long-Term Manufacturing and
Service Industry Changes
Thousands of jobs
120

First revision
Second revision

100
80
60
40
20
0
-20
AUG

SEP

OCT

NOV

Source: Department of Labor, Bureau of Labor Statistics, January 2006.

DEC

Service-sector jobs continued to increase at a
relatively strong pace (up 178,000), whereas manufacturing jobs were still declining (off 12,000). For
2006, the service sector added a net monthly average of 151,000 jobs; manufacturing employment,
on the other hand, fell by 6,000 jobs monthly.
Professional and business services drove the service
sector’s jobs growth in December (as it did over
most of the year), with a net gain of 50,000 in
December and 420,000 jobs total during 2006.
Health care followed closely, adding 31,000 new
jobs for the month and 324,000 for the year as a
whole. December’s loss of construction jobs was
small (–3,000) and, in light of the sector’s 53,000
net job loss during October and November, suggests that construction activity may have begun to
level off at year’s end.
The strength in the December jobs report was especially surprising, given that earlier in the week, the
ADP Employer Services’ survey of 307,000 businesses (covering about 18 million payroll workers)
showed a decline of 40,000 jobs during the month.
The survey results may have led some analysts to reduce their estimates of labor market strength—two
major investment houses reportedly cut their December jobs growth projections by roughly 40,000
to 50,000 jobs after the ADP survey was released.
Predicting job growth is no easy task, not even for
the BLS, which adjusts its estimates on the basis
of incoming payroll data as they are reported by
businesses. The BLS has made substantial revisions
to their preliminary estimates over the past few
months: The first published estimate for September
26

showed a 51,000 job increase; the second preliminary estimate showed an increase of 148,000 jobs;
and the final estimate for the month reported an
increase of 203,000—four times the original estimate. The point here is a cautionary one: Take care
when examining monthly changes in the employment data. Recent revisions have revealed that the
U.S. labor market was considerably stronger than
the preliminary jobs report led us to believe. The
BLS acknowledges that recent revisions have been
somewhat high, but notes that “the overall magnitude of revisions has held steady in recent years”
and further, that “the revisions have not been either
predominantly upward or predominantly downward.”

Revisions on Monthly Payroll
Job growth, in thousands
400
360
320
280
240
200
160
120
80
40
0
-40
-80
-120
-160
-200
2000

Service industries

Manufacturing

2001

2002

2003

2004

2005

2006

*November received the first revision only, and December has not yet been revised.
Source: Department of Labor, Bureau of Labor Statistics.

Labor Market Conditions

Average monthly change (thousands of employees, NAICS)
2003
Payroll employment

2004
9

2005
175

Jan.-Nov. 2006
165

Dec 2006

152

167

Goods-producing

–42

28

22

3

–11

Construction

10

26

25

4

–3

–51

0

–6

–5

–12

Manufacturing
Durable goods

–32

9

1

0

–6

Nondurable goods

–19

–9

–7

–5

–6

Service-providing

51

147

143

149

178

Retail Trade

–4

17

13

–4

–9

7

8

12

13

9

PBS**

23

40

41

34

50

Temporary help svcs.

12

13

14

–3

15

Education & health
svcs.

30

33

31

37

43

Leisure and hospitality

19

26

21

29

31

-4

13

14

21

17

4.6

4.5

Financial activities*

Government

Average for period (percent)
Civilian unemployment rate

6.0

5.5

5.1

a. Financial activities include the finance, insurance, and real estate sector and the rental and leasing sector.
b. PBS is Professional Business Services (professional, scientific, and technical services, management of companies and
enterprises, administrative and support, and waste management and remediation services.
Source: Department of Labor, Bureau of Labor Statistics.

27

Regional Activity

The Akron Metropolitan Statistical Area
12.21.06
by Bob Sadowsky and Brian Rudick

Population

The Akron metropolitan area—home to 702,000
residents—stretches across Summit and Portage
Counties. The region is typical of many metro areas
in the Fourth District in that it has seen limited
population growth over the past three decades. In
fact, since 1970 Akron’s population grew by only
3.5 percent compared to 46 percent for the United
States.

