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January 2009 (Covering December 12, 2008 to January 8, 2009) In This Issue Inflation and Prices November Price Statistics Financial Markets, Money, and Monetary Policy The Yield Curve, December 2008 International Markets The Ups and Downs of Current-Account Deficits Economic Activity and Labor Markets Labor Costs GDP: Third-Quarter Final Estimate Regional Activity Ohio’s Business Cycle Fourth District Employment Conditions Banking and Financial Markets The Changing Face of Consumer Finance Inflation and Prices November Price Statistics 12.18.08 by Brent Meyer November Price Statistics Percent change, last 1mo.a 3mo.a 6mo.a 12mo. 5yr.a 2007 avg. Consumer Price Index All items Less food and energy −18.4 −10.2 0.4 0.3 −1.9 11 2.9 4.2 1.9 2.0 2.2 2.4 Medianb 2.6 2.4 3.3 3.1 2.9 3.1 16% trimmed meanb 0.0 0.2 2.4 2.7 2.6 2.8 Producer Price Index Finished goods Less food and energy −23.5 −19.5 1.4 3.9 −6.6 0.2 3.6 7.1 4.4 4.2 2.4 2.1 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 Component Price Change Distributions Weighted frequency 50 November 2008 45 July 2008 40 2008 year-to-date average 35 30 25 20 15 10 5 0 <0 0 to 1 1 to 2 2 to 3 3 to 4 4 to 5 Annualized monthly percentage change >5 Source: Bureau of Labor Statistics. The CPI fell further than expected, posting a record decrease of −18.4 percent (annualized rate) in November. As you may have guessed, rapidly falling energy prices (down 89.3 percent at an annualized rate), accounted for a large part of the decrease. Outside of energy prices, there was a rather curious uptick in owners’ equivalent rent (OER)—it increased 3.4 percent in November. OER is basically the implicit rent that the home–owner would pay to rent his or her home. Given the recent economic environment and the outlook for housing services, it seems unlikely that OER would continue to increase that rapidly. Excluding food and energy prices (core CPI), the index was virtually unchanged, ticking up a slight 0.3 percent in November. Over the past three months, the core CPI is only up 0.4 percent. The median CPI actually rose 2.6 percent in November, up from 1.8 percent in October, while the 16 percent trimmed mean was unchanged during the month. Parsing through the distribution of price changes yields some interesting facts. First, 30 percent of the index (by expenditure weight) exhibited price decreases, down slightly from 33 percent last month. Also, the percentage of the index in the tails of the distribution (<0 or >5) declined to 40 percent from 51 percent in October. Both of those may be very tentative signs that prices are starting to gravitate toward the center of the distribution. However, suppose you take a broad definition of price stability—say a distribution centered on increases in the range of 1 percent and 3 percent. It turns out that just 5 of the 45 components we use in the median calculation, with a combined relative importance value of 7.6 percent, were in that range in November. This figure is down from 17 percent in October and 29 percent if you go back to July. The longer–term trend (12-month growth rate) in the CPI fell to 1.1 percent in November, compared to 5.6 percent just four months ago. Measures of Federal Reserve Bank of Cleveland, Economic Trends | January 2009 2 CPI, Core CPI, and Trimmed-Mean CPI Measures 12-month percent change 6 Just as headline inflation measures have decreased rapidly in the past few months, so have average one-year-ahead inflation expectations. These fell to 1.9 percent in December, from 2.9 percent last month. The longer-term (5-year and 10-year) average inflation expectations decreased 0.4 percentage point to 2.7 percent during the month, a record low (the series goes back to April 1990). 5 4 CPI Median CPIa 3 2 1 1998 Core CPI 16% trimmedmean CPIa 2000 2002 2004 2006 underlying inflation (core, median, and trimmedmean CPI measures) all edged down in November and are ranging between 2.0 percent and 3.1 percent. 2008 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. Household Inflation Expectations 12-month percent change 7.5 7.0 6.5 6.0 5.5 5.0 4.5 One-year-ahead 4.0 3.5 3.0 Five to ten years-ahead 2.5 2.0 1.5 1.0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Note: Mean expected change as measured by the University of Michigan’s Survey of C onsumers. Source: University of Michigan. Financial Markets, Money and Monetary Policy The Yield Curve, December 2008 12.17.08 by Joseph G. Haubrich and Kent Cherny In the midst of the horrendous economic news of the last month, the yield curve might provide a slice of optimism. Though the yield curve has flattened since November, with long rates falling more than Federal Reserve Bank of Cleveland, Economic Trends | January 2009 3 short rates, the difference between the rates remained strongly positive. Yield Spread and Real GDP Growth Percent 12 10 This difference, 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. Yield curve inversions have preceded each of the last seven recessions (as