Full text of Economic Trends (Federal Reserve Bank of Cleveland) : Economic Trends - July 2006

View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

1
•

•

The Economy in Perspective
by Mark Sniderman

FRB Cleveland • July 2006

People often ask me to recommend books about
economics but now, with the onset of summer, I am
getting requests for “beach books” on the dismal
science. I certainly can relate—you can’t just take a
pass on macroeconomics for an entire season, yet
you want something that won’t give you a headache
when you are out all afternoon in the sun. So here
are my recommendations for books with an economics theme—for your summer reading pleasure:
Quayle’s Quandary is the eighth novel in Chris
Cournot’s thriller series about everyone’s favorite
government crusader, Casey Quayle. The story
opens with a ceremony at which the Treasury
Department bestows on the hero its highest honor
for valor, which he earned by thwarting a hedge
fund managers’ plot to slip self-serving language
into pending tax legislation (read book seven,
Quayle’s Query). Through a series of circumstances not to be divulged here, the president
decides to nominate Quayle as the next Secretary of
the Treasury.
The night before his Senate hearing, Quayle sits
at his desk, reminiscing about his career and looking back at his numerous studies. He skims through
his path-breaking report on foreign exchange markets, the study that propelled him into prominence
(read book one, Qualye’s Quagmire), and there he
finds—egad!—a computational flaw. He doublechecks his calculations, but there is no escape—his
original conclusion is simply wrong. Like the ethical
man that he is, he vows to come clean in tomorrow’s hearing. But there is a problem: He knows
that the day after the hearing, the Republic of China
plans to announce its decision to freely float the
renminbi instead of pegging it to the dollar—and
that their decision rests on the persuasiveness of
his report. If he disavows the report’s conclusion,
the Chinese government will surely change its plan.
How will Quayle resolve the tension between his
country’s welfare and his own honor? This spellbinding story of intrigue and deception features a
complex web of characters engaged in naked trades
and dirty floats. As Cournot turns up the heat, make
sure you keep applying your sunblock—the time
will fly.

Another novel on my beach-reading list is Legally
Bland, by Elinor Ely. This first-time author performs
a tour de force about a central banker who tries her
best to be completely forthright in her public
discussions about monetary policy, only to be constantly second-guessed and misunderstood by
media groupies. Meet Samantha (“Sam”) Powers, a
central banker with all the right credentials. After
being appointed to her central-banking post, Sam
decides to demystify the secrets of the temple by
saying what she means and meaning what she says.
But complications arise when commentators try to
“decode” her messages, not willing to believe that
they were never coded in the first place.
Ely, who was formerly a central-bank official,
turns her finely tuned ear to the everyday foibles of
central banking. In one episode, Sam agonizes over
how to phrase a sentence in her upcoming “Nuts
and Bolts” speech, so nicknamed by her staff, who
enjoy its double entendre: The speech, which is
about the tools of monetary policy, will be given to a
convention of hardware industry executives. Sam
wants to stake out a middle-of-the-road position on
a policy issue, wishing to appear neither hawk nor
dove. She edits the draft of the speech, drawing a
red line through the sentence, “Under some circumstances, an action might be warranted, but its
merits will depend partly on other considerations
that may exist at the time,” and penning simply, “I’ll
cross that bridge when I come to it.” What could be
clearer? But one media outlet prints its coverage of
her speech under the headline, “Powers Hints of
Interest Rate Moves.” The article’s lead sentence
is, “Samantha Powers indicated her desire to hike
interest rates another notch, declaring that she
would ‘cross that bridge’ at the next policy meeting.” Powers’ repeated encounters with the media
spin-meisters take financial markets on a roller
coaster ride in this rolicking parable about who’s
listening and who’s not. The heroine eventually has
her day, and when you stop laughing, you will realize
that Legally Bland challenges you to know the truth
when you see it. This tale about central banking in
the sunshine is a perfect choice for summer fun.

2
•

•

Inflation and Prices
12-month percent change
4.75 CPI AND CPI EXCLUDING FOOD AND ENERGY

May Price Statistics

4.50

Percent change, last:
a
a
a
1 mo. 3 mo. 12 mo. 5 yr.

2005
avg.

CPI

3.75

Consumer prices
All items

4.25
4.00

5.5

5.7

4.2

2.6

3.6

3.50
3.25

Less food
and energy

3.6

3.8

2.4

2.1

2.2

Medianb

4.3

4.2

3.0

2.7

2.5

3.00

CPI excluding
food and energy

2.75
2.50
2.25

Producer prices
Finished goods

2.3

6.7

4.5

2.5

5.8

2.00
1.75

Less food and
energy

3.1

2.0

1.5

1.2

1.7

1.50
1.25
1.00
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

12-month percent change
4.25 TRIMMED-MEAN CPI INFLATION MEASURES
4.00

12-month percent change
4.25 PCE PRICE INDEX INFLATION MEASURES
4.00
3.75

3.75
Median CPI b

3.50

PCE

3.25
3.25

3.00

2.75

2.50

2.25

2.00

Trimmed-mean PCE

1.75

2.00

1.50
1.75

16% trimmed-mean CPI b

1.25

1.50

1.00

CPI excluding food and energy
1.25
1.00
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

PCE excluding food and energy
0.75
0.50
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

FRB Cleveland • July 2006

a. Annualized.
b. Calculated by the Federal Reserve Bank of Cleveland.
SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; U.S. Department of Commerce, Bureau of Economic Analysis; Federal Reserve Bank of
Dallas; and Federal Reserve Bank of Cleveland.