Index, 1970 = 100
150
140
U.S.
130
120
110
Ohio

Although Akron enjoys a relatively diverse economy, the manufacturing sector still claims the
highest employment concentration relative to the
United States, followed by professional and business services.

100
Akron MSA
90
1970

1980

1990

2000

Source: U.S. Department of Commerce, Bureau of the Census.

Location Quotients, Akron MSA / U.S.,
2005
Natural resources,
mining, construction
Manufacturing
Trade, transportation,
utilities
Information
Financial activities
Professional,
business services
Education,
health services
Leisure, hospitality
Other services
Government
0

0.5

1

1.5

Note: The location quotient is the simple ratio between a given industry’s employment share
in two locations.
Source: U.S. Department of Labor, Bureau of Labor Statistics.

Nevertheless, manufacturing employment in the
Akron region has experienced a dramatic decline
since the last business cycle peak in March 2001—
17.4 percent compared to a 16.3 percent decrease
for the United States. In contrast, Akron outpaced
the country as a whole in non-manufacturing job
growth during the same time period—8.4 percent
locally versus 5.3 percent nationally.
Looking more closely at total annual employment
growth, we see that the United States did slightly
better than the Akron metro area in 2001 and
2002. This was due primarily to a larger decline in
local manufacturing jobs. However, beginning in
2003 and continuing through 2005 the trend was
reversed. During this latter period Akron showed
annual employment gains of 1.5 to 2.0 percent.
Further, manufacturing job losses became negligible
and increases were seen in two broad sectors—finance, information and business services and
education, health, leisure, government and other
services.

28

Components of Employment Growth,
Akron MSA
Percent change
4

2

0

Local employment trends seen during 2003
through 2005 continued into 2006. For the 12month period ending in October, financial activities, information, and professional and business services led all other industry sectors in employment
growth with increases ranging from 2.3 to 4 percent. Manufacturing continued to show a negligible
employment change on a year-over-year basis.

U.S.
. growth
-2

-4
2001

2002

2003

2004

2005

Natural resources, mining, construction

Retail, wholesale trade
Manufacturing

Financial, information, business services

Transportation,
warehousing, utilities

Education, health, leisure,
government, other services

Note: The white bars represent total annual growth for the Akron MSA.
Source: U.S. Department of Labor, Bureau of Labor Statistics.

Over time, average per capita personal income
across all U.S. metro areas has been somewhat
higher than in Akron with a gap of about 6.4 percent. However, when comparing per capita income
growth, we find that the growth rates in Akron and
the United States are almost the same. Between
1980 and 2004, local income increased by 219
percent compared to 226 percent nationally.

Payroll Employment Growth,
October 2006
Total nonfarm
Goods-producing
Manufacturing
Natural resources, mining,
construction
Service-providing
Trade, transportation,
utilities
Information
Financial activities
Professional,
business services
Education, health services
Leisure, hospitality
Other services
Government
U.S.
Akron MSA

-2

During the 1990s, the Akron metro area enjoyed
a consistently lower unemployment rate than the
United States. In fact, during the mid 1990s, local
unemployment was about one percentage point less
than was reported nationally. Only during the past
three years has this trend been reversed. For the
12-month period ending in October 2006, Akron’s
average unemployment rate was 0.5 percentage
point higher than in the United States.

The similarity in growth may be partially due to
the educational attainment of Akron residents.
In 2005, over 28 percent of these residents held a
bachelor’s degree or higher. This compares to 23.3
percent in Ohio and 27.2 percent nationally.

-1

0
1
2
3
4
Year-over-year percent change

5

Source: U.S. Department of Labor, Bureau of Labor Statistics.

29

Unemployment Rate

Per Capita Personal Income

Percent
Dollars, thousands

8

40
U.S.

7

U.S. metropolitan areas
6

30

U.S.
Akron MSA

5

Ohio
20

4
Akron MSA
3
1990

10
1980

1990

1992

1994

1996

1998

2000

2002

2004

2006

2000
Source: U.S. Department of Labor, Bureau of Labor Statistics.

Source: U.S. Department of Commerce, Bureau of Economic Analysis.

Payroll Employment since March 2001

Selected Demographics
Akron
MSA

Ohio

U.S.