defined by the NBER), the current recession being a case in point. The yield curve inverted in August 2006, a bit more than a year before the recession started in December 2007. Two notable false positives include an inversion in late 1966 and a very flat curve in late 1998. More generally, a flat curve indicates weak growth, and conversely, a steep curve indicates strong growth. One measure of slope, the spread between 10-year Treasury bonds and 3-month Treasury bills, bears out this relation, particularly when real GDP growth is lagged a year to line up growth with the spread that predicts it. R eal G DP growth (year-to-year percent change) 8 6 4 2 0 Ten-year minus three-month yield s pread -2 -4 1953 1963 1973 1983 1993 2003 Note: Shaded bars represent recessions Sources: Bureau of Labor Statistics and the Federal Reserve Board. Yield Spread and One-Year Lagged Real GDP Growth Percent 12 One year lagged real GDP growth (year-to-year percent change) 10 The financial crisis showed up in the yield curve, with rates falling since last month as investors fled to quality. The 3-month rate dropped from an already tiny 0.07 percent down to a miniscule 0.02 percent (for the week ending December 12), the lowest level since the Treasury constant maturity series started in 1982. 8 6 4 2 0 Ten-year minus three-month yield spread -2 -4 1953 1963 1973 1983 1993 2003 The 10-year rate dropped from 3.38 percent to 2.67 percent. Consequently, the slope decreased by 66 basis points to 265 basis points, down from November’s 331, and October’s 360. The flight to quality and the turmoil in the financial markets may affect the reliability of the yield curve as an indicator, but projecting forward using past values of the spread and GDP growth suggests that real GDP will grow at about a 3.0 percent rate over the next year. This remains on the high side of other forecasts, many of which are predicting reductions in real GDP. 2 Sources: Bureau of Economic Analysis and the Federal Reserve Board. Yield Spread and Predicted GDP Growth Percent 6 Real GDP growth (year-to-year percent change) 5 4 Predicted GDP growth 3 2 1 0 Ten-year minus three-year yield spread -1 -2 2002 2003 2004 2005 2006 2007 2008 2009 Sources: Bureau of Economic Analysis and the Federal Reserve Board. Federal Reserve Bank of Cleveland, Economic Trends | January 2009 3 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 4 of the economy being in a recession next December stands at a low 0.5 percent, up a bit from November’s miniscule 0.05 percent. Probability of Recession Based on the Yield Spread Percent Loyal readers may note the chart above looks a bit different this month; with the NBER declaring a recession, the model now has additional recession points to work with. 100 90 ty of recession n Probability 80 70 F st Forecast 60 50 40 30 20 10 0 1960 1966 1972 1978 1984 1990 1996 2002 2008 4 Note: Estimated using probit model. Sources: Bureau of Economic Analysis, the Federal Reserve Board, and authors’ calculations. The probability of recession coming out of the yield curve is very low and may seem strange in the midst of recent financial news, but one aspect of those concerns has been a flight to quality, which lowers Treasury yields. Furthermore, both the federal funds target rate and the discount rate have remained low, which tends to result in a steep yield curve. Remember also that the forecast is for where the economy will be next December, not earlier in the year. Again, though, in the spring of 2007, the yield curve was predicting a 40 percent chance of a recession in 2008, something that looked out of step with other forecasters at the time. To compare the 0.5 percent to some other probabilities, and learn more about different techniques of predicting recessions, head on over to the Econbrowser blog. Of course, it might not be advisable to take this number quite so literally, for two reasons. First, this probability is itself subject to error, as is the case with all statistical estimates. Second, other researchers have postulated that the underlying determinants of the yield spread today are materially different from the determinants that generated yield spreads during prior decades. Differences could arise from changes in international capital flows and inflation expectations, for example. The bottom line is that yield curves contain important information for business cycle analysis, but, like other indicators, should be interpreted with caution. For more detail on these and other issues related to using the yield curve to predict recessions, see the Commentary, “Does the Yield Curve Signal Recession? ” To see other forecasts of GDP growth: http://www.cbo.gov/ftpdocs/89xx/doc8979/02-15-EconForecast_ ConradLetter.pdf Federal Reserve Bank of Cleveland, Economic Trends | January 2009 5 To see other probabilities of recession: http://www.bloomberg.com/apps/news?pid=20601087&sid=aEX73 qWiBrb4 Econbrowser blog is available at: http://www.econbrowser.com/archives/2008/02/predicting_rece.html Does the Yield Curve Signal Recession?,” by Joseph G. Haubrich. 