Inflation pressures intensified further
in May. The Consumer Price Index
(CPI) continued to accelerate, rising
at an annualized rate of 5.5%. Brisk
monthly growth in the core retail
price measures outpaced longerterm trends: The CPI excluding food
and energy rose at a 3.6% annualized
rate, while the median CPI surged at
a 4.3% annualized rate.
Longer-term growth trends in the
core retail price measures reveal increased pressure since at least last
fall. The 12-month growth rate in the

CPI excluding food and energy ratcheted up to 2.4%, a bit above the
2%–21/4% range in which it has fluctuated for about a year. The 12-month
growth rates of the 16% trimmedmean CPI and the median CPI ticked
up to 2.7% and 3.0%, respectively.
The growth rate of both these measures has risen roughly 1/4 to 1/2 percentage point since last fall. Meanwhile, the Personal Consumption
Expenditure (PCE) Price Index excluding food and energy, an alternative measure of underlying retail

price pressure, rose 2.6% on a yearto-date basis in May, also up about 1/2
percentage point from its 12-month
trend.
Intense retail price increases are
widespread. In 2005, about one-third
of non-energy CPI components
posted average monthly increases of
2%–3%, and prices of another third
of these components rose more than
3%. Since the beginning of this year,
a majority of the non-energy components have risen at average monthly
rates exceeding 3%, while nearly 70%
(continued on next page)

3
•

•

Inflation and Prices (cont.)
Weighted frequency
45 PRICE CHANGE DISTRIBUTION, NON-ENERGY COMPONENTS
40

4.5

May 2006
2006 to date

12-month percent change
5.0 HOUSING COSTS

CPI: Rent of primary residence

2005
4.0

30
25

3.5

3.0

15
2.5
10
2.0

CPI: Owner’s equivalent rent of primary residence (OER)
0

1.5
Less than 0

0–1

1–2

2–3

3–4

4–5

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

More than 5

One-month annualized percent change
16 CPI: OWNER’S EQUIVALENT RENT OF PRIMARY RESIDENCE

12-month percent change
6.0 HOUSEHOLD INFLATION EXPECTATIONS a

5.5
5.0

4.5

Five to 10 years ahead
Period average

4.0

8
3.5
6
3.0
4
2.5
2

2.0
One year ahead

1.5

–2
1983

1.0
1986

1989

1992

1995

1998

2001

2004

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

FRB Cleveland • July 2006

a. Mean expected change as measured by the University of Michigan’s Survey of Consumers.
SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; and University of Michigan.

of such components rose 3% or
more in May. Indeed, almost 45% of
non-energy CPI components rose
5% or more in May, including the
single largest component, owner’s
equivalent rent of primary residence
(OER).
OER—the costs that homeowners
would assume if they rented their
homes instead of owning them—
accounts for nearly one-quarter of
the CPI market basket. Monthly
growth in OER has accelerated since
the beginning of the year. OER

jumped 6.8% in May, well above its
3.1 average monthly percent change.
Some of the recent rise can be tied to
decelerating utilities costs, which are
subtracted from this housing cost
measure, but some part of the rise
seems to come from a rental market
that is growing stronger after several
years of relative softness.
The recent pressure on the
OER component of the CPI may be
with us for the summer. Since 1995,
the monthly OER index has been
computed from six-month rent

changes, a procedure that reduces
its monthly volatility but also causes
the measure to exhibit some persistence. In other words, monthly
changes in OER tend to influence
the CPI’s behavior over a period of
several months.
One encouraging development is
that household inflation expectations
moderated a bit in June. Short-term
inflation expectations fell from 4.7% to
4.4%, while longer-term expectations
dropped from 3.8% to 3.4%.

4
•

•

Monetary Policy
Percent
8 RESERVE MARKET RATES

Percent
6 REAL FEDERAL FUNDS RATE c,d

Effective federal funds rate a

4
Intended federal funds rate b

2
Primary credit rate b
1

2
Discount rate b

–1

1
0
2000

2001

2002

2003

2004

2005

2006

Percent, daily
100 IMPLIED PROBABILITIES OF ALTERNATIVE TARGET
FEDERAL FUNDS RATES, JUNE MEETING OUTCOME e
90
5.25%

–2
1990

1992

1994

1996

1998

2000

2002

2004

2006

Percent, daily
100 IMPLIED PROBABILITIES OF ALTERNATIVE TARGET
FEDERAL FUNDS RATES, AUGUST MEETING OUTCOME e
90
80
June 14: CPI

June 3: May employment
70

70
5.00%
60

June 5: Bernanke speaks
5.00%
5.25%

5.50%
4.75%
10

4.50%

0
2/27

5.50%
3/27

4/27
2006

5/27

10
0
4/28

5.75%

4.75%

5/12

5/26

6/09

6/23

2006

FRB Cleveland • July 2006

a. Weekly average of daily figures.
b. Daily observations.
c. Defined as the effective federal funds rate deflated by the core PCE Chained Price Index.
d. Shaded bars indicate periods of recession.
e. Probabilities are calculated using trading-day closing prices from options on May 2006 federal funds futures that trade on the Chicago Board of Trade.
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; Chicago Board of Trade; and Bloomberg Financial Information Services.

On June 29, the Federal Open Market
Committee (FOMC) raised its target
for the federal funds rate 25 basis
points (bp), taking it to 5.25%. The
inflation-adjusted (or real) fed funds
rate now stands near 3%. The most
recent policy action was widely anticipated, but uncertainty remains
about the future course of policy.
Between the May and June FOMC
meetings, analysts’ expectations
about policy shifted markedly, largely
based on the understanding that

future policy decisions were likely to
be data dependent. Financial market
participants sift through incoming
economic reports and speeches by
Federal Reserve officials to formulate
expectations about policy actions at
upcoming meetings. More precisely,
analysts assess how such information
could change the FOMC’s outlook
and thus affect the likelihood of alternative policy outcomes.
Sometimes the effects are transitory, as they appeared to be after

the May employment report was
released on June 3. At other times,
the effects on the distribution of market opinion are more permanent. This
is often the case after a surprising
inflation report because price stability
is a key goal for the Federal Reserve.
The CPI release on June 14 illustrates
the point: The new inflation numbers
seemed to be unexpectedly strong
and broad based, causing analysts to
revise their expectations of how the
FOMC would react. After the report,
(continued on next page)

5
•

•

Monetary Policy (cont.)
Percent
5.6 IMPLIED YIELDS ON FEDERAL FUNDS FUTURES a

Percent, weekly average
5.6 YIELD CURVE a,c

June 23, 2006
5.4

5.4
May 11, 2006 b

June 23, 2006
5.2

5.2
March 29, 2006 b

May 12, 2006 d

5.0

February 1, 2006 b

4.8

4.8
February 3, 2006 d

March 31, 2006 d
4.6

4.6

4.4

4.4
Feb.

Mar.

Apr.

May

June

July Aug. Sept.
2006

Oct.

Nov.

Dec.

Jan.