0.7

11.2

288.4

White

86.1

85.7

76.3

Black

12.2

12.3

12.8

Other

1.7

2.0

10.9

0 to 19

26.0

27.0

27.8

20 to 34

19.3

19.3

20.1

35 to 64

41.6

40.8

40.0

Index, March 2001 = 100
110

Total population
(millions)

Nonmanufacturing

Percent by race
100
Akron MSA
U.S.
90
Manufacturing

80
2001

2002

2003

2004

2005

Source: U.S. Department of Labor, Bureau of Labor Statistics.

2006

Percent by age

65 or older

13.0

12.8

12.1

Percent with a bachelor’s
degree or higher

28.1

23.3

27.2

Median age

38.3

37.6

36.4

Source: U.S. Department of Commerce, Bureau of the Census.

30

Regional Activity

State Per Capita Personal Income
01.04.07
by Yoonsoo Lee, Brian Rudick, and Bethany Tinlin

Relative Per Capita Personal Income
in 2005

NE
KS
MI
VT
SD
TX
OR
OH
IA
MO
ND
GA
IN
NC
TN
ME
AZ
OK
AL
MT
ID
KY
SC
NM
UT
AR
WV
MS
LA

–80

NH
VA
CO
MN
WY
DE
CA
IL
NV
WA
RI
PA
FL
WI

–30

NY

NJ
MA
MD

Of the fifty U.S. states, the one with the highest per capita income in 2005 was Connecticut,
where residents’ median income hit $42,620 (all
figures are in real 2000 dollars). As for the states
within the Fourth District, per capita incomes grew
in Kentucky and West Virginia, to $25,398 and
$23,345, respectively. Compared with the median state per capita income, Kentucky’s is about
13 percent lower, and West Virginia’s is about 20
percent lower. While Ohio’s per capita income was
2 percent lower than the median, Pennsylvania was
7 percent higher.

CT

20

With respect to rankings of median per capita incomes among the fifty states, the ranking of each of
the four states in the district has fallen since 1929.
Overall, the gap between the richest state and
poorest state has narrowed since 1929, as economic
growth theory predicts (See our 2005 Annual Report essay for a more detailed analysis of per capita
income growth across U.S. states).

70

Percent above or below state average
Source: U.S. Department of Commerce, Bureau of Economic Analysis.

Relative Per Capita Personal Income
in 1929

GA
NC
AL
AR
MS
SC

–80

–60

TX
WV
OK
VA
SD
LA
NM
KY
ND
TN

–40

UT
KS
FL
ID

–20

VT
CO
MO

IN
ME
AZ
MN
MT
NE
IA

0

NH
WI
WY
OR

MI
PA
OH
MD
WA

20

RI
NV

40

NJ
MA

IL

CA

NY

DE
CT

60

Percent above or below state average

In 1929, New York had the highest per capita personal income of all the states at $9,837. The disparity across states was greater then than in 2005, with
the standard deviation of state incomes in 1929
more than twice the 2005 level. While Ohio and
Pennsylvania’s income levels were about 30 percent
higher than the median in 1929, Kentucky’s and
West Virginia’s, at $3,316 and $3,923 respectively,
were 35 percent and 23 percent lower than the
median.

80

100

Since 1929, incomes have grown in real terms for
every state. The U.S. average, which was $5,969
in 1929 and $30,939 in 2005, grew 418 percent.
Growth in Pennsylvania (373 percent) and Ohio
(334 percent) trailed the national mark, but growth
in Kentucky (666 percent) and West Virginia (495
percent) exceeded it.

Source: U.S. Department of Commerce, Bureau of Economic Analysis.

31

More recently, Ohio’s per capita income growth
has started to slow. Since the beginning of 2000, it
has grown by 3.1 percent, compared to 6.9 percent
for the U.S. as a whole. Meanwhile, growth in
per capita incomes in Pennsylvania (8.4 percent),
Kentucky (5.8 percent), and West Virginia (10.6
percent) all outpaced Ohio’s over this time period.

Components of Earnings Growth,
2000–2005
Percent change
25

20

Looking at the industrial components of earnings
growth reveals that no one specific sector is responsible for Ohio’s relatively slower growth. In fact,
in terms of the contributions that different industry sectors make to earnings growth, every major
industry in Ohio lagged with respect to the contribution it made to U.S. growth from 2000 to 2005.
For example, while the natural resources, mining,
and construction industry added 2.5 percent to
overall U.S. earnings growth in this time period, it
added only 0.8 percent to Ohio earnings growth.