2006. Federal Reserve Bank of Cleveland, Economic Commentary, is available at: http://www.clevelandfed.org/Research/Commentary/2006/0415.pdf Financial Markets, Money and Monetary Policy A Focus on Quantitative Easing 01.12.09 by John Carlson and Sarah Wakefield Reserve Market Rates Percent 8 In an unprecedented move at its December 16 meeting, the Federal Open Market Committee (FOMC) decided to establish a target range for the federal funds rate of 0 to ¼ percent. The Board of Governors also reduced the primary credit rate to ½ percent. 7 6 5 Primary credit rate 4 3 2 Intended federal funds rateb 1 Effective federal funds ratea 0 8/07 10/07 1/08 4/08 7/08 10/08 a. Weekly average of daily figures. b. As of December 16, 2008, defined as range of 0 to 0.25 percent. Sources: Board of Governors of the Federal Reserve System, “Selected Interest Rates,” Federal Reserve Statistical Releases, H.15. Components of the Monetary Base Trillions of dollars, SA Recognizing that interest rate policy reductions had essentially reached a zero bound, the Committee stressed that the “Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.” Further, the Committee stated that the focus of “policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level.” 2.00 Open market operations and other measures have added greatly to the supply of the monetary base, which jumped from around $850 billion in late August to nearly $1.7 trillion on December 31. The doubling of the monetary base in such a short time highlights the fact that the Federal Reserve had already employed other available tools in dramatic fashion to support the functioning of financial markets. 1.75 Excess reserves 1.50 1.25 Required reserves 1.00 Currency component 0.75 0.50 0.25 0.00 12/07 2/08 4/08 6/08 8/08 10/08 12/08 Source: Federal Reserve Board Federal Reserve Bank of Cleveland, Economic Trends | January 2009 It is apparent from the explosion of the excessreserves component that the surge in total bank reserves has not been associated with a commensu6 rate surge in bank loans. Rather than lending the additional reserves, many banks have held on to them in an effort to improve their balance sheets. Libor-OIS Spread Percentage points 4.0 The additional reserves have been associated with some positive signs for liquidity. A key indicator of liquidity is the spread between the London Interbank Borrowing Rate (Libor) on a term loan and the interest rate paid on an Overnight Index Swap (OIS) for a comparable maturity. The Libor–OIS spreads on both one-month and three-month maturities jumped to record levels in September, but have receded substantially as the monetary base has expanded. 3.5 3.0 2.5 2.0 1.5 One-month Three-month 1.0 0.5 0.0 1/07 4/07 7/07 10/07 1/08 4/08 7/08 10/08 1/09 Sources: Bloomberg Financial Services, Financial Times. International Markets The Ups and Downs of Current-Account Deficits 01.06.09 by Owen F. Humpage and Michael Shenk Current Account Balance Percent of GDP 1.0 Index, March 1973=100 140 0.0 130 -1.0 120 -2.0 110 -3.0 100 -4.0 90 Real Broad Dollar Index -5.0 -6.0 -7.0 1980 80 Current account 70 60 1985 1990 1995 2000 2005 Sources: Bureau of Economic Analysis, Board of Governors of the Federal Reserve System. Federal Reserve Bank of Cleveland, Economic Trends | January 2009 After reaching a record deficit of nearly $825 billion (annual rate) or 6½ percent of GDP in the fourth quarter of 2005, the U.S. current-account deficit has since narrowed. By and large, our current-account balance reflects trade patterns, with a deficit indicating that the United States imports more goods than it exports. The connection between current-account deficits and trade patterns, however, does not mean that Americans spend too much and save too little. Maybe America is just a good place to invest. Over the past 25 years, different underlying developments have contributed to the U.S. current-account deficit. Some of these developments reflected trade decisions; some reflected investment decisions. Between 1995 and 2002, for example, the U.S. current-account deficit rose from roughly 2 percent of GDP to slightly more than 4 percent of GDP because of an influx of global savings. America was a good place to invest. As foreigners sought dollar-denominated investments in the United States, they bid up the dollar’s exchange value. The dollar appreciated on a real (inflation adjusted) 7 basis, raising the foreign-currency prices of U.S. goods, lowering the dollar prices of foreign goods, and thereby shifting worldwide demand away from U.S. goods and services. This pattern seemed to end with the dot-com bust in 2001. The U.S. current-account deficit, however, continued to grow as a percent of GDP until it reached its 2005 high. This expansion reflected strong U.S. aggregate demand growth after the 2001 recession. As U.S. residents bought foreign goods and services, they supplied dollars to the exchange market and bought foreign currencies. The dollar depreciated on a real basis against the