Full text of Economic Trends (Federal Reserve Bank of Cleveland) : Economic Trends - June 2004

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
The Rates They Are A-changin’
(with apologies to Bob Dylan)
Come gather ’round people wherever you roam
Recognize that inflation around you has grown
And accept there’s a chance it could rise through its zone
Price stability is worth preservin’
So less stimulus from the Fed don’t bemoan
For the rates they are a-changin’.
Come writers and critics who prophesize with your pens
Who are so confident in your opinions
But don’t speak too soon for the data still spins
And there’s no tellin’ where it is goin’
The theories out now could later be in
For the rates they are a-changin’.
Come savers, investors, please heed the call
The signs are well-posted and the writin’s on the wall
Inflation dynamics no longer are stalled
For markets are equilibratin’.
And many have said that the funds rate’s too small
For the rates they are a-changin’.
Thank goodness most people throughout the land
No longer criticize for they quite understand
Reputation requires that you protect your brand
When patience so plainly is wanin’
So stay with the program while the Fed plays its hand
For the rates they are a-changin’.

FRB Cleveland • June 2004

The line it is drawn, the course nearly cast
The risks we face now appeared small in the past
But with measured steps the expansion will last
Futures markets are anticipatin’
A considerable time will be comin’ to pass
For the rates they are a-changin’.
Disclaimer: These lyrics are a Dylanesque take on the current situation; they are not an official statement
about the likely course of monetary policy.

2
•

•

Inflation and Prices
One month percent change
12 CPI AND CPI EXCLUDING FOOD AND ENERGY
11

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

2003
avg.

10
CPI

9
8

Consumer prices

All items

2.6

3.9

2.3

2.5

1.9

Less food
and energy

3.1

3.3

1.8

2.1

1.1

Medianb

4.1

3.4

2.4

2.9

2.1

6
5

Core CPI

Producer prices
Finished goods
Less food and
energy

8.5

5.3

3.6

2.3

4.4

1.1

–2

–1

2.4

1.9

1.4

0.9

–3
–4
1990

1992

1994

1996

1998

2000

12-month percent change
4.00 CPI AND CPI EXCLUDING FOOD AND ENERGY

12-month percent change
4.25 CPI AND TRIMMED-MEAN MEASURES

3.75

4.00

3.50

3.75

3.25
CPI

3.00

2004

Median CPI b

CPI

3.50

2002

3.25
3.00

2.75
2.75
2.50
2.50
2.25

2.25

2.00

1.75

1.50

1.50
CPI excluding food and energy

1.25
1.00
1995

1996

1997

1998

1999

2000

2001

CPI, 16% trimmed mean b

1.25
2002

2003

2004

1.00
1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

FRB Cleveland • June 2004

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.

The recent broad-based rise in retail
prices continues: The volatile Consumer Price Index (CPI) increased at
a 2.6% annualized rate in April after
surging 6.0% in March. Interestingly,
the core CPI, which excludes volatile
food and energy prices, increased at
a faster rate than the overall index,
advancing 3.1% (annualized rate) in
April. The median CPI rose at a 4.1%
annualized rate, its largest monthly
increase since November 2001.
Year-over-year inflation rates continue to rise. The CPI has increased
2.3% since last April, while the core

CPI, median CPI, and 16% trimmedmean CPI posted their highest 12month growth rates in a year or
more, rising by 1.8%, 2.4%, and 2.0%,
respectively.
The Blue Chip panel of economists has increased its CPI inflation
forecasts. They predict inflation will
average 2.1% over the next three
quarters, up from their 1.8% estimate
last month. The range of inflation
forecasts has widened, but both optimists and pessimists have increased
their quarterly forecasts for 2004. Optimists anticipate that inflation will

register 1.1% by the end of 2004,
while pessimists expect a 2.9% inflation rate.
Some economists question the
ability of our economic models to
predict inflation. Since 1993, economists’ year-ahead inflation predictions have had an average error of 0.3
percentage point and 0.7 percentage
point in absolute terms. This is no
better than a naïve forecast, in which
next year’s inflation rate is assumed
to be the same as this year’s.
One particularly contentious issue
is how useful measures of economic
(continued on next page)

3
•

•

Inflation and Prices (cont.)
Annualized quarterly percent change
5 ACTUAL CPI AND BLUE CHIP FORECAST a

Annual percent change
4.50 CPI FORECAST ERRORS b
4.25

4.00

Highest 10%

Mean

3.75

Forecast Errors
Economists Naïve
0.3
0.1

Mean-absolute

0.7

Root mean-squared

0.8

0.9

3.50

3.25

Consensus

Actual
3.00

2.75

Lowest 10%

2.50
1
2.25
2.00
0

1.75
1.50

–1
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

1.25
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Percent
6.50 NAIRU

Four-quarter difference in core CPI inflation rate
6 PHILLIPS CURVE c
5
1962–1984
1985–2002

6.25

3
2

6.00

1
5.75

0
–1

5.50

–2
–3

5.25

–4
–5
–6
2

5
6
8
9
10
4
7
Average unemployment rate, percent (past four quarters)

5.00
1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004

FRB Cleveland • June 2004

a. Blue Chip panel of economists.
b. CPI forecasts from the Livingston Survey.
c. Core CPI inflation rate calculated as the four quarter percent change of the Core CPI Price Index.
SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; Congressional Budget Office; Federal Reserve Bank of Philadelphia, Livingston Survey; and
Blue Chip Economic Indicators, May 10, 2004.

slack are in predicting inflation rate
changes. The idea that inflation accelerates as the economy’s resources
become strained is a key assumption
in most forecasts, but gauging the
amount of slack in the economy is a
daunting task.
Several alternative measures of
economic slack have been suggested
such as the gap between potential
and actual GDP, and capacity utilization. Another popular approach,
sometimes termed the Phillips curve,
suggests that inflation will increase

when labor markets are tight, that is,
when the rate of unemployment falls
below the NAIRU (non-accelerating
inflation rate of unemployment).
If we assume that NAIRU is constant, the relationship between unemployment and inflation changes
has deteriorated since the mid-1980s.
One reason for this may be that the
economy’s potential, as embodied by
measures like NAIRU, is not constant;
it fluctuates over time. According to
the Congressional Budget Office,
NAIRU peaked at around 61/4% in the

late 1970s, falling below 51/4% sometime in the last decade. Perhaps inflation has picked up recently because
there is less slack in the economy
than these measures suggest. That is,
NAIRU may now be higher than
51/4%. Most economists, however, do
not believe NAIRU has increased so
much that the economy has begun
straining against its capacity or that
the recent rise in inflation will persist
for long. But, of course, only time
and more research will tell.