15

10

5

0
OH

PA

KY

WV

U.S.

Other services
Leisure and hospitality
Education and health services
Professional and business services
Finance, insurance, and real estate
Information
Manufacturing
Trade, transportation, and utilities
Natural resources, mining and
construction
Source: U.S. Department of Commerce, Bureau of Economic Analysis.

Per Capita Personal Income Growth

Per Capita Personal Income Growth
Index, Q1:1990 = 100

Thousands of real (2000) dollars
35

140
WV

30

OH

130

KY
WV

25
U.S.

KY

OH

120

20

PA

15
10

110
PA

U.S.

100

5
0
1930

1940

1950

1960

1970

1980

1990

Source: U.S. Department of Commerce, Bureau of Economic Analysis.

2000

90
1990

1993

1996

1999

2002

2005

Source: U.S. Department of Commerce, Bureau of Economic Analysis.

32

Regional Activity

Fourth District Employment Conditions
01.10.07
by Christian Miller and Paul Bauer

Unemployment Rates*
Percent
8

The Fourth District’s unemployment rate rose from
5.0 percent in October to 5.2 percent in November. The main causes were a 4.8 percent monthly
increase in the number of unemployed and slight
reductions in employment (–0.3 percent) and the
labor force (–0.1 percent). Over the same period,
the U.S. unemployment rate rose from 4.4 percent
to 4.5 percent.

7

6

United States

5
Fourth District a
4

3
1990

1992

1994

1996

1998

2000

2002

2004

2006

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.

Unemployment Rates,
November 2006*
U.S. average = 4.5%

Lower than U.S. average
About the same as U.S.
average (4.4% to 4.6%)
Above U.S. average

In November, 12 of the District’s counties posted
unemployment rates below the national average,
another 12 counties were close to average, and the
remaining 145 exceeded the U.S. rate; these levels
were slightly higher than October’s. The vast majority of counties (151) reported rising unemployment
rates. However, rates remained low in the Columbus, Pittsburgh, and Lexington metropolitan areas.
As for employment growth, Lexington was the only
metro area in the District that has kept pace with
the U.S. since November. The District’s goods-producing industries continued to lose jobs, whereas its
service-providing industries were the main engines
of growth. Only Dayton lost service-sector jobs
over the past year. Lexington is the fastest-growing
metro area in the District, but Cincinnati’s employment has also grown 1.0 percent, with a 1.4 percent
increase in service-sector jobs.

More than double U.S.
average

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.

33

Payroll Employment by Metropolitan Statistical Area
12-month percent change, November 2006
Cleveland
Total Nonfarm

Columbus

Cincinnati

Dayton

Toledo

Pittsburgh

Lexington

U.S

-0.2

0.4

1.0

-0.6

0.6

0.6

1.4

1.3

-1.4

-0.2

-0.7

-1.5

0.0

-1.7

0.6

0.1

Manufacturing

-0.9

-0.8

-1.4

-2.1

0.2

-3.5

-0.6

-0.4

Natural resources, mining, construction

-3.1

0.9

0.9

0.6

-0.6

1.3

3.9

1.0

0.1

0.5

1.4

-0.4

0.8

1.0

1.5

1.6

Trade, transportation, utilities

0.0

-0.4

0.7

-3.2

0.2

-0.2

2.3

0.4

Information

-1.6

-0.5

-1.9

-0.9

0.0

-3.1

-2.2

-0.1

Financial activities

-0.3

-0.8

0.3

-1.1

3.7

0.6

-1.9

1.8

Professional and business services

0.8

0.6

3.3

1.7

-1.7

1.3

1.6

2.3

Education and health services

1.3

2.6

3.0

-0.5

2.0

2.1

0.0

2.6

Leisure and hospitality

0.6

1.0

1.6

1.1

3.4

2.5

3.2

2.6

Other services

-0.7

1.6

1.4

1.8

-0.7

-1.2

0.0

0.7

Government

-1.4

0.1

-0.6

-0.2

0.2

1.3

2.7

1.3

5.1

4.5

4.9

5.8

5.9

4.6

4.2

4.5

Goods-producing

Service-providing

November unemployment rate (percent)

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.