currencies of our major trading partners. The dollar’s depreciation increased the attractiveness of investing in the United States, but trade decisions were the driving force. Beginning in 2005, foreign investors became increasingly reluctant to hold dollar-denominated assets. As investment flows into dollar assets slowed, the dollar depreciated on a real basis. The depreciation shifted world demand, which at the time was going gangbusters, to U.S. products. The currentaccount deficit narrowed to just below 5 percent in the first three quarters of 2008. Once again, investment decisions held sway. All-encompassing explanations for the various levels of the U.S current–account deficit, like “Americans spend too much,” rarely offer much traction. Current-account and exchange-rate patterns reflect myriad and changing economic decisions. Economic Activity Labor Costs 12.23.08 by Murat Tasci and Beth Mowry Growth in compensation costs is monitored by economists as an indicator of future inflationary pressures (compensation costs include employers’ costs for wages, salaries, and employee benefits). As measured by the employment cost index (ECI), cost growth has leveled off and begun to slowly recede during the second and third quarters of 2008. In these two quarters, the four-quarter percentage Federal Reserve Bank of Cleveland, Economic Trends | January 2009 8 Employment Cost and Inflation Four-quarter percent change 6.5 6.0 5.5 Employment Cost Index, 5.0 private Employment Cost Index, 4.5 wages & salaries component 4.0 3.5 3.0 2.5 2.0 1.5 Core CPI 1.0 0.5 3/00 3/01 3/02 3/03 3/04 3/05 3/06 3/07 3/08 Sources: U.S. Department of Labor, Bureau of Labor Statistics. Productivity and Unit Costs Four-quarter percent change 7.0 6.0 Output per hour, nonfarm 5.0 4.0 change in the index dipped below 3 percent for the first time since the second quarter of 2006. This moderation comes after solid gains in index growth throughout 2006 and early 2007. Wages and salaries account for roughly 70 percent of total worker compensation, and this component has steadily declined since the second quarter of 2007, suggesting it is largely responsible for the decline in the overall ECI. Of course, workers might be compensated less simply because they are producing less, but this does not appear to have been the case recently. While unit labor costs (a productivity-adjusted measure of employment costs) started to lose momentum in the first quarter of 2007, changes in this measure have been negatively correlated with changes in output per hour in the nonfarm business sector. This pattern in the two measures has been especially visible since 2000, and the relatively slower growth in unit labor costs coincided with relatively larger gains in output per hour in the nonfarm business sector. 3.0 2.0 1.0 0.0 -1.0 Unit labor cost, nonfarm -2.0 -3.0 3/00 3/01 3/02 3/03 3/04 3/05 3/06 3/07 3/08 Source: U.S. Department of Labor, Bureau of Labor Statistics. Distribution of Total Compensation 2007 Retirement and savings benefits 3.1% Legally required benefits 8.2% Wages and salaries 71.9% Insurance benefits 7.2% Supplemental pay 2.7% Paid leave 6.9% Note: Data include private service-providing industry workers. Sources: U.S. Department of Labor, Bureau of Labor Statistics. Federal Reserve Bank of Cleveland, Economic Trends | January 2009 In 2007, almost 72 percent of the total compensation cost for private service workers consisted of wages and salaries. (For workers in goods-producing industries, the figure was 67 percent.) The nextlargest components were legally required benefits (8.2 percent), insurance benefits (7.2 percent), and paid leave (6.9 percent). Even though benefits account for just 30 percent of total compensation, swings in benefits growth have often been large enough to noticeably influence growth in total compensation, particularly when growth in wages and salaries was nearly stagnant. For example, between the fourth quarter of 2002 and the second quarter of 2004, wages and salaries moved from 2.6 percent to just 2.8 percent (in terms of four-quarter percent change), but total compensation growth climbed from 3.1 percent to 3.9 percent because benefits growth shot up from 4.3 percent to 7.2 percent. A similar interaction in the opposite direction was taking place up until the first quarter of 2006: Benefits and total compensation growth both fell, and wages and salaries growth sat tight. The last couple of years, though, have seen a convergence of growth rates, leaving 9 them much more in line with core CPI growth. Components of Employment: Compensation and Inflation Four-quarter percent change 8.0 7.5 7.0 6.5 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 Core CPI 1.5 1.0 3/00 3/01 3/02 Benefits Total compensation Wages and salaries 3/03 3/04 3/05 3/06 3/07 3/08 Note: Colored boxes highlight the following time periods referred to in the text: Q4 2002-Q2 2004, Q2 2004-Q1 2006, and Q1 2007-Q3 2008. Sources: Department of Labor, Bureau of Labor Statistics. Economic Activity Real GDP: Third-Quarter Final Estimate 01.06.09 by Brent Meyer Real GDP and Components, 2008:Q3 Final Estimate Annualized percent change, last: Quarterly change (billions of 2000$) Quarter Four quarters Real GDP −15.0 −0.5 0.7 Personal consumption −80.7 −3.8 −0.2 Durables −48.2 −14.8 −5.5 Nondurables −44.4 −7.1 −0.9 Services −0.8 −0.1 1.1 Business fixed investment −6.1 −1.7 1.6 −20.7 −7.5 −3.1 Equipment 7.9 9.6 11.2 Residential investment Structures −15.9 −16.1 −20.6 Government spending 29.2 5.8 3.1 National defense 22.3 18.0 7.7 28.2 — — Exports 11.4 3.0 6.1 Imports −16.9 −3.5 −3.5 Private inventories −29.6 — — Net exports Real GDP decreased at an annualized rate of 0.5 percent in the third quarter of 2008 (unchanged from the preliminary estimate), according to the final estimate released by the Bureau of Economic Analysis. Personal consumption expenditures were revised down 0.1 percentage point to −3.8 percent, reflecting downward adjustments to both nondurables and services consumption, which were partially offset by an upward revision to durables consumption. Business fixed investment was largely unchanged during the revision. However, residential investment was revised up from −17.6 percent to −16.1 percent. Export growth in the third quarter was revised down again, increasing only 3.0 percent, compared to 3.4 percent in the preliminary release and 5.9 percent in the advance estimate. Imports were revised down to −3.5 percent from −3.2 percent in the preliminary release and −1.9 percent in the advance estimate. Source: Bureau of Economic Analysis. Personal consumption expenditures, which last quarter added 0.9 percentage point to real GDP growth, subtracted 2.8 percentage points in the Federal Reserve Bank of Cleveland, Economic Trends | January 2009 10 Contribution to Percent Change in Real GDP Percentage points 2.5 2.0 1.5 2008:Q3 advance 2008:Q3 preliminary 2008:Q3 final Government spending Exports 1.0 0.5 Residential investment Personal consumption 0.0 Change in inventories Business fixed investment -0.5 -1.0 Imports -1.5 -2.0 -2.5 -3.0 -3.5 Source: Bureau of Economic Analysis. Real Personal Consumption Expenditures Annualized percent change 10 8 6 4 2 0 -2 -4 -6 -8 -10 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 Source: Bureau of Economic Analysis Real GDP Growth Annualized quarterly percent change 6 Final estimate Advance estimate Preliminary estimate Blue Chip consensus forecast 5 4 3 2 1 0 -1 third quarter, marking the first time this component has subtracted from growth since the fourth quarter of 1991. Net exports added 1.1 percentage points to growth in the third quarter, following a 2.9 percentage point addition in the second quarter and a 1.4 percentage point addition over the past four quarters. The contribution from private inventories in the third quarter was revised up from 0.6 percentage point in the advance release to 0.8 percentage point in the final estimate (though this is down 0.1 percentage point from the preliminary estimate). Government spending added 1.1 percentage points to real GDP growth during the quarter, outpacing the this component’s average contribution over the past four quarters of 0.6 percentage point. Much of the increase was due to a jump in national defense spending, which added 0.9 percentage point to growth in the third quarter, compared to 0.4 percentage point last quarter. Personal consumption decreased at an annualized rate of 3.8 percent in the third quarter of 2008, its steepest decline since 1980. The latest indicators of monthly personal consumption show a 5.5 percent decrease in October, followed by a 6.9 percent increase in November. However, it may not mean that consumers are headed to the mall just yet. Prices plummeted in November, outpacing the decline in nominal consumption, which led to the net increase. Nominal personal consumption (unadjusted for price effects) declined 11.5 percent in October and 6.5 percent in November. The latest Blue Chip consensus forecast is for real GDP to drop 4.1 percent in the fourth quarter of 2008, marking the economy’s worst performance since the 1982 recession. The estimate fell 1.3 percentage points from the November forecast. Also, it seems that the 2009 outlook has darkened considerably, as nearly every panelist revised down his or her respective 2009 growth estimate from the last report. The 2009 consensus estimate fell from −0.4 percent in November to −1.1 percent in December. -2 -3 -4 -5 Q3 Q4 2007 Q1 Q2 Q3 2008 Q4 Q1 Q2 Q3 2009 Q4 Source: Blue Chip Economic Indicators, December 2008; Bureau of Economic Analysis. Federal Reserve Bank of Cleveland, Economic Trends | January 2009 11 Regional Activity Ohio’s Business Cycle 01.07.09 by Kyle Fee The National Bureau of Economic Research (NBER) has designated December 2007 as the starting point of the current recession. However, the recession referred to is the nation’s as a whole— individual states vary with respect to the timing of their business cycles as well as in the severity of their recessions. For instance, according to a 2006 report by the Federal Reserve Bank of Philadelphia (“What a New Set of Indexes Tells Us about State and National Business Cycles,”) about only half of the states experienced all four of the national recessions that occurred between 1979 and 2006. Economic Activity Index: January 1979 –November 2008 Index, July 1992 = 100 To see how Ohio’s business cycle compares to those of other states and the nation, we examine the state coincident indexes published by the Federal Reserve Bank of Philadelphia. These indexes combine nonfarm employment, average hours worked in manufacturing, the unemployment rate, and real wages and salaries into a composite measure of economic activity. 