4
•

•

Monetary Policy
Trillions of dollars
2.2 THE M1 AGGREGATE

Billions of dollars
850 THE MONETARY BASE
Sweep-adjusted base growth, 1999–2004 a
15
12
Sweep-adjusted base b
9

800

750

2.0

700

1.8

3
0

Sweep-adjusted M1 growth, 1999–2004 a
15

1.6

650

Sweep-adjusted M1 b

2%
Monetary base

12%

600

1.4
M1
1.2

550

1.0
1999

500
1999

2000

2001

2002

2003

2004

Trillions of dollars
6.8 THE M2 AGGREGATE
7%

M2 growth, 1999–2004 a
12
6.2

2001

10%

6
3

1999

4%
Monetary
basec

5%
12%
8%
8%

5.0
8%

2003

5%
4.4

2004

Growth Rates of Monetary Components
(percent)

2002

5.6

2000

Annual
2001 2002

Average,
YTD 1999–
2003 2004 2003

12.7

2.1

8.7

7.8

6.2

3.9

7.5

5.0
M1d
M2
6.3
Currency
11.1
Total
reserves
–7.2
Check and
demande –4.8
Money market
funds
13.7
Small time
deposits –0.7
Savings
deposits 10.1

1.7
6.1
4.3

7.9
10.3
9.1

6.7
6.8
8.2

7.3
5.3
5.9

12.2
6.4
2.9

5.7
6.9
7.7

–6.2

8.8

–6.7

8.3

11.3

–0.6

–6.8

4.9

–1.5

7.7

7.0

–0.1

11.3

8.4

–6.1

–11.6 –14.7

3.2

9.6

–4.9

–9.0

–9.5

–5.1

–2.9

6.7

21.7

21.1

15.2

15.4

15.0

3.8
1999

2000

2001

2002

2003

2004

FRB Cleveland • June 2004

a. The far-right bar refers to the most recent data available. Growth rates are calculated on a fourth-quarter over fourth-quarter basis. The 2004 growth rates for
the sweep-adjusted monetary base and sweep-adjusted M1 are calculated on a March over 2003:IVQ basis. The 2004 growth rate for M2 is calculated on a
May over 2003:IVQ basis. Data are seasonally adjusted.
b. The sweep-adjusted base contains an estimate of required reserves saved when balances are shifted from reservable to nonreservable accounts. Sweepadjusted M1 contains an estimate of balances temporarily moved from M1 to non-M1 accounts.
c. Refers to the sweep-adjusted base.
d. Refers to sweep-adjusted M1.
e. Refers to demand deposits and other checkable deposits.
SOURCE: Board of Governors of the Federal Reserve System, “Money Stock Measures,” Federal Reserve Statistical Releases, H.6.

Growth in the sweep-adjusted monetary base (total currency in circulation
plus total reserves plus vault cash of
depository institutions not applied to
reserve requirements) has moderated
so far in 2004 to an annualized growth
rate of 3.9%, in contrast with its fiveyear average of 7.5%. The decline in
base growth results primarily from currency growth’s drop of 4.8 percentage
points from its five-year average of
7.7%. Given currency’s larger share, its
decline more than offset the 11.3%
growth of total reserves in 2004.

M1, which consists of currency in
the hands of the public plus demand
and other checkable deposits, is a
slightly broader monetary aggregate.
So far in 2004, sweep-adjusted M1 has
shown an annualized growth rate of
12.2%, roughly 6.5 percentage points
above its five-year average. The acceleration in M1 growth is largely
explained by the sharp increase in
demand deposits and other checkable
deposits, which comprise 49% of M1.
Their year-to-date annualized growth
rates in 2004 exceed their five-year
averages by 7.1 percentage points.

Since 2003:IVQ, the broader monetary aggregate, M2, grew 6.4%, which
is 0.5 percentage points less than its
1999–2003 average. Concerns about
persistently slow M2 growth since mid2003 were assuaged when the monetary aggregate began to rebound in
January. Since then, M2 has grown at a
9.5% annualized rate, a surge that was
associated with positive economic
news such as employment reports.
At its May 4 meeting, the Federal
Open Market Committee (FOMC) decided to keep the target federal funds
(continued on next page)

5
•

•

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

Percent
8 RESERVE MARKET RATES

2.000

Effective federal funds rate a

May 25, 2004
1.875

6
1.750
5

1.625

May 5, 2004 c

Intended federal funds rate b
1.500

1.375

April 1, 2004

Primary credit rate b

1.250

Discount rate b
2

1.125
January 29, 2004 c
1

March 17, 2004 c

1.000
0.875

0
2000

2001

2002

2003

Jan.

2004

Mar.

May

July

Nov.

Sept.

2004
Probability d
1.0 IMPLIED FEDERAL FUNDS RATE CHANGES BY JULY

Percent, weekly average
6.0 YIELD CURVE e,f

0.9

5.5
0.83

0.8
0.68

0.7

April 1, 2004

5.0

May 5, 2004
May 25, 2004

4.5

May 7, 2004 g

May 21, 2004

March 19, 2004 g

4.0
0.6

0.54

Jan.
2005

3.5

0.5
0.4

January 30, 2004 g

3.0

0.40

2.5
April 2, 2004

0.3
0.2

2.0
0.18
0.14

0.13
0.07

0.1
0.03
0
No change

25 basis point increase

50 basis point increase

1.5
1.0
0.5
0

10
Years to maturity

FRB Cleveland • June 2004

a. Weekly average of daily figures.
b. Daily observations.
c. One day after the FOMC meeting.
d. Probabilities are calculated using prices from options on July 2004 federal funds futures that trade on the Chicago Board of Trade.
e. All yields are from constant-maturity series.
f. Average for the week ending on the date shown.
g. The 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; Chicago Board of Trade;
and Bloomberg Financial Information Services.

rate at 1% and the primary credit rate
at 2%. Despite a growing economy, the
target has remained at 1% since June
2003. The FOMC reiterated its prior
statement that “output is continuing
to expand at a solid rate,” but changed
its assessment of hiring activity, noting
that it now “appears to have picked
up.” The FOMC also stated that “policy
accommodation can be removed at a
pace that is likely to be measured”
rather than with the “patience” mentioned in the prior statement.