Years to maturity

Percent, weekly average
8 SHORT-TERM INTEREST RATES a

Percent, weekly average
9 LONG-TERM INTEREST RATES

7
8
Three-month Treasury bill
6

Conventional mortgage
7

6
Two-year Treasury note
One-year Treasury bill

3
5
2

20-year Treasury bond
4

1
10-year Treasury note
0
1998

3
1999

2000

2001

2002

2003

2004

2005

2006

1998

1999

2000

2001

2002

2003

2004

2005

2006

FRB Cleveland • July 2006

a. Yields are from constant-maturity series.
b. One day after the FOMC meeting.
c. Average for the week ending on the date shown.
d. First weekly average available 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.

analysts became certain there would
be a rate hike at the June meeting.
Moreover, the odds of another rate
hike at the August 8 meeting went
from even to likely.
Market commentary suggests that
changes in the distribution of expected policy outcomes were somewhat shaped by concerns expressed in
recent speeches by Federal Reserve
officials, who have used words like
“unwelcome,” “bothersome,” and
“uncomfortable” to describe the inflation report. Thus, market participants’

response seems to confirm a belief
that the FOMC will take whatever
policy actions are required to assure
price stability.
At this time, the prices of fed funds
futures imply that another rate hike
in August would take the funds rate
very near a level where it will plateau.
However, as we have seen in the past,
markets are often surprised—and in
both directions. An August increase
is not set in stone. Potential lagged
effects of cumulative policy tightening
might turn out to be sufficient to contain inflation.

Since the initial hike in 2004, the
fed funds rate has risen more than
four percentage points. Short-term
interest rates—such as those on
home-equity credit lines—have increased in lockstep with policy rates.
Longer-term rates—such as those on
home mortgages—have also risen,
but to a far lesser extent. Ultimately,
however, higher borrowing costs are
expected to be associated with both a
moderation in economic growth and
lower inflation.

6
•

•

Money and Financial Markets
Percent of total refinancing
100 CASH-OUT REFINANCING OF RESIDENTIAL PROPERTY a
Loan amount at least 5% higher than before b

Percent, daily
12 YIELD SPREADS: CORPORATE BONDS
MINUS THE 10-YEAR TREASURY NOTE c
10

80
8
High yield
60

BBB
2
Lower loan amount b
20

AA
0

–2
1987 1989

1991

1993

1995

1997

1999

2001

2003

2005

1999

2000

2001

2002

2003

2004

2005

Index, 1985 = 100
155 CONSUMER ATTITUDES

Percent, daily
5 10-YEAR REAL INTEREST RATE AND
TIPS-BASED INFLATION EXPECTATIONS
10-year TIPS d

1998

2006

Index, 1966:IQ = 100
115

Consumer sentiment, University of Michigan f

135

105

Corrected 10-year TIPS-derived
expected inflation e
3

115

75
Consumer confidence,
Conference Board

10-year TIPS-derived expected inflation d
0
1998

55
1999

2000

2001

2002

2003

2004

2005

2006

65
2000

2001

2002

2003

2004

2005

2006

FRB Cleveland • July 2006

a. Annual data until 1997; quarterly data thereafter.
b. Compared with previous financing.
c. Merrill Lynch AA, BBB, and High Yield Master II indexes, each minus the yield on the 10-year Treasury note.
d. Treasury inflation-protected securities.
e. Ten-year TIPS-derived expected inflation adjusted for the liquidity premium on the market for the 10-year Treasury note.
f. Data are not seasonally adjusted.
SOURCES: Board of Governors of the Federal Reserve System, “Selected Interest Rates,” Federal Reserve Statistical Releases, H.15; Federal Home Loan
Mortgage Corporation; University of Michigan; Conference Board; and Bloomberg Financial Information Services.

Although long-term interest rates
have trended upward from their 2003
trough, they remain low by historical
standards. Some view this as the consequence of a savings glut in developing countries, especially in Asia.
Low mortgage rates have been a
key stimulant in the housing boom,
which has been reflected in a surge
in housing prices over recent years.
The modest rise in mortgage rates is
ultimately expected to be associated
with a cooling in spending on housing and hence housing prices. If

foreign savings are abruptly curtailed, however, interest rates could
start to rise more quickly.
Moreover, some analysts worry that
housing prices may have become unsustainable, especially in coastal cities,
where those prices have risen the
most sharply. In such areas, the housing market could fall off more swiftly
than anticipated. Together, persistently low mortgage rates and rapidly
rising housing values have enabled
households to refinance their homes
at higher loan values.

The difference between old and
new loan amounts—known as cashout refinancing—has provided a
deep well of cash to finance robust
consumer spending in recent years.
Indeed, more than 80% of residential
refinancing in the first quarter of
2006 resulted in a loan amount that
was at least 5% higher than before.
Such a source of funds cannot persist if mortgage rates continue to rise
and housing prices cool. Thus, consumer spending, which like housing
(continued on next page)

7
•

•

Money and Financial Markets (cont.)
Index, monthly average
2,200 STOCK MARKET INDEXES

Index, monthly average
5,500

Dollars per share, four-quarter moving average
26 EARNINGS PER SHARE, S&P 500 a

5,000

1,800

1,500
1,400

2,400
2,200

4,500

1,600

1,300
1,200

2,000
1,800

4,000

2,000

Nov. Jan.
2005

1,400

Mar. May
2006

3,500

20
18
16

3,000

1,200

Operating
14

2,500

1,000

S&P 500

800

2,000
1,500

600
NASDAQ

10
As reported
8

400

1,000

200

500

0
1990

1992

1994

1996

1998

2000

2002

2004

2006

Index
50 OPTIONS VOLATILITY, S&P 500 b

1990

1993

1996

1999

2002

2005

2008

Ratio
50 PRICE/EARNINGS RATIO, S&P 500
26
22
18
14
10
Nov. Jan.
2005

45
40
Mar May
2006

35
Average
30

23.7

25
25
20
20

13.3

5
1998

1999

2000

2001

2002

2003

2004

2005

2006

1946 1952

1958

1964

1970

1976

1982

1988

1994

2000

2006

FRB Cleveland • July 2006

a. Dashed lines indicate the forecast as of June 22, 2006.
b. Chicago Board Options Exchange Volatility Index (VIX). Monthly data.
SOURCES: Standard and Poor’s Corporation; Chicago Board Options Exchange; and Bloomberg Financial Information Services.