160 150 140 130 120 Ohio 110 National 100 90 80 70 60 1979 1983 1987 1991 1995 1999 2003 Note: Shaded areas are NBER designated recession dates. Source: Federal Reserve Bank of Philadelphia. 2007 Several patterns stand out when comparing Ohio’s coincident index and the national index. First, Ohio’s index declined during the five national recessionary periods that have occurred since the late 1970s, including the current recession. Second, Ohio’s index falls more sharply and for a longer period of time during recessionary periods than the national index. This likely reflects the fact that Ohio has a larger share of cyclically sensitive industries, such as manufacturing, compared to the nation as a whole. Third, while the coincident index for Ohio generally tracks the national index between the early 1980s and the early part of this decade, the indexes diverge in the recovery cycle after the 2001 recession. Ohio’s economy has clearly underperformed the national economy, as Ohio generated particularly weak employment growth over this period. A closer look at more recent levels of the indexes reveals slightly different patterns across states head- Federal Reserve Bank of Cleveland, Economic Trends | January 2009 12 Economic Activity Index: January 2007–November 2008 Index, July 1992 = 100 160 National 155 Kentucky Pennsylvania 150 June 2007 Ohio 145 December 2007 140 1/07 4/07 7/07 10/07 1/08 4/08 7/08 10/08 Note: Dashed line is NBER designated recession date. Source: Federal Reserve Bank of Philadelphia. ing into the current recession. Ohio’s economy appeared to weaken earlier than those of Kentucky and Pennsylvania. Ohio’s economy peaked in June 2007 and declined moderately between June 2007 and March of 2008. Kentucky’ sand Pennsylvania’s economic activity continued to expand through early 2008. In early 2008, all three states’ economic activity began to fall at a sharper rate. As of November of 2008, Ohio’s index had declined 3.9 percent from its peak, while Kentucky’s and Pennsylvania’s had fallen 2.8 percent and 5.4 percent from theirs, respectively. It is interesting to note that the national coincident index did not turn down until August 2008. This delay relative to Fourth District states reflects the fact that real GDP growth in the first two quarters of 2008 was still positive. Comparing the dates of the peaks and troughs of Ohio’s business cycle with those of the nation(NBER) shows that Ohio has typically entered periods of declining economic activity earlier than the nation and that the declines have persisted longer. On average, Ohio’s economic activity slowed down 5.5 months prior to the typical national recession and lasted 1.3 months longer. When compared to the Philly Fed’s coincident index for the nation, Ohio enters periods of declining economic activity even earlier (7.3 months) than the nation. While Ohio’s coincident index is subject to revision, a peak date of June 2007 for the current cycle is not out of the question, based upon previous business cycle data. Business Cycle Peaks and Troughs Ohio (Philly Fed Index) Cycle Peak Nation (Philly Fed Index) Trough Peak Nation (NBER) Trough Peak Trough 1 May 1979 August 1980 March 1980 July 1980 January 1980 July 1980 2 March 1981 November 1982 August 1981 November 1984 July 1981 November 1982 3 June 1990 May 1991 September 1990 April 1991 July 1990 March 1991 4 June 2000 January 2002 May 2001 January 2002 March 2001 November 2001 5 June 2007 -- June 2008 -- December 2007 -- Source: The Federal Reserve Bank of Philadelphia. To see read the Philadelphia Fed’s 2006 report “What a New Set fo Indexes Tells Us about State and National Business Cycles”: http://www.philadelphiafed.org/research-and-data/publications/ business-review/2006/q1/Q1_06_NewIndexes.pdf Federal Reserve Bank of Cleveland, Economic Trends | January 2009 13 Regional Activity Fourth District Employment Conditions 01.07.09 by Kyle Fee Unemployment Rates Percent 8 7 Fourth Districta 6 5 United States 4 3 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 a. Seasonally adjusted using the Census Bureau’s X-11 procedure. Notes: Shaded bars represent recessions; Some data reflect revised inputs, reestimation, and new statewide controls. For more information, see http://www.bls.gov/lau/launews1.htm. Source: U.S. Department of Labor, Bureau of Labor Statistics. County Unemployment