The horizon for the next expected
change, as implied by federal funds futures, has been pushed far forward; it
is now expected to occur by July. Since
early spring, the Chicago Board of
Trade has provided a market for
options on federal funds futures.
Prices on these options enable one to
estimate the implied probabilities
associated with implied federal funds
rate changes. In response to strong
employment reports and higher-thanexpected inflation numbers, market
participants raised their expectations

of a June rate increase (there is no July
meeting). In early April, they saw only
a 17% chance of an increase, versus
81% in late May.
Reflecting strong economic news as
well as the likelihood of funds rate
hikes in the near future, the yield
curve has shifted significantly since
the March meeting (up 36 bp for the
six-month rate and almost 100 bp for
the 10-year rate). For the past three
weeks, 90-day Treasury bill rates have
remained at 1.04%, slightly above the
intended federal funds rate.

6
•

•

Treasury Inflation-Indexed Securities
Percent, monthly
4.0 INFLATION EXPECTATIONS, TIIS

Percent, monthly
5.0 REAL INTEREST RATES, TIIS
4.5

3.5

10-year
4.0

3.0

10 years ahead a

3.5

30 years ahead b
2.5

3.0

30-year
2.0

2.5
2.0

1.5
Five years ahead c

1.5
1.0

Five year
1.0

0.5

0.5
0
1997

1998

1999

2000

2001

2002

2003

0
1997

2004

1998

1999

2001

2000

2002

2003

2004

Percent, monthly
2.9 TIIS-DERIVED, FIVE-YEAR INFLATION EXPECTATIONS
AND FIVE-YEAR ACTUAL INFLATION

Percent
4.0
TIIS-DERIVED AND SURVEY OF PROFESSIONAL
FORECASTERS INFLATION EXPECTATIONS d

2.6

3.5
Survey measure: 10th percentile e

2.3
3.0
2.0

Survey measure: 50th percentile e
2.5

Actual inflation f
1.7

2.0
1.4
1.5

Survey measure: 90th percentile e

1.1
Inflation expectations, TIIS, five years prior g

1.0

0.8
10-year inflation expectations

0.5
1997

0.5
1998

1999

2000

2001

2002

2003

2004

July

Oct.
2002

Jan.

Apr.

July
2003

Oct.

Jan.

Apr.
2004

FRB Cleveland • June 2004

a. Yield spread: 10-year Treasury minus 10-year TIIS.
b. Yield spread: 30-year Treasury minus 30-year TIIS.
c. Yield spread: five-year Treasury minus five-year TIIS.
d. Brian Sack and Robert Elsasser, “Treasury Inflation-Indexed Debt: A Review of the U.S. Experience,” Federal Reserve Bank of New York Economic Policy
Review, 2004: 47–63.
e. The survey measure is the expected 10-year consumer price index inflation.
f. Annualized five-year CPI inflation.
g. Plotted observations represent inflation expectations from five years prior.
SOURCES: Federal Reserve Bank of Philadelphia, Survey of Professional Forecasters; and Bloomberg Financial Information Services.

Today’s monetary policy decisions
focus on future inflation prospects.
Treasury inflation-indexed securities
(TIIS) give us market measures of real
interest rates with maturities of five,
10, and 30 years. Subtracting these
rates from nominal Treasury bills of
the same maturity provides marketbased measures of expected inflation
over that period. These measures
suggest that inflation is expected to
drift up over time, averaging nearly
2.6 percent over the next five and 10
years. What may be more troubling is

that this measure has increased 0.9
percentage point during the past year.
But how accurate are the inflation
expectations derived from TIIS data?
On average, 10-year inflation expectations derived from TIIS have been
more than 50 basis points (bp) lower
than those predicted by the Survey of
Professional Forecasters. However,
over the previous five years, actual inflation has averaged only 7 bp higher
than forecasts based on TIIS data.
Should we expect inflation derived
from five- and 10-year TIIS data to be

underestimated? Even if it is, is this
bias constant? If the bias is constant,
then movements in expected inflation will still reflect movements in
actual inflation.
One reason that expected inflation derived from TIIS data might be
underestimated is that the TIIS market
is less liquid than other government
bonds; consequently, bid–ask spreads
for TIIS tend to be larger than for the
others. Real TIIS returns contain a premium resulting from these transaction
(continued on next page)

7
•

•

Treasury Inflation-Indexed Securities (cont.)
Billions of dollars, 12-week moving average
30 TRADING VOLUME FOR TIIS

Typical Bid—Ask Spreads for Treasury
Securities (1/32nds of price)a

Type
20

On-the-run
nominal

Off-the-run
nominal

Maturities
of five
years or less
1/
4

1/
2

Maturities
of five to
10 years

Maturities
beyond
10 years

1/
2

—

1/
2

to 1

1/
2

to 1

Inflationindexed

1 to 2

4 to 16

0
1998

1999

2000

2001

2002

2003

2004

Percent, monthly
1.50 ERROR: ACTUAL INFLATION MINUS
TIIS-DERIVED INFLATION EXPECTATIONS b,c
1.25

Predictability of the Sign of Next Month’s
Error

1.00

Next month’s error sign
Current month’s error size

0.75

Positive

Negative

Greater than 0.5

0 to 0.5

–0.5 to 0

Less than –0.5

0.50
0.25
0
–0.25
–0.50
–0.75
–1.00
July

Sept. Nov.
2002

Jan.

Mar.

May

July
2003

Sept.

Nov.

Jan.

Mar.