Regional Activity

Fourth District Banking Conditions
12.21.06
By O. Emre Ergungor and Cara Stepanczuk

Annual Net Income*

FDIC-insured commercial banks headquartered
in the Fourth Federal Reserve District posted net
income of $8.7 billion for the first three quarters
of 2006 or $11.6 billion on an annual basis. (JP
Morgan Chase, chartered in Columbus, is not
included in this discussion because its assets are
mostly outside the District and its size—roughly
$1 trillion—dwarfs other District institutions.) The
U.S. banking industry as a whole posted earnings
of $112.75 billion for the same period or $150.32
billion on an annual basis.

Dollars, billions
22
20

Excluding JP Morgan Chase
Including JP Morgan Chase

18
16
14
12
10
8
6
4
2
0
1995

1997

1999

2001

2003

2005

*Through 2006:IIIQ only. Data for 2006 are annualized.
Sources: Author’s calculation from Federal Financial Institutions Examination Council,
Quarterly Banking Reports of Condition and Income, Third Quarter 2006.

Fourth District banks’ net interest margin (core
profitability computed as interest income minus
interest expense divided by average earning assets)
fell slightly to 3.06 percent of total income at the
end of 2006:IIIQ, but still exceeds the 2.95 percent
34

Income Ratios*
Percent
5.00

Percent
44
42

4.75
Net interest margin
excluding JP Morgan
Chase

4.50
4.25
4.00

40
Non-interest
income/income including
JP Morgan Chase

38
36

3.75
3.50
3.25
3.00

34
32

Non-interest
income/income excluding
JP Morgan Chase

30
28

2.75

26

2.50

24

Net interest margin
including JP Morgan
Chase

2.25
2.00
1995

22
20

1997

1999

2001

2003

2005

*Through 2006:IIIQ only. Data for 2006 are annualized.
Sources: Author’s calculation from Federal Financial Institutions Examination Council,
Quarterly Banking Reports of Condition and Income, Third Quarter 2006.

Efficiency*,**
Percent
70
68
66
64

Excluding JP Morgan Chase
Including JP
Morgan
Chase

62
60
58
56
54
52
50
1994

1996

1998

U.S. average. Fourth District banks’ non-interest income edged up to 30.48 percent, while the
national average slipped down to 30.52 percent of
total income.

2000

2002

2004

2006

* Through 2006:IIIQ only. Data for 2006 are annualized.
** Efficiency is operating expenses as a percent of net interest income plus non-interest income.
Sources: Author’s calculation from Federal Financial Institutions Examination Council,
Quarterly Banking Reports of Condition and Income, Third Quarter 2006.

Fourth District banks’ efficiency (operating expenses as a percent of total income) continued
to worsen in 2006:IIIQ, deteriorating to 56.21
percent from the 52.64 percent record set in 2002.
(Lower numbers correspond to greater efficiency.)
Banks outside the Fourth District fared better,
with the national average continuing to improve
to 54.46 percent (from 56.40 percent at the end of
2005).
At the end of 2006:IIIQ, District banks posted a
1.39 percent return on assets (down from 1.43 percent at the end of 2005) and a 14.45 percent return
on equity (down from 15.32 percent at the end of
2005). The District’s decline contrasted with an
upward trend nationwide: At the end of 2006:IIIQ,
the U.S. banking industry reported that return on
assets rose to 1.19 percent (from 1.08 percent at the
end of 2005); and return on equity rose to 12.63
percent (from 11.55 percent at the end of 2005).
Overall, Fourth District banks’ financial indicators
point to stable balance sheets. Asset quality, as measured by net charge-offs (losses realized on loans
and leases currently in default minus recoveries on
previously charged-off loans and leases) continued
to improve in 2006:IIIQ. Net charge-offs dropped
from 0.38 percent at the end of 2005 to 0.3 percent of total loans, the lowest level in over a decade.
Problem assets (nonperforming loans and repossessed real estate) as a share of total assets, however,
rose to 0.68 percent, from 0.59 percent at the end
of 2005. The increase in problem assets may translate into higher charge-offs in the future if borrowers cannot catch up with their late payments. At
the national level, both asset quality ratios are still
improving. Net charge-offs and nonperforming
loans fell to a historically low 0.32 percent of loans
(down from 0.46 percent at the end of 2005) and
0.42 percent of assets (down from 0.45 percent at
the end of 2005), respectively.
35