Rates Percent 13.0 12.0 11.0 10.0 Ohio Kentucky Pennsylvania West Virginia Median unemployment rate = 7.5% 9.0 8.0 7.0 6.0 5.0 4.0 3.0 County Note: Data are seasonally adjusted using the Census Bureau’s X-11 procedure. Source: U.S. Department of Labor, Bureau of Labor Statistics. The District’s unemployment rate remained steady at 7.0 percent for the month of November. The stable unemployment rate reflects an increase of the number of people unemployed (0.5 percent), a decrease in the number of people employed (−0.4 percent) and a decrease in the labor force (−0.4 percent). As it has consistently been since early 2004, the District’s unemployment rate was higher than the nation’s (0.3 percentage point). Since this time last year, the Fourth District’s unemployment rate has increased 1.7 percentage points, while the nation’s has increased 2.0 percentage points. There are considerable differences in unemployment rates across counties in the Fourth District. Of the 169 counties that make up the District, 50 had an unemployment rate below the national average in October and 119 counties had rate higher than the national average. There were 24 District counties that reported double-digit unemployment rates, while only one county had an unemployment rate below 5.0 percent. Rural Appalachian counties continue to experience higher levels of unemployment, as do counties along the Ohio-Michigan border. The distribution of unemployment rates among Fourth District counties ranges from 4.6 percent to 12.4 percent, with a median county unemployment rate of 7.5 percent. Counties in Fourth District West Virginia and Pennsylvania generally populate the lower half of the distribution, while Fourth District Kentucky and Ohio counties are dominant in the upper half of the distribution. These county– level patterns are reflected in state-wide unemployment rates. The states of Ohio and Kentucky have unemployment rates of 7.3 and 7.0 percent, respectively, compared to Pennsylvania’s 6.1 percent and West Virginia’s 4.6 percent. Continued unemployment insurance claims serve as an alternative measure of local labor market conditions and reflect the number of persons receiving Federal Reserve Bank of Cleveland, Economic Trends | January 2009 14 unemployment benefits. At the national level, average weekly claims have increased 33.1 percent since the beginning of 2008. However, Fourth District states have seen continued unemployment insurance claims grow at an even faster pace. Kentucky has seen the largest increase (54.6 percent), while Ohio’s and Pennsylvania’s growth in continued claims has been somewhat slower (41.8 percent and 38.5 percent, respectively). Moreover, much of the rise in continued claims has occurred in the past four months, indicating an increase in the rate of deterioration of Fourth District labor markets. County Unemployment Rates U.S. unemployment rate = 6.7% 4.6% - 5.9% 6.0% - 6.9% 7.0% - 7.9% 8.0% - 8.9% 9.0% - 9.9% 10.0% - 12.4% Note: Data are seasonally adjusted using the Census Bureau’s X-11 procedure. Source: U.S. Department of Labor, Bureau of Labor Statistics. Unemployment Insurance: Continued Claims Weekly average, thousands 225 200 Pennsylvania 175 150 125 Ohio 100 75 Kentucky 50 25 1/08 3/08 5/08 7/08 9/08 Source: U.S. Department of Labor. Banking and Financial Institutions The Changing Face of Consumer Finance 12.23.08 by O. Emre Ergungor and Kent Cherny Distressed credit markets are changing the look of consumer finance for financial institutions and consumers alike. While the nonmortgage consumer loan assets of commercial banks have grown by roughly 25 percent over the past three years, the reFederal Reserve Bank of Cleveland, Economic Trends | January 2009 15 ness and the lack of easy bank financing may slow or halt this trend. Consumer ABS Issuance Billions 25 Student loan ABS 20 Auto ABS 15 10 5 Credit card ABS 0 01/07 05/07 09/07 01/08 05/08 09/08 Source: Bloomberg. As the chart below shows, the issuance of new consumer ABSs all but dried up in the fourth quarter. Securities backed by credit cards have not been issued since September, and no new student loan securities have been sold since August. As a result, risk-aversion by banks and investors is affecting the supply of credit that individuals use to finance large purchases (automobiles and higher education) and for monthly cash management (credit cards). Asset-Backed Security Rates Percentage rate 20 TALF announced 18 16 Merrill Lynch Asset-Backed Master 14 12 Auto ABS 10 8 Credit card ABS 6 4 2 0 06/07 10-year Treasury 09/07 12/07 03/08 06/08 09/08 One factor weighing heavily on the supply of consumer credit is the frozen asset-backed securities (ABS) market. Credit cards and student loans (and a fair amount of auto loans) are typically packaged together into a trust by financial institutions, who then sell securities representing ownership interests on the trust to sophisticated investors. In the recent past, ABS issuance allowed banks to extend a great deal of credit since the securities were often not kept on their balance sheets, freeing up additional money to lend. Following the credit panic of mid-September and its roots in residential mortgage securities, investors have fled all ABSs, putting substantial pressure on a major source of consumer loan funds. 