2004

FRB Cleveland • June 2004

a. Brian Sack and Robert Elsasser, “Treasury Inflation-Indexed Debt: A Review of the U.S. Experience,” Federal Reserve Bank of New York Economic Policy
Review, 2004: 47–63.
b. Annualized five-year CPI inflation.
c. Plotted observations represent inflation expectations from five years prior.
SOURCES: 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.

costs, so expected inflation calculated
from TIIS will be underestimated.
Transaction costs, however, can only
account for around 6 bp of the 50 bp
bias found in the 10-year TIIS data.
Another reason for a bias is that
inflation variability makes the real
return from holding non-indexed
government bonds uncertain. By construction, the real return from holding a TIIS contract is known with
certainty. If people dislike the uncertainty associated with holding nonindexed government debt, then these
bonds will have a larger real return.
This, however, would predict that

expected inflation from TIIS data
would overstate true expected inflation. The bias in inflation expectation
derived from 10-year TIIS measures
suggests that investors actually prefer
this uncertainty.
Why might investors prefer the
uncertainty associated with holding
non-indexed government debt? Uncertainty concerns investors to the
extent it affects the variability of their
consumption. If realized real returns
are negatively associated with consumption, then these risky securities
may actually reduce consumption
variability. In fact, the Phillips curve

suggests that inflation and consumption may be positively correlated;
thus real returns and consumption
may be negatively correlated.
If these biases are constant over
time, then movements in expected
inflation derived from TIIS will still
reflect movements in actual inflation
expectations. But the data suggest
that, at least for the five-year TIIS,
these premiums might not be
constant. Today’s error contains
information predicting tomorrow’s
bias; but 20 out of 21 times, the sign
of today’s error predicted the sign
of tomorrow’s.

8
•

•

Oil Prices and the Business Cycle
Dollars per barrel
100

Percent
15.0 ENERGY, MONETARY POLICY, AND THE BUSINESS CYCLE a
12.5

10.0

7.5

70
Effective federal funds rate minus year-over-year percent change in core PCE

5.0

2.5

40
West Texas intermediate crude oil price,
deflated by core PCE

–2.5

–5.0

–7.5

West Texas intermediate crude oil price

–10.0
1972

1976

1980

1984

1988

Thousands of Btu / real GDP in 2000 dollars
25 ENERGY PRODUCTION AND CONSUMPTION
PER DOLLAR OF REAL GDP

1992

1996

2000

2004

Percent
12-month percent change
60
16 ENERGY CPI AND INLFATION EXPECTATIONS
14

Consumption

One-year-ahead average inflation expectations

Production

CPI energy

8
10

–10

0
1950

–20

0
1956

1962

1968

1974

1980

1986

1992

1998

2004

1980

1984

1988

1992

1996

2000

2004

FRB Cleveland • June 2004

a. Shaded areas indicate recessions as dated by the National Bureau of Economic Research.
SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; U.S. Department of Labor, Bureau of Labor Statistics; U.S. Department of Energy,
Annual Energy Review 2002; Board of Governors of the Federal Reserve System, “Selected Interest Rates,” Federal Reserve Statistical Releases, H.15;
University of Michigan, Survey of Consumers; National Bureau of Economic Research; and Wall Street Journal.

With oil trading around a record high
of $40 per barrel, is another recession far behind? Since World War II,
oil prices have spiked before nearly
every U.S. recession, including the
most recent one.
Many economists suggest that oil
costs alone are too small relative
to output to explain such a severe
business cycle response to energy
price spikes. They contend that imperfections in the adjustment process or
some other mechanism must interact
with oil prices to leverage such shocks
into full-blown economic downturns.

A prime suspect is monetary policy.
Indeed, an increase in the real federal
funds rate—the observed funds rate
minus the inflation rate—also has preceded nearly every recession.
If the relationship between business activity and oil prices does, in
fact, turn on the stance of monetary
policy, more’s the concern. Market
observers expect the FOMC to raise
the federal funds target rate before
year’s end.
Fortunately, some studies suggest
that the economic impact of oil price
shocks has waned since the early

1980s. The U.S. economy has become
much less dependent on oil. We now
use about half as much energy to
produce a unit of GDP as we did in the
1970s. Other analysts, however, attribute the post-1980 break between
oil prices and economic activity to
monetary policy changes. Over the
past two decades, the Federal Reserve has built a strong reputation
for price stability, and inflation expectations no longer parallel energy
price patterns closely. Calm inflation
expectations provide the Fed with
more policy leeway.

9
•

•

Emerging Market Debt
Percent
2.125 IMPLIED YIELDS ON FEDERAL FUNDS FUTURES

U.S. BANKS’ CLAIMS ON FOREIGN BORROWERS a

2.000
May 24, 2004
1.875

Banking centers
3.3%

1.750

Emerging markets
14.7%

May 5, 2004

1.625
1.500

Non G-10
developed countries
13.4%

1.375
November 11, 2003

1.250

G-10 developed countries
and Switzerland
68.5%

April 2, 2004
1.125
March 17, 2004

1.000
January 29, 2004
0.875
Nov.

Jan.

Mar.

2003

May

July

Sept.

Nov.

2004

U.S. BANKS’ CLAIMS ON FOREIGN BORROWERS
IN EMERGING MARKETS a
Africa
1.1%
Eastern Europe
7.9%

Percent, sovereign debt spread over U.S. Treasuries
10 RISK SPREAD, EMERGING MARKETS BOND INDEX b
9
8
7
Argentina
6

Asia
37.4%

5
4
Latin America and
the Carribean
53.7%

3
Brazil

2
Mexico
1

Russia

0
Jan.

July
2002

Jan.

July
2003

Jan.

July
2004

FRB Cleveland • June 2004

a. Federal Financial Institutions Examination Council, Country Exposure Lending Survey (March 31, 2004), Table 1. Based on a survey of 72 U.S. banking
organizations.
b. Data from J.P. Morgan. Includes external-currency-denominated Brady bonds, loans, and eurobonds as well as U.S. dollar-denominated local market
instruments.
SOURCES: Chicago Board of Trade; J.P. Morgan; and Bloomberg Financial Information Services.

In late March, expectations about the
future course of U.S. monetary policy
began to change. As suggested by implied yields of federal funds futures,
markets have come to anticipate a
substantial hike in the federal funds
target rate by the end of the year. Fed
watchers now wonder whether rate
hikes will come in a series of incremental moves or through a few large
jumps. The pattern may matter.
For one thing, a sharp hike in U.S.
interest rates could present particular problems for heavily indebted

emerging markets and their international creditors. According to a recent survey, U.S. banking organizations hold approximately $101
billion in total claims on emerging
market economies. Latin American
countries account for roughly 54%
(or $54.3 billion) of all U.S. bank
loans to emerging markets. Our two
most important Latin American
debtor countries have received the
great bulk of all U.S. bank loans in
the region: Mexico accounts for
nearly 40% and Brazil for 29%. Chile,

Argentina, Venezuela, and Columbia
combined hold another 19% of our
total Latin American bank exposure.
As a rule of thumb, debtor countries must grow at a rate greater than
the interest cost on their obligations
if they hope to avoid painful fiscal
adjustments and remain solvent. In
March, some emerging market risk
spreads, a barometer of lenders’ sentiments, had already begun to widen
slightly.