is expected to slow, is also vulnerable
to rapidly deteriorating financial
conditions.
Market commentary cited the minutes of the FOMC’s May meeting,
which noted that “participants
discussed in some detail inflation
expectations—a potentially important
factor influencing future inflation
trends … Measures of inflation compensation based on the difference
between yields on nominal Treasury
securities and inflation-indexed issues
had edged higher. It was possible,
though, that investors’ uncertainty
regarding inflation prospects, not just

inflation expectations themselves,
had risen. On balance, participants
judged that inflation expectations
had risen somewhat—a development that would have to be taken
into account in policymaking and
warranted close monitoring—but
remained contained.”
Market reaction in the period between FOMC meetings seemed to
validate these views. Market-based
estimates of expectations about the
future path of policy reacted consistently with the revelation of factors
affecting the inflation outlook.
Market-based estimates of inflation
expectations actually fell in response

to unfavorable inflation news, suggesting a belief that the FOMC would
do whatever was necessary to contain inflation expectations.
The market’s view that additional
policy firming would be needed roiled
an already unsettled equities market.
Low and stable bond rates have been
good for equities prices, which
are fundamentally based on the discounted present value of future earnings. Higher, more uncertain interest
rates imply a lower discount factor and
hence lower equities prices. Equities
prices fell sharply during the intermeeting period.

8
•

•

Global Market Developments
Index, May 2, 2006 = 100
105 GLOBAL STOCK MARKETS

100
S&P 500

FTSE 350

DJ Euro

TOP 500
85

80
5/1

5/11

5/21

5/31

6/10

6/20

2006
Percent
6 GDP GROWTH AND ESTIMATES a

Index, May 1, 2006 = 100
130 COMMODITIES MARKETS

U.S.

120

U.K.

Silver

Euro area

110

Japan

World
100
3
Oil
90
Gold

80
1

60
5/1

5/15

5/29
2006

6/12

2002

2003
2004
Actual growth

2005

2006
2007
Estimated growth

FRB Cleveland • July 2006

a. 2006 and 2007 data are International Monetary Fund estimates.
SOURCES: International Monetary Fund, World Economic Outlook Database, April 2006; and Bloomberg Financial Information Services.

In recent weeks, equities markets
have taken a tumble. Although
falling stock prices are nothing new,
the scope of the recent downturn
makes it noteworthy. Since the beginning of May, the S&P 500 has
slipped about 5%, the English and
European markets have fallen about
7% and 8%, respectively, and the
Japanese market has dropped more
than 10%. It is also surprising that
during the same period, commodities markets, which typically move in

the direction opposite to equities,
have also fallen. Silver has slumped
almost 20%, while gold has decreased more than 10%; even oil is
off about 5%. Do these declines in
equities and commodities prices
mean the world is headed for a period of slow economic growth? Not
according to recent forecasts: World
output is expected to expand at a
rate close to 5% this year; the euro
area, the U.K., and Japan are all expected to grow at a faster pace this
year than last.

However, inflation, which can
have a negative impact on growth,
has trended up slightly in the past
few months. Even Japan, which has
experienced deflation in the recent
past, has shown signs of inflation in
2006. In response, central banks
have been raising their discount
rates. The European Central Bank
raised rates on June 15, and the
FOMC announced the seventeenth
consecutive rate hike at its June 29
meeting; although the Bank of

(continued on next page)

9
•

•

Global Market Developments (cont.)
Percent, daily
6 MONETARY POLICY TARGETS a

Three-month pecent change, annualized
12 CONSUMER PRICE INDEX

Trillions of yen
–25

10
5

U.S.
U.K.
Euro area
Japan

–15
Bank of England
–5

6
European Central Bank

Federal Reserve
5

0
25

1
–2

Bank of Japan
35

–4
Jan.

Mar.

May

July

Sept.

Nov.

Jan.

2005

Mar.
2006

May

01/02 07/02

01/03

07/03

01/04

07/04

01/05

07/05

01/06

Percent
0.25 YIELD SPREAD: TWO-YEAR TO 10-YEAR TREASURIES

Index, May 1, 2006 = 100
115 GLOBAL BOND YIELDS
Japanese Broad Market Index
110

0.20
Global Broad Market Index
0.15

105
0.10
100
0.05
EMU Broad Market Index
95
U.S. Corporate and Government Index

–0.05

–0.10

85
5/1

5/15

5/29
2006

6/12

5/1

5/15

5/29
2006

6/12

FRB Cleveland • July 2006

a. Japan targets a range of quantity of current account balances.
SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; Board of Governors of the Federal Reserve System; Bank of England; Bank of Japan;
European Central Bank; International Monetary Fund, World Economic Outlook Database, April 2006; Organisation for Economic Co-operation and
Development, OECD Main Economic Indicators, 2006; and Bloomberg Financial Information Services.

Japan’s discount rate remains effectively zero, it is expected to begin
tightening soon.
The behavior of equities prices
over the past couple of months is a
bit of a puzzle. These prices are
determined by the present value of
expected future dividend payments,
so they will drop if expected dividends fall and/or the interest rate that
discounts dividends increases. In May
and the first part of June, however,
interest rates did not change appreciably, nor did private forecasters’

views of future growth. A weaker
growth forecast could lower expectations of future dividend payments.
The U.S. economy represents another concern for global markets. A
slowdown could affect U.S. consumer
spending, which has been a major
force for global economic growth over
the past few years. Concerns that
higher interest rates could push the
U.S. into a period of slower growth are
beginning to take hold. The yield
spread between two-year and 10-year
U.S. securities has recently become

inverted, an indicator that often—but
not always—precedes a period of
slower growth. However, many expect
global growth to be healthy, even if
the U.S. faces a slowdown. Robust
growth in Europe and Asia over the
last few years should allow consumers
there to pick up some of the slack
should U.S. consumer spending taper
off. All in all, this would produce a
period of more balanced economic
growth and a global economy that is
less dependent on U.S. consumers.