Earnings*
Percent
1.7

Percent
20

Return on equity
excluding JP
Morgan

1.6

18

1.5

16

1.4

14

1.3

12

1.2
1.1

Return on
assets
excluding JP
Morgan

10
Return on
equity
including JP
Morgan

1.0
0.9

0.7
1995

1997

1999

2001

2003

6
4
2
0
2005

*Through 2006:IIIQ only. Data for 2006 are annualized.
**Efficiency is operating expenses as a percent of net interest income plus non-interest income.
Sources: Author’s calculation from Federal Financial Institutions Examination Council,
Quarterly Banking Reports of Condition and Income, Third Quarter 2006.

Asset Quality*
Percent
1.2

Net charge-offs,
excluding JP
Morgan Chase

1.1

Equity capital as a percent of Fourth District banks’
assets (the leverage ratio) rose to 9.65 percent (from
9.36 percent at the end of 2005).

8

Return on
assets
including JP
Morgan

0.8

Fourth District banks held $17.62 in equity capital
and loan loss reserves for every dollar of problem
loans, well above the recent coverage ratio low of
10.75 at the end of 2002 but below the record high
of 24.97 at the end of 2004.

The percent of unprofitable institutions in the
Fourth District fell to 5.17 percent for the third
quarter of 2006 (from 5.43 percent at the end of
2005). Unprofitable banks’ asset size also dropped
because the share of District banks’ assets accounted for by unprofitable banks fell from 0.56
percent to 0.14 percent. Industrywide, the share
of unprofitable institutions rose from 6.28 percent
to 6.82 percent at the end of 2006:IIIQ. However,
unprofitable banks’ asset size dropped from 1.13
percent at the end of 2005 to 0.43 percent at the
end of 2006:IIIQ. Thus, the industrywide increase
in the number of unprofitable banks comes from
the smaller financial institutions.

1.0
0.9
0.8

Problem assets,a
excluding JP
Morgan Chase

0.7
0.6
Problem assets,a
including JP
Morgan Chase
Net charge-offs,
including JP
Morgan Chase

0.5
0.4
0.3
0.2
1994

1996

1998

2000

2002

2004

2006

*Through 2006:IIIQ only. Data for 2006 are annualized.
a. Problem assets are shown as a percent of total assets, net charge-offs as a
percent of total loans.
Sources: Author’s calculation from Federal Financial Institutions Examination Council,
Quarterly Banking Reports of Condition and Income, 2006:IIIQ.

36

Coverage Ratio*

Core Capital (Leverage) Ratio*

Percent
30

Percent
11

27
Including JP
Morgan
Chase

24

10

Capital ratio, excluding
JP Morgan Chase
Capital ratio, including
JP Morgan Chase

9
21
8

18

Excluding JP Morgan
Chase

7

15

6

12
9
1994

5
1996

1998

2000

2002

2004

2006
4

*Through 2006:IIIQ only. Data for 2006 are annualized.
Sources: Author’s calculation from Federal Financial Institutions Examination Council,
Quarterly Banking Reports of Condition and Income, 2006:IIIQ.

1994

1996

1998

2000

2002

2004

2006

*Through 2006:IIIQ only. Data for 2006 are annualized.
Sources: Author’s calculation from Federal Financial Institutions Examination Council,
Quarterly Banking Reports of Condition and Income, 2006:IIIQ.

Unprofitable Institutions*
Percent
9
Assets in unprofitable
institutions excluding JP
Morgan

8
7
6

Unprofitable
institutions
excluding JP
Morgan

5
4

Unprofitable
institutions
including JP
Morgan

3
2

Assets in
unprofitable
institutions
including JP
Morgan

1
0
-1

1994

1996

1998

2000

2002

2004

2006

*Through 2006:IIIQ only. Data for 2006 are annualized.
Sources: Author’s calculation from Federal Financial Institutions Examination Council,
Quarterly Banking Reports of Condition and Income, 2006:IIIQ.

37