10
•

•

GDP Growth and Household Finances
Percentage points
3.5 CONTRIBUTION TO PERCENT CHANGE IN REAL GDP b

Real GDP and Components, 2004:IQ
(Preliminary estimate)

3.0
Annualized
Change, percent change, last:
billions
Four
of 2000 $
Quarter
quarters

Real GDP
115.9
Personal consumption 71.1
Durables
–11.4
Nondurables
35.0
Services
44.5
Business fixed
investment
16.6
Equipment
22.2
Structures
–4.3
Residential investment
4.9
Government spending 13.7
National defense
15.0
Net exports
–10.0
Exports
13.0
Imports
23.0
Change in business
inventories
19.2

4.4
3.9
–4.2
6.6
4.2

5.0
4.3
9.8
5.1
2.9

5.8
9.8
–7.1
3.8
2.9
13.3
__
4.9
5.9

9.1
12.5
–1.6
9.3
3.0
13.0
__
8.3
7.9

Personal
consumption

Last four quarters

2.5

2004: IQ

2.0
1.5
1.0

0
–0.5

Exports

Residential
investment

0.5

Business fixed
investment

Government
spending

Change in
inventories

–1.0

Imports

–1.5

Percent change from previous quarter
9
REAL GDP AND BLUE CHIP FORECAST b

Percent change from previous year
7 REAL PERSONAL INCOME AND SPENDING TRENDS b

8
Final percent change
Blue Chip forecast c

6
Real disposable personal income

Advance estimate
Preliminary estimate

Real personal
consumption expenditures

5
30-year average
4

3
2
2
1

1
0

0
IQ

IIQ

IIIQ
2002

IVQ

IIQ

IIIQ
2003

IVQ

2000

2001

2002

2003

2004

FRB Cleveland • June 2004

a. Chain-weighted data in billions of 2000 dollars. Components of real GDP need not add to the total because the total and all components are deflated using
independent chain-weighted price indexes.
b. Data are seasonally adjusted and annualized.
c. Blue Chip panel of economists.
SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; National Bureau of Economic Research; and Blue Chip Economic Indicators,
May 10, 2004

According to the preliminary estimate
from the U.S. Commerce Department’s Bureau of Economic Analysis,
real gross domestic product (GDP)
rose at an annual rate of 4.4% for
2004:IQ, up from the advance estimate of 4.2%. Most of the revisions
were minor; the most significant
were modest increases in inventories
and imported goods.
Because of its larger share, the
major contributor to real GDP
growth was personal consumption.
Contributions from business fixed
investment, change in inventories,

and government spending were similar to one another.
Blue Chip forecasters expect solid
economic growth to continue at an annual rate of about 4%, well above the
3.1% averaged over the last 30 years.
Because personal consumption
accounts for roughly 70% of GDP and
about 60% of the change in real GDP
over the last year, the household sector’s health is an important concern
for policymakers. One positive sign is
that real personal disposable income
has grown at an annual rate of at about
4% since last September; however, it

has been more than matched by
growth in real personal consumption
expenditures. These expenditures
have been fueled partly by rising levels
of consumer credit outstanding, which
topped $2 trillion for the first time at
the beginning of the year.
Is this high debt load cause for concern? Bankruptcy filings have been
down in the last two months but they
remain at a fairly high level despite a
significant decline late last year.
Some analysts consider the level
of personal bankruptcies to be a
(continued on next page)

11
•

•

GDP Growth and Household Finances (cont.)
Billions of dollars
2,100

Thousands
160 HOUSEHOLD FINANCES

Percent
8 DELIQUENCY RATES a

1,925

133

1,750

119

1,575

105

1,400

1,225

1,050

875

700

0
1991

146

Consumer credit outstanding a

Real estate loans

Personal bankruptcies

50
1991

1993

1995

1997

1999

2001

2003

Percent
15 FINANCIAL OBLIGATION RATIO a

Percent
35

Consumer loans

1993

1995

1997

1999

2001

2003

Ratio
8.0 HOUSEHOLD ASSETS-TO-DEBT RATIO
7.5

Renter

Average
Median b

30
7.0

6.5

6.0
All households
12

5.5

5.0
Homeowner

4.5
10

10
1991

1993

1995

1997

1999

2001

2003

4.0
1989

1992

1995

1998

2001

2003

FRB Cleveland • June 2004

a. Data are seasonally adjusted.
b. Median data are from the Survey of Consumer Finances, which is published every three years.
SOURCES: Administrative Office of the U.S. Courts; and Board of Governors of the Federal Reserve System.

flawed measure of household financial health because it is affected by
changes in lender practices and the
law. Delinquency rates, another measure of consumers’ ability to keep up
with debt obligations, have been on a
downward trend for real estate loans
and fairly flat for consumer loans.
Many observers prefer to look at debt
service ratios because they include
information from all households, not
just those filing for bankruptcy
or falling behind in their payments.
This ratio has risen only modestly for

homeowners since the early 1990s
but much more sharply for renters.
Since the beginning of 2003, the ratio
for both groups has been flat or
declining.
Of course, to assess the financial
health of households fully, one must
look not only at their incomes and
liabilities but also at their assets.
Before the stock market drop that
followed the dot-com collapse, the
average ratio of household assets
to debts was fairly flat going back
to 1989. Because a relatively few

households hold a majority of shares,
the median is better than the average
as a gauge of the typical household.
The median fell from 1989 until 1998
but rose in 2001. Unfortunately, it is
only available every three years, but it
is likely to be up further. More of the
median household’s wealth is tied up
in a home than in stocks, so the price
of its home matters more than the
value of its shares. Although share
prices have not performed very well
since 2001, real estate is up sharply.