10
•

•

Economic Activity
Percentage points
4 CONTRIBUTION TO PERCENT CHANGE IN REAL GDP c

a,b

Real GDP and Components, 2006:IQ
(Final estimate)

Annualized
percent change
Current
Four
quarter
quarters

Change,
billions
of 2000 $

Real GDP
155.3
Personal consumption 98.2
Durables
52.9
Nondurables
33.6
Services
21.6
Business fixed
investment
44.5
Equipment
37.9
Structures
7.7
Residential investment
5.0
Government spending 23.4
National defense
11.3
Net exports
–5.7
Exports
42.6
Imports
48.2
Change in business
inventories
–8.4

5.6
5.0
20.3
5.9
1.9

3.7
3.3
4.3
4.5
2.6

14.2
14.8
12.6
3.3
4.8
9.5
__
14.7
10.7

8.9
10.3
5.1
6.0
2.3
3.3
__
8.1
6.1

Last four quarters
2005:IVQ
2006: IQ

Personal
consumption
2
Exports
1

Government
spending

Residential
investment

0
Business fixed
investment

Change in
inventories

–1

–2

Imports

–3

Annualized quarterly percent change
6 REAL GDP AND BLUE CHIP FORECAST c,d

Annualized quarterly percent change
3.5 DISPOSABLE INCOME AND PERSONAL OUTLAYS c
3.0

5
Final estimate
Blue Chip forecast

2.5
2.0

4
30-year average

1.5

1.0
Consumption

0.5
2
0

Disposable income
–0.5

–1.0
0

–1.5
IIQ

IIIQ
2005

IVQ

IIQ

IIIQ
2006

IVQ

IIQ

1996

1998

2000

2002

2004

2006

2007

FRB Cleveland • July 2006

a. Chain-weighted data in billions of 2000 dollars.
b. Components of real GDP need not add to the total because the total and all components are deflated using independent chain-weighted price indexes.
c. Data are seasonally adjusted and annualized.
d. Blue Chip panel of economists.
SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; and Blue Chip Economic Indicators, June 10, 2005.

Real GDP increased at an annual rate
of 5.6% in 2006:IQ, according to
the Commerce Department’s final
estimate, which was 0.3 percentage
point (pp) above the preliminary
estimate of 5.3%. The upward revision resulted primarily from a downward revision to imports. This was
the strongest quarter of economic
growth since 2003:IIIQ.
Most components made significantly higher contributions to real
GDP change in 2006:IQ than in the
previous quarter. PCE contributed
3.53 pp, compared to only 0.62 pp in

2005:IVQ. Exports added 1.0 pp more,
bringing its total contribution to 1.5
pp. The exception was changes in private inventories, which subtracted 0.2
pp in 2006:IQ after adding 1.9 pp the
previous quarter. Profits from current
production were $1.656 trillion in the
quarter at a seasonally adjusted annualized rate. This new record represented an upward revision of $60 billion from the preliminary estimates.
The first quarter of 2006 was only
the third time that GDP growth has
topped 5.0% since the beginning
of 2000; it was also 2.4 pp above the

30-year average of 3.2%. However,
recent data releases suggest that the
economy is losing momentum. Blue
Chip forecasters revised their growth
estimates downward for the rest of
this year. Most notably, they lowered
their estimate for 2006:IIQ by 0.5 percentage points from 3.4% to 2.9%.
Once again, disposable income, up
only 1% in 2006:IQ, lagged personal
outlays. The change in personal outlays increased 1.7% for 2006:IQ, up
from 0.9% in 2005:IVQ.
With many analysts anticipating
that the FOMC is nearing the end of
(continued on next page)

11
•

•

Economic Activity (cont.)
Percent
18 BUSINESS FIXED INVESTMENT SHARE OF GDP
AND CAPACITY UTILIZATION a

Index, 2002 = 100
120 INDUSTRIAL PRODUCTION a

Percent
86

116

112
Manufacturing

17
Business fixed investment as a share of GDP b,c

108
Total

104
16

100

Utilities

Mining

Capacity utilization

92
15

88
72

84
80
1999

Ratio
1.50

2000

2001

2002

2003

2004

2005

2006

14
1999

70
2000

2001

2002

2003

2004

2005

2006

Index, 1999 = 100
Billions of dollars
140 CORPORATE PROFIT AND S&P 500 COMPOSITE INDEX
1,600

INVENTORY-TO-SALES RATIO a

1.45
120

1,400

1.40
100

1.35

S&P 500 composite

1.30

1,200

80
1,000

1.25
60
1.20

Corporate profit a,b

1.15

800

1.10

600

20
1.05
0

1.00
1999

2000

2001

2002

2003

2004

2005

2006

400
1999

2000

2001

2002

2003

2004

2005

2006

FRB Cleveland • July 2006

a. Seasonally adjusted.
b. Annualized.
c. Fiscal year GDP.
SOURCES: U.S. Department of Commerce, Bureau of the Census and Bureau of Economic Analysis; Board of Governors of the Federal Reserve System; and
the Wall Street Journal.

its current sequence of rate increases,
economic observers are scouring incoming economic data for signs that
the economy is either heating up too
much or cooling down too fast. Driven by manufacturing output, which
increased 5.4% over the last year, total
industrial production rose 4.3% but
was essentially flat from April to May
2006. Utilities were up only 3.4% from
May 2005 to May 2006, but this series
is highly volatile because unseasonable weather can cause sharp swings
in demand. Except for the hurricanes’

disruptions of Gulf Coast oil and natural gas production last fall, mining
output has been essentially flat since
April 2003.
As output has expanded, so has
capacity utilization, a widely followed
measure of how close the economy is
to its potential; however, at 81.1% it
has just reached the level it averaged
in the late 1990s. Consequently, there
is little upward pressure on prices
from this source. Investment, which
expands capacity, was up 3.9% from
March 2005 to March 2006 and could
keep capacity utilization at a moderate

level. The inventory-to-sales ratio is
another measure that is often considered an indicator of the health of the
economy. This series also seems to
be sending a favorable signal: It has
been relatively unchanged over the
last 12 months.
Despite the stock market’s recent
downturn of about 2% since the end
of the first quarter, investors have
been pleased with corporate profits,
which increased 28.5% from 2005:IQ
to 2006:IQ. Over the same period, the
S&P 500 Composite Index rose 7.6%.