12/-08 Source: Federal Reserve Board; Merrill Lynch. Similarly, the repricing of risk in the ABS market has sent rates on outstanding securities significantly higher relative to most other asset classes. To help unfreeze the market for consumer credit, the Federal Reserve Board announced on November 25 that it will create a facility—the Term Asset-Backed Securities Loan Facility (TALF)—that will lend to purchasers of AAA-rated credit card, auto, SBA, and student loan securities. The announcement immediately arrested the run-up of rates on credit card and auto ABSs, though the facility will not be operational until early 2009. Consumer ABS rates remain 6-8 percentage points above those of 10year Treasury securities, though other ABS rates are considerably higher. Meanwhile, consumers themselves have changed their saving and borrowing habits in response to both the shortage of credit and economic conditions generally. First, they have begun saving a larger portion of their income. A steep rise in sav- Federal Reserve Bank of Cleveland, Economic Trends | January 2009 16 ings in June reflects the economic stimulus package enacted in early 2008. Then, following the events of mid-September, individuals decreased consumption (an almost unprecedented change in trend) and increased personal savings, which had previously been about zero. Banks’ Consumer Loan Assets Billions 600 TALF announced 550 Home equity loans 500 Other consumer loans 450 400 Credit card/revolving consumer loans 350 300 06/07 09/07 12/07 03/08 06/08 09/08 12/08 Source: Federal Reserve Board. Savings and Consumption Billions 10,400 Percentage of disposable personal income 5 Savings rate 4 10,200 Personal consumption 3 10,000 2 9,800 1 9,600 0 06/07 9,400 09/07 12/07 03/08 06/08 09/08 Source: Bureau of Economic Analysis. Commercial Bank Deposits Billions 4,500 Billions 2,500 4,375 2,250 Consumers haven’t completely retreated from the debtor role, however. Amid the uncertainty of September, home equity loans increased dramatically. This might have occurred if, for example, consumers foresaw a tightening of the economy and credit going forward, and consequently preferred to hold their homes’ equity value in cash for transactional purposes. The flight to safety away from securities and into cash is evident when looking at commercial banks’ deposits in the last few months as well. Depositors have added more than half a trillion dollars to their accounts since September and have shown a marked shift out of extended time deposits, preferring to hold more of their savings in more readily accessible vehicles like traditional savings and checking accounts. Banks had a hand in the move to deposits as well: In the absence of interbank and capital market funding, larger commercial banks aggressively priced interest rates to lure new deposits, a more stable source of funding. In short, the events of the third and fourth quarters have been accompanied by an extreme aversion to risky assets, which in turn has begun to change the dynamics of the consumer credit market. Assetbacked securities have fallen heavily out of favor, with issuance in important sectors of the market (like credit cards and student loans) disappearing altogether. However, the Federal Reserve’s TALF program has been announced in an effort to return these markets to functionality. Large time deposits 4,250 2,000 Other nontransactional deposits 4,125 4,000 01/08 1,750 1,500 03/08 05/08 07/08 09/08 11/08 Source: Federal Reserve Board. Federal Reserve Bank of Cleveland, Economic Trends | January 2009 Consumers have hunkered down as well, boosting their cash savings, avoiding deposit investments with long durations, and when necessary, extracting the equity from their homes to make purchases that consumer installment loans may have funded in the past. It is far too early to judge the likelihood that these trends represent a long-term shift to higher savings versus merely being the necessary reconfigurations in an environment with credit scarcity 17 and rapidly declining personal wealth (due to falling asset values). What is clear is that at a time of widespread illiquidity in numerous asset classes, consumers are rapidly acting to make their own financial position as liquid as possible. Economic Trends is published by the Research Department of the Federal Reserve Bank of Cleveland. Views stated in Economic Trends are those of individuals in the Research Department and not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. Materials may be reprinted provided that the source is credited. If you’d like to subscribe to a free e-mail service that tells you when Trends is updated, please send an empty email message to econpubs-on@mail-list.com. 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