12
•

•

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

Labor Market Conditions

350

Average monthly change
(thousands of employees, NAICS)

Preliminary

300

Revised

250

Payroll employment

200

Goods producing
Construction
Manufacturing
Durable goods
Nondurable goods

150
100

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

50
0
–1
–50

2002
–47

2003
–5

–124
–1
–123
–88
–35

–76
–8
–67
–48
–19

–42
7
–48
–30
–18

47
27
16
17
–1

72
37
32
26
6

–25
–24
8
–63
–37
50
–1

29
–11
6
–17
2
40
–11

37
–5
6
23
15
28
8

191
37
10
54
21
33
32

176
19
15
64
31
44
40

–100

YTD
238

May
2004
248

2001
–149

Average for period (percent)
Civilian unemployment
rate

–150

4.8

5.8

6.0

5.6

–200
2000 2001 2002 2003

IIQ

Mar.

IIIQ IVQ IQ
2003
2004

Apr. May
2004

Percent
65.0 AVERAGE MONTHLY NONFARM EMPLOYMENT CHANGE

Percent
6.5

Percent of total employment
24 MANUFACTURING EMPLOYMENT c
22

Employment-to-population ratio
64.5

6.0
Ohio
20
5.5

64.0

Kentucky
18
Pennsylvania

63.5

5.0

16
U.S.
14

63.0

4.5

West Virginia
12

62.5

4.0
10
Civilian unemployment rate

62.0

3.5
1995 1996

1997

1998

1999

2000

2001

2002

2003

2004

8
1990

1992

1994

1996

1998

2000

2002

2004

FRB Cleveland • June 2004

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.
c. Shaded areas indicate recessions as dated by the National Bureau of Economic Research.
SOURCE: U.S. Department of Labor, Bureau of Labor Statistics.

Nonfarm payroll employment rose
248,000 in May. The net job gain for
April was revised up 58,000 to
346,000, bringing the total increase in
nonfarm employment over the past
three months to nearly 950,000. Since
declining by 2.7 million jobs from
March 2001 to August 2003, nonfarm
payroll employment has increased by
more than 1.4 million over the past
nine months.
Goods-producing industries added
72,000 net jobs in May, 32,000 of them
in manufacturing. Since bottoming
out in January, manufacturing employment has increased by 91,000, with

most of the gain coming from durable
goods industries. Service-providing
industries added 176,000 net jobs in
May after gaining mor1e than 250,000
in each of the previous two months.
Within the sector, professional and
business services, education and
health services, and leisure and hospitality each had substantial job gains for
the third consecutive month. Both
the unemployment rate of 5.6% and
the employment-to-population ratio
of 62.2% remained at their previous
levels in April. After falling 0.6% in the
second half of 2003, the unemployment rate has been fairly stable in

2004 so far. The labor force participation rate remained at 65.9%, its lowest
level since 1988.
Since 1990, manufacturing’s share
of employment has declined 5.3 percentage points in the U.S. and
5.8 percentage points in Fourth District states, with more abrupt drops
occurring around recessions. In the
years between the last two recessions,
Kentucky’s share of employment in
manufacturing fell 1.5 percentage
points. During the same period, the
share for the other Fourth District
states and the U.S. as a whole fell between 2.5 and 3.75 percentage points.

13
•

•

The Employment Services Industry
Index, January 1990 = 100
350 EMPLOYMENT

12-month percent change
5 EMPLOYMENT GROWTH
4

12-month percent change
25
20

Employment services

300

250
Employment services
200

5
0

0
Total nonfarm
Temporary help services

–1

–5

–2

–10

150
Total nonfarm
–3

100

–15

Temporary help services

–20

–4
50
1990

1992

1994

1996

1998

2000

2002

2004

Largest Occupations in Employment Services,
May 2003
Thousands of
workers in
employment
services

Laborers and
hand movers a
Office clerks,
general
Packers and
packagers—hand
Helpers—production
workers
Packaging and
filing machine
operators
Secretaries b
Registered nurses
All occupations

Share of
occupation in
employment
services
industry
(percent)

–5
1991

–25
1993

1995

1997

1999

2001

2003

2005

Share of total nonfarm employment, seasonally adjusted
4.0 WORKERS IN EMPLOYMENT SERVICES c
3.5

3.0
U.S.
2.5

476

21.1

179

6.1

146

16.2

18.8

79
73
70

19.6
4.0
3.1

3,299

2.6

Ohio

Kentucky

2.0

1.5

Pennsylvania

1.0
West Virginia
0.5
0
1990

1992

1994

1996

1998

2000

2002

2004

FRB Cleveland • June 2004

NOTE: Shaded bars indicate recessions as dated by the National Bureau of Economic Research.
a. Hand movers include freight, stock, and material movers.
b. Excludes legal, medical, and executive secretaries.
c. State data are seasonally adjusted by the author using the X-11 procedure.
SOURCE: U.S. Department of Labor, Bureau of Labor Statistics; and National Bureau of Economic Research.

Employment services was one of the
fastest-growing industries throughout
the 1990s. By March 2001, the end
of the expansion, it accounted for
3.6 million workers (2.7% of U.S. employment). About two-thirds of these
workers are at temporary help agencies; the remaining third work for
professional employer organizations
and employee placement agencies.
This makes employment in the industry more volatile than aggregate
employment and potentially a leading
indicator. The potential for signaling
future employment gains comes from
firms’ tendency to make permanent

hires from their temporary workers.
The data reveal that hiring in employment services and temporary-help
agencies leads aggregate employment
by about six months and is about five
times as volatile. The scale of these
changes can make this industry appear
to be the only or primary expanding
sector. However, its workers are
spread throughout the economy.
One way to determine where people are actually working is to observe
their occupations. For the seven
largest occupations, employees in
employment services are likely to be
found working in manufacturers and

wholesalers, offices, and hospitals.
Indeed, about one-fifth of all laborers
(typically employed throughout the
industries that produce and deliver
goods) and packaging machine operators (primarily involved in manufacturing) come from the employment
services industry.
Among Fourth District states, the
number of employment services workers has increased significantly in Ohio,
Kentucky, and West Virginia since
2003:IVQ. Pennsylvania, whose recent
employment growth has lagged the
other three states, still reports net job
losses in employment services.