12
•

•

Labor Markets
Change, thousands of workers
450 AVERAGE MONTHLY NONFARM EMPLOYMENT CHANGE

Labor Market Conditions

400

Average monthly change
(thousands of employees, NAICS)

350

Revised
Preliminary estimate

300

Payroll employment

250

Goods producing
Construction
Manufacturing
Durable goods
Nondurable goods

200
150

Service providing
Retail trade
Financial activitiesa
PBSb
Temporary help svcs.
Education & health svcs.
Leisure & hospitality
Government

100
50
0
–50

Jan.–
May
2005 2006
165
147

June
2006
121

2003
9

2004
175

–42
10
–51
–32
–19

28
26
0
9
–9

22
25
–6
1
–7

27
19
3
9
–7

15
–4
15
15
0

51
–4
7
23
12
30
19
–4

147
17
8
40
13
33
26
13

143
13
12
41
14
31
21
14

120
–15
19
27
–6
35
19
12

106
–7
3
25
–8
26
16
31

Average for period (percent)

–100

Civilian unemployment
rate

–150
2002 2003 2004 2005

IIQ

IIIQ IVQ
2005

Percent
65.0 LABOR MARKET INDICATORS

IQ April
2006

May
2006

6.0

5.5

5.1

4.7

4.6

June

Percent
6.5

UNEMPLOYED PERSONS, DISTRIBUTION BY REASON
FOR UNEMPLOYMENT, JUNE 2006

Employment-to-population ratio
64.5

6.0
New entrants
9%

64.0

5.5

63.5

5.0

63.0

Laid off
temporarily
14%

Re-entrants
30%
Lost job permanently
or completed
temporary job
35%

4.5
Job leavers
12%

62.5

4.0
Civilian unemployment rate

62.0

3.5
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

FRB Cleveland • July 2006

NOTE: All data are seasonally adjusted.
a. Financial activities include the finance, insurance, and real estate sector and the rental and leasing sector.
b. Professional and business services include professional, scientific, and technical services, management of companies and enterprises, administrative and
support, and waste management and remediation services.
SOURCE: U.S. Department of Labor, Bureau of Labor Statistics.

Nonfarm payroll growth was muted in
June, showing a net increase of only
121,000 jobs. In 2006:IIQ, payroll
growth averaged 108,000 per month,
less than the average monthly increase
of 169,000 jobs during the previous
four quarters.
Employment growth in serviceproviding industries was sluggish:
It was up 106,000 jobs during the
month, well below the average
monthly growth since the beginning
of this year and throughout the
previous two years. Job growth

among private service-providing industries was concentrated in education and health services (up 26,000)
and professional and business services, which increased by 25,000 jobs
in June, only slightly less than the
27,000 average monthly gain since
January and below the 41,000 average
monthly gain in 2005. Job growth in
temporary help services, an industry
that is generally considered a bellwether of underlying job growth, fell
in June and has been sluggish so far
this year. Meanwhile, manufacturing

employment rose by 15,000 jobs during the month, well above its average
monthly growth rate since January.
The employment-to-population
ratio inched up to 63.1%, while the
unemployment remained at 4.6%
(the lowest rate in five years) for the
second consecutive month. People
who have lost their jobs permanently
or have completed temporary jobs
account for the largest share of the
unemployed (35%), while re-entrants
into the labor force account for 30%.

13
•

•

Low-Wage Workers
Current dollars
5.5 FEDERAL MINIMUM WAGE RATES a

MINIMUM WAGE WORKERS BY AGE, 2005

5.0
4.5
4.0

1966 and subsequent amendments
16 to 19 years
26%

3.5
3.0

25 years and older
47%

2.5
2.0

1961 amendments

20 to 24 years
27%

1.5
1.0
0.5

1938 Fair Labor Standards Act

0
1938 1944 1950 1956 1962 1968 1974 1980 1986 1992 1998 2004

MINIMUM WAGE WORKERS BY GENDER
AND MARITAL STATUS, 2005
Men, other
Men, married with
marital status 3%
spouse present 6%

Current dollars (May 2006 = 100)
24 REAL WAGE RATES
22
20
Average hourly nonfarm earnings
18
16

Men, never married
25%

Women, never married
39%

14
12
Minimum wage combined with maximum EITC subsidy b

10
8
Women, other
marital status 10%

Women, married with
spouse present 17%

Minimum wage

4
1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004

FRB Cleveland • July 2006

a. Overlaps represent extended coverage established by amendments.
b. The maximum EITC subsidy is for a family with two or more eligible children.
SOURCES: Department of Labor, Bureau of Labor Statistics and Employment Standards Administration.

Last year, nearly two million workers,
or about 11/2% of all wage and salary
workers, earned the prevailing federal minimum wage of $5.15 per
hour—or less. Roughly half of them
were under 25, and about one-fourth
were teenagers; most worked part
time, and most were in service occupations such as food preparation. Of
the hourly workers who earned the
prevailing minimum wage or less,
66% were women and about 40%
were never-married women.

Studies suggest that raising the
minimum wage by 10% will reduce
employment among low-skilled workers by about 1% to 2%. However,
studies also indicate that a higher minimum wage not only induces firms
to substitute capital for unskilled
labor, thereby laying off part-time and
lower-wage workers, but also leads to
reduced hours for those who remain.
Thus, minimum wage increases,
which are designed to aid low-wage
workers, can actually lower their earnings because the pay increase is offset
by a decrease in hours.

A more effective antipoverty policy is the Earned Income Tax Credit
(EITC), a refundable tax credit that
reduces or eliminates the taxes paid
by low-wage workers. Studies suggest that the EITC does help families
rise above poverty-level earnings and
serves as a positive work incentive,
which leads to higher earnings.
The maximum EITC subsidy can
boost effective wages for eligible
workers by up to 40%.

14
•

•

Fourth District Employment
Percent
8.5 UNEMPLOYMENT RATES a

UNEMPLOYMENT RATES, APRIL 2006 b

8.0

U.S. average = 4.7%

7.5
7.0
6.5
6.0
U.S.
5.5
Lower than U.S. average

5.0

About the same as U.S. average
(4.6% to 4.8%)
Higher than U.S. average

4.5
Fourth District b

More than double U.S. average

4.0
3.5
1990

1993

1996

1999

2002

2005

Payroll Employment by Metropolitan Statistical Area
12-month percent change, May 2006
Cleveland Columbus Cincinnati Dayton
Total nonfarm
Goods-producing
Manufacturing
Natural resources, mining,
and construction
Service-providing
Trade, transportation, and utilities
Information
Financial activities
Professional and business
services
Education and health services
Leisure and hospitality
Other services
Government
April unemployment rate (percent) b

Toledo Pittsburgh Lexington

U.S.

0.0
–1.2
–0.7

1.0
1.2
0.9

1.1
–0.1
–0.6

–0.3
–0.9
–1.2

0.4
–0.7
–1.0

0.6
–0.7
–2.5

1.0
0.0
–0.8

1.4
1.3
–0.1

–2.9
0.2
–1.0
–2.5
–0.4

1.7
0.9
0.5
–0.5
–0.3

1.3
1.3
–0.5
–2.5
0.9

0.0
–0.2
–1.5
–2.7
–3.1

0.0
0.6
–0.2
–7.3
4.4

2.2
0.8
0.2
–3.9
0.1

2.3
1.3
2.6
–2.2
2.8

3.9
1.4
0.5
–0.4
2.7

1.8
1.6
2.0
–0.7
–1.5

2.1
2.3
1.1
1.6
0.0

3.5
2.1
2.5
1.2
0.7

2.3
0.6
1.8
–1.8
–1.1

1.8
2.4
0.9
0.0
–1.2

0.5
2.2
3.7
–0.8
–0.8

0.0
1.3
3.9
–1.0
–0.2

2.7
2.4
1.7
0.6
0.6

4.9

5.5

5.9

6.1

4.9

4.7

FRB Cleveland • July 2006

a. Shaded bars represent recessions.
b. Seasonally adjusted using the Census Bureau’s X-11 procedure.
SOURCE: U.S. Department of Labor, Bureau of Labor Statistics.

The Fourth District’s unemployment
rate rose from 5.1% in March to 5.5%
in April, largely because the estimated number of unemployed rose
8.3%. (However, compared to April
2005, the number who had no job
but were looking for one fell 6.1%.)
In comparison, the U.S. unemployment rate dropped from 4.7% in April
to 4.6% in May.
In April, 11 of the District’s counties had unemployment rates that
were lower than the national average,

and 10 had rates near that mark; jobless rates in the other 148 counties
were higher than average. From
March to April, rates in all of the District’s major metropolitan areas stayed
the same or increased. Unemployment rates exceeded the U.S. average
in each of these areas except Lexington, which matched the average.
May’s nonfarm employment was
up from May 2005 levels in each of
the District’s major metropolitan
areas but Dayton, which lost 0.3%

of its jobs. Part of the reason for Dayton’s poor showing was a decrease
in service-providing employment
over the year; it was the only major
metro area in the District where this
occurred. Nevertheless, industries
such as professional and business
services, education and health services, and leisure and hospitality
continue to do well: Employment in
these three industries increased over
the year in every major metropolitan
area in the District.

15
•

•

The Fourth District’s Daytime Population
DAYTIME POPULATION CHANGE, 2000

RESIDENT POPULATION, 2000

Less than 10,000
10,000 to 49,999
50,000 to 99,999

Less than –15.0%

100,000 to 500,000

5.0% to 15%
Greater than 15%

–15.0% to –4.9%
–5.0% to 4.9%

Greater than 500,000

EMPLOYMENT-TO-RESIDENCE RATIO, 2000

City Populations, 2000
Total
Estimated
resident
daytime
Employment-topopulation, population, Percent residence
thousands thousands change
ratio

Less than 0.6
0.6 to 0.7

Columbus

711

794

11.6

1.22

Pittsburgh

335

473

41.3

1.97

Cincinnati

331

434

31.0

1.70

Cleveland

478

593

24.0

1.65

Lexington

261

291

11.6

1.22

Toledo

314

329

5.1

1.12

0.8 to 0.9
1.0 to 1.1
Greater than 1.1

FRB Cleveland • July 2006

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

People usually think of population in
terms of residents, that is, the number of people living in an area. That
number can change significantly during the day, however, because some
people commute to work in an area
different from that in which they live.
The measure of daytime population
captures this by adjusting resident
population by the number of incommuters and out-commuters.
The populations of counties such
as Franklin (which contains Columbus), Hamilton (Cincinnati), Cuyahoga

(Cleveland), Allegheny (Pittsburgh),
and Fayette (Lexington) all expanded
at least 5% during the day in 2000
because more workers commuted
into than out of them. Not surprisingly, the daytime population of surrounding counties tended to fall. For
example, the number in Campbell
County, which borders Cincinnati’s
Hamilton County, fell an estimated
18% during the day.
Very similar to the daytime population measure is the employment-toresidence ratio, which represents the

number of people working in an area
relative to the number of workers
living there. A ratio higher than one
would indicate that more workers are
working in an area than living there,
making the area a net importer of
labor. This is the case in most counties that contain major cities.
Among the largest cities in the District, Pittsburgh’s population changes
most by day, expanding more than
40%. Indeed, the number of workers
who have jobs in the city is almost
double the number who live there.

16
•

•

Educational Attainment in the Fourth District
Percent
100 HIGH SCHOOL DIPLOMA OR HIGHER, 2004

Percent
30 BACHELOR’S DEGREE OR HIGHER, 2004

95
25
90
20
85

75
10
70
5
65
60

0
Kentucky

Ohio

Pennsylvania

West Virginia

Kentucky

U.S.

Ohio

Pennsylvania

West Virginia

U.S.

Thousands
10 AVERAGE ANNUAL NET INFLOW OF PEOPLE HOLDING
A BACHELOR’S DEGREE OR HIGHER, 2001–2005

Percent
100 HIGH SCHOOL GRADUATES ENTERING COLLEGE
IN THEIR HOME STATES, FALL 2004
95

5
90
0
85
–5

75
–10
70
–15
65
–20

60
Kentucky

Ohio

Pennsylvania

West Virginia

U.S.

Ohio

Kentucky

Pennsylvania

FRB Cleveland • July 2006

SOURCES: U.S. Department of Commerce, Bureau of the Census; and U.S. Department of Education, National Center for Education Statistics.

In the Fourth District states, 84.6% of
the residents who were 25 or older
in 2004 had attained a high school
diploma, slightly beating the national
average of 83.9%. The percentage of
residents with high school diplomas
was higher in Ohio and Pennsylvania
than in the nation; however, Kentucky and West Virginia trailed the
national average by 6.3% and 4.5%,
respectively.
A similar pattern is apparent at the
post-secondary level. The percentage
of residents holding a bachelor’s

degree lagged the U.S. average in
Kentucky (by 8.0%) and West Virginia (by 10.7%). Although much
closer to the national average, Ohio
and Pennsylvania still trailed it by
3.7% and 2.3%, respectively.
When the Fourth District states’
2004 high school graduates went on
to college in the fall, the vast majority
remained in their home states. In
Kentucky, 89% of college-bound graduates stayed in the state. The percentages were similar in Ohio, Pennsylvania, and West Virginia, all of which are
above the national average.

Besides educating its own residents, a state can raise educational
attainment levels by importing people who earned college degrees elsewhere. Ohio has done poorly in this
respect: In the last five years, the
state suffered net annual losses of
almost 17,000 people with a bachelor’s degree or higher. Kentucky, in
contrast, imported more than 6,000
college grads annually during the
same period.

17
•

•

Fourth District Banking Conditions
Billions of dollars
22 ANNUAL NET INCOME a

Percent
5.00 INCOME RATIOS a

4.75

42
Non-interest income/income including JPMorgan Chase

4.50

18
Excluding JPMorgan Chase

4.25

Including JPMorgan Chase

Percent
44

Net interest margin excluding JPMorgan Chase

4.00

3.75

12
3.50

Non-interest income/income
excluding JPMorgan Chase

3.25
8
6
4

3.00

2.75

2.50

1994

1996

1998

2000

2002

2004

2006

Net interest margin including
JPMorgan Chase

2.25

2.00
1994

22
20

1996

1998

Percent
70 EFFICIENCY a,b

Percent
1.7 EARNINGS a

1.6

2000

2002

2004

2006

Percent
20

Return on equity excluding JPMorgan Chase

1.5

1.4

1.3

1.2

66
Including JPMorgan Chase

10
Return on assets excluding JPMorgan Chase
8

1.1

Excluding JPMorgan Chase

Return on equity including JPMorgan Chase

1.0

0.9

6
4
Return on assets including JPMorgan Chase

0.8

0.7

50
1994

1996

1998

2000

2002

2004

2006

0
1994

1996

1998

2000

2002

2004

2006

FRB Cleveland • July 2006

a. Through 2006:IQ only. Data for 2006 are annualized.
b. Efficiency is operating expenses as a percent of net interest income plus non-interest income.
SOURCE: Author’s calculations from Federal Financial Institutions Examination Council, Quarterly Bank Reports of Condition and Income.

FDIC-insured commercial banks headquartered in the Fourth Federal Reserve District posted net income of
$2.74 billion for 2006:IQ ($10.94 billion on an annual basis), up about 1%
from 2005. (JPMorgan Chase, chartered in Columbus in 2004, is not included in this discussion because its
assets are mostly outside the District
and its size—roughly $1 trillion—
dwarfs that of other District institutions.) For the same period, the U.S.
banking industry as a whole posted
earnings of $37.69 billion ($150.76 billion on an annual basis), an increase of
about 20% from the end of 2005.

At the end of 2006:IQ, Fourth District banks’ net interest margin (a measure of core profitability computed
as interest income minus interest expense divided by average earning
assets) had fallen slightly to 3.12% but
still exceeded the 3.04% U.S. average.
Non-interest income, however, fell to
30.60% of total income, about a 13%
decline from the peak of 35.30% at the
end of 2004. Nationwide, net interest
margin was nearly unchanged from
the end of 2005. Non-interest income
fell to 31.63% of total income. This
trend suggests that in an environment
of rising interest rates, interest income

is returning to its traditional role as
banks’ primary source of income.
At the end of 2006:IQ, District
banks’ efficiency (operating expenses
as a percent of net interest income
plus non-interest income) had deteriorated to 55.23% from the 52.64%
record set in 2002 (lower numbers
correspond to greater efficiency). Nationwide, efficiency improved significantly, declining to 54.92% from
56.40% at the end of 2005.
At the end of 2006:IQ, District banks
posted a 1.43% return on assets (unchanged from the end of 2005) and
a 15.15% return on equity (slightly
(continued on next page)

18
•

•

Fourth District Banking Conditions (cont.)
Ratio
30 COVERAGE RATIO

Percent
1.2 ASSET QUALITY a
1.1

Net charge-offs excluding JPMorgan Chase

Including JPMorgan Chase

1.0
24

0.9
Problem assets excluding
JPMorgan Chase

0.8

0.7
18

0.6

Excluding JPMorgan Chase
0.5

0.4
Problem assets including JPMorgan Chase

0.3
Net charge-offs including JPMorgan Chase
9

0.2
1994

1996

1998

2000

2002

2004

2006

1994

1996

1998

2000

Percent
11 CORE CAPITAL (LEVERAGE) RATIO

Percent
12 UNPROFITABLE INSTITUTIONS

10
Excluding JPMorgan Chase
Including JPMorgan Chase

2002

2004

2006

Unprofitable institutions including JPMorgan Chase

Assets in unprofitable institutions
excluding JPMorgan Chase

Unprofitable institutions
excluding JPMorgan Chase
7

0
Assets in unprofitable institutions including JPMorgan Chase

4
1994

1996

1998

2000

2002

2004

2006

–2
1994

1996

1998

2000

2002

2004

2006

FRB Cleveland • July 2006

a. Problem assets are shown as a percent of total assets, net charge-offs as a percent of total loans.
SOURCE: Author’s calculations from Federal Financial Institutions Examination Council, Quarterly Bank Reports on Condition and Income.

down from 15.32% at the end of 2005).
Despite a hiccup in income numbers
relative to the nation, the District performed better than the industry nationwide. At the end of 2006:IQ, the
U.S. banking industry’s return on
assets was 1.25% (up from 1.08% at the
end of 2005), while return on equity
was 13.32% (up from 11.55% at the
end of 2005).
Fourth District banks’ overall financial indicators pointed to fairly strong
balance sheets at the end of 2006:IQ.
Net charge-offs (losses realized on
loans and leases currently in default
minus recoveries on previously

charged-off loans and leases) represented 0.30% of total loans (down
from 0.38% at the end of 2005), the
same as the U.S. average (down from
0.46%). Problem assets (nonperforming loans and repossessed real estate)
as a share of total assets fell slightly to
0.57% from 0.59% at the end of 2005,
worse than the national average of
0.42% of assets (down from 0.45%).
Fourth District banks held $20.54 in
equity capital and loan loss reserves
for every dollar of problem loans,
which was 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. Equity capital
as a share of Fourth District banks’
assets (the leverage ratio) rose from
9.36% at the end of 2005 to 9.45% at
the end of 2006:IQ.
The share of unprofitable banks in
the Fourth District fell from 5.43% at
the end of 2005 to 5.17% at the end
of 2006:IQ. The average size of such
banks also fell, from 0.56% of District
banks’ assets to 0.20%. Industrywide,
the share of unprofitable banks grew
from 6.28% at the end of 2005 to
6.54% at the end of 2006:IQ; their
asset size, however, fell from 1.13%
to 0.76% during the same period.

Full text of Economic Trends (Federal Reserve Bank of Cleveland) : Economic Trends - July 2006

FRASER