14
•

•

Fourth District Unemployment Rates
Percentage points
2.5 12-MONTH CHANGE IN UNEMPLOYMENT RATE a

Percent
9.0 UNEMPLOYMENT RATE a
8.5

2.0

8.0
1.5

7.5

U.S.
1.0

7.0
6.5

0.5

6.0
U.S.

5.5

–0.5

5.0
4.5
Fourth District

4.0

–1.0
Fourth District
–1.5

3.5
3.0
1990

–2.0
1992

1994

1996

1998

2000

2002

2004

UNEMPLOYMENT RATE, MARCH 2004

1990

1992

1994

1996

1998

2000

2002

2004

ANNUAL CHANGE IN UNEMPLOYMENT RATE, MARCH 2004

Greater than U.S. average
About the same as U.S. average
(5.8% to 6.2%)
Lower than U.S. average

Declined less than U.S. average,
showed no change, or increased
Declined about the same as U.S.
average (–0.1% to –0.3%)
Declined more than U.S. average

FRB Cleveland • June 2004

NOTE: Data are not seasonally adjusted unless otherwise noted.
a. Seasonally adjusted.
SOURCES: U.S. Department of Labor, Bureau of Labor Statistics and Employment Training Administration.

Unemployment patterns in the Fourth
District generally follow national
trends very closely. In the last two
recessions, the rise in national unemployment was mirrored by the Fourth
District rate. In the most recent recession, however, the rise in the District’s
unemployment rate lagged the nation
by two months. In the recovery from
the 1990–91 recession (the “jobless
recovery”) unemployment rates in
both the U.S. and the District continued to climb for a year, then fell
steadily through the expansion. After
the most recent recession, however,

changes in the District’s unemployment rate did not follow the same pattern: Unemployment in the District
and the nation did not climb drastically after the recession ended in November 2001, nor did it begin falling a
year after the recession ended. According to March 2004 data (the most
recent available), unemployment in
the District and across the nation continued to hover around 5.7%, well
above the rates of about 4.2% that
both areas enjoyed throughout 2000.
During the most recent recession,
national and District unemployment

levels remained well below those
experienced during and immediately
after the 1990–91 recession (when
Fourth District unemployment peaked
at 7.7%). But the year-over-year
increase in unemployment rates was
actually greater in the most recent
recession than in 1990–91.
Examined by county, unemployment rates in the District tend to be
lower around major metropolitan
areas and along the transportation
corridors that connect them (including I-75, which stretches from Toledo
to Lexington, and I-71, which crosses
(continued on next page)

15
•

•

Fourth District Unemployment Rates (cont.)
Percent
7.00 OHIO LABOR MARKET a

52-week percent change
175 INITIAL UNEMPLOYMENT CLAIMS
150
Kentucky

Thousands
36

6.75

6.50

125
100
Unemployment rate

6.25

Pennsylvania

Ohio

6.00

50
25

5.75

–9
Labor force (monthly change)

Number employed (monthly change)

5.50

–18

–25
U.S.

–50

5.25

–27
–36

5.00

–75
1/3

3/28

6/20
2003

9/12

12/05

2/27
2004

Percent
7.00 KENTUCKY LABOR MARKET a

Apr. May June July Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. Apr.
2003
Thousands
36

6.75

Percent
7.00

2004
Thousands
72

PENNSYLVANIA LABOR MARKET a

6.75

54
Labor force (monthly change)
Number employed (monthly change)

6.50

6.25

6.00

–9

5.75

–18

5.50

–36

–27

5.25

–54

–36

5.00

6.50
Unemployment rate

5.75

5.50

Labor force (monthly change)
Number employed (monthly change)

Unemployment rate

5.25
5.00
Apr. May June July Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. Apr.
2003

–72
Apr. May June July Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. Apr.

2004

2003

2004

FRB Cleveland • June 2004

a. Data are seasonally adjusted.
SOURCE: U.S. Department of Labor, Bureau of Labor Statistics.

the state from Cincinnati to Cleveland). The District’s Appalachian area
tends to show significantly higher
unemployment rates than the nation,
as does Eastern Kentucky, whose
economy is dominated by agriculture.
Annual changes in unemployment do
not display such clear patterns.
The two-month lag in reporting
local unemployment rates does not
allow for timely analysis of current
market conditions, so economists
sometimes use unemployment insurance claims to gain perspective on
current conditions. Since January, the

number of initial claims has generally
declined from year-ago levels. Seasonally adjusted data for states with
more than 10 counties in the District
(Kentucky, Ohio, and Pennsylvania)
show significant monthly fluctuations
in employment levels. But the January numbers are probably misleading
because annual revisions made that
month adjust sample-based employment estimates to actual job counts
from employer tax reports.
Earlier this year, Ohio’s unemployment rate fell because its labor force
shrank faster than jobs did; the rate
rose slightly in April because labor

force growth outpaced job growth.
Kentucky’s rate declined recently because labor force changes were negligible compared to employment
changes in January, February, and
April. Recent labor market conditions
have been stronger in Kentucky and
Pennsylvania than in Ohio. In fact,
Pennsylvania’s unemployment rate
has not exceeded 5.75% for the past
year; although the state’s job growth
has continued over the past four
months, its unemployment rate has
remained close to 5.25% because its
labor force has also been growing.

16
•

•

FDIC Funds
Percent of insured deposits
1.8 FDIC RESERVES

Number
45 FAILED INSTITUTIONS

1.6

Bank Insurance Fund
Savings Association Insurance Fund

1.4
Target
1.2

1.0

0.8

0.6

0.4

0.2

5
0

1993 1994 1995 1996 1997 1998

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Billions of dollars
7 TOTAL ASSETS OF FAILED INSTITUTIONS

1999 2000 2001 2002 2003

Number
500 PROBLEM INSTITUTIONS
450

Bank Insurance Fund
Savings Association Insurance Fund

6
Bank Insurance Fund
Savings Association Insurance Fund
5

400
350
300

250
3

200
150

100
1
50
0

0
1993 1994 1995 1996 1997 1998

1999 2000 2001 2002 2003

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

FRB Cleveland • June 2004

SOURCE: Federal Deposit Insurance Corporation, Quarterly Banking Profile, various issues.

Insured deposits have grown over the
past five years at an average annual
rate of nearly 4% for members of the
Bank Insurance Fund (BIF) and more
than 5% for members of the Savings
Association Insurance Fund (SAIF),
both funds of the Federal Deposit Insurance Corporation. This robust deposit growth, coupled with the increased costs associated with bank
and thrift failures from 2000 to 2003,
has had a small but detrimental impact on the two funds.
While BIF reserves increased between 2002 and 2003, they stood at

1.32% of insured deposits at the end of
this period, compared to their peak of
1.39% in 1998. SAIF reserves stood at
1.37% of insured deposits, making
2003 the third straight year that the
fund balance grew at the same rate as
SAIF-insured deposits; however, it was
still below the peak of 144 basis points
of reserves per dollar of insured
deposits that it reached in 1999. Both
funds are considered stable because
their year-end reserves continue to
exceed the 1.25% target set by Congress in the Financial Institution
Reform, Recovery, and Enforcement
Act of 1989.

The solid position of the two FDIC
funds is evidenced by the stability of
the banking and thrift industries. Bank
failures since 1995 have been miniscule in terms of the numbers and total
assets of the failed institutions. The
three BIF members that failed in 2003
were small institutions with total assets
of only $1,097 million. For the third
time in the last seven years, no SAIF
member failed; it has been more than
eight years since more than one SAIF
member failed in a single year. The
minimal number of thrift institution
failures over the past decade contrasts
(continued on next page)

17
•

•

FDIC Funds (cont.)
Percent of total assets
2.0 NONPERFORMING ASSETS OF INSURED INSTITUTIONS

Billions of dollars
300 TOTAL ASSETS OF PROBLEM INSTITUTIONS

1.8
250

Bank Insurance Fund
Savings Association Insurance Fund

1.6

Bank Insurance Fund
Savings Association Insurance Fund

1.4

200

1.2
1.0

150

0.8
100

0.6
0.4

0.2
0

0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

BIF Assessment Base Distribution
(Number of members and total assessable deposits in billions of dollars)
A
Capital group
1. Well capitalized
2. Adequately capitalized
3. Undercapitalized

Members
7,357
64
2

Deposits
3,988
10
0

Supervisory Risk Group
B
Members
Deposits
468
119
9
1
0
0

C
Members
81
9
6

Deposits
20
1
0

SAIF Assessment Base Distribution
(Number of members and total assessable deposits in billions of dollars)
Supervisory Risk Group
A
Capital group
1. Well capitalized
2. Adequately capitalized
3. Undercapitalized

Members
1,099
3
0

B
Deposits
1,008
1
0

Members
67
2
0

C
Deposits
32
0
0

Members
13
1
0

Deposits
1
0
0

FRB Cleveland • June 2004

a. BIF-assessable deposits held by both BIF and SAIF members.
b. SAIF-assessable deposits held by both BIF and SAIF members.
SOURCE: Federal Deposit Insurance Corporation, Quarterly Banking Profile, various issues.

dramatically with the widespread solvency problems that plagued the industry throughout the 1980s. Not
only did the number of bank and
thrift failures in 2003 decrease from
the previous year; total failures represented a tiny share of FDIC-insured
institutions in terms of number of
firms and total assets.
Since the end of 2002, problem
institutions (those with substandard
examination ratings) have declined
from 116 to 102 for the BIF and from
20 to 14 for the SAIF. Moreover, the
decrease in the BIF’s number of
problem institutions was matched by
a decline in assets in problem banks

and thrifts. For both funds, however,
the continued low number of problem institutions and the small sum of
assets they held suggest that losses to
the insurance fund will remain low in
the near future. This conjecture is
supported by the low levels of nonperforming assets as a share of total
assets on the books of BIF and SAIF
members.
The Federal Deposit Insurance
Corporation Improvement Act of
1991 mandated that FDIC insurance
premiums be risk-adjusted. To do
this, the FDIC assigns an insured institution to one of three risk groups
(A–C) based upon their most recent

examination rating and one of three
risk groups (1–3) based on their level
of capitalization, creating a total of
nine risk groups. With both funds
above their target reserve ratio, wellcapitalized institutions in supervisory
risk group A by statute pay no premiums. Currently, 92% of all BIF members (7,357 out of 7,996) and nearly
93% of all SAIF members (1,099 out
of 1,185) are in this group. Furthermore, these banks and thrifts account for more than 96% of the BIF’s
assessable deposits (3,928 out of
4,079) and nearly 97% of the SAIF’s
assessment base (1,008 out of 1,042).

18
•

•

Foreign Central Banks
Percent, daily
7 MONETARY POLICY TARGETS a
6

Trillions of yen
–35
–30

–25
Bank of England

–20

Trillions of yen
39 BANK OF JAPAN b
36

Current account balances

–15

European Central Bank

–10

2
Federal Reserve

1
0

Bank of Japan

–1
–2
–3

–5

Current account balances (daily)

–4

–5

–6

35
40

–7
4/1

9/28

3/27

2001

9/23

3/22

2002

9/18

Current account less required reserves
Excess reserve balances
3
0

3/16
2004

2003

12-month percent change
25 CHINA'S CONSUMER PRICE INDEX
AND REAL EXCHANGE RATE

9
6

4/1

10/1

4/1

2001

Yuan per U.S. dollar
9.0

10/1

4/1

2002

10/1
2003

4/1
2004

Percent, daily
15 PEOPLE'S BANK OF CHINA INTERBANK LOAN RATES
14

8.8

20
8.6

13
12
11

8.4
15
Real exchange rate

8.2

CPI

10
9
8

8.0
7.8

7
6
5

5
7.6
7.4
0

4
3
2

7.2
7.0

–5
6/95

6/96

6/97

6/98

6/99

6/00

6/01

6/02

6/03

6/04

1
0
7/96

7/97

7/98

7/99

7/00

7/01

7/02

7/03

7/04

FRB Cleveland • June 2004

a. Federal Reserve: overnight interbank rate. Bank of Japan: a quantity of current account balances (since December 19, 2001, a range of quantity of current
account balances). Bank of England and European Central Bank: repo rate.
b. Current account balances at the Bank of Japan are required and excess reserve balances at depository institutions subject to reserve requirements plus the
balances of certain other financial institutions not subject to reserve requirements. Reserve requirements are satisfied on the basis of the average of a bank’s
daily balances at the Bank of Japan starting the sixteenth of one month and ending the fifteenth of the next.
SOURCES: Board of Governors of the Federal Reserve System; Bank of Japan; European Central Bank; Bank of England; People’s Bank of China; and
Bloomberg Financial Information Services.

The Monetary Policy Committee
raised the Bank of England’s policy
rate 25 basis points to 4.25% on May 6,
“to keep CPI inflation on track to meet
the 2% target in the medium term.”
The committee deemed this change
necessary because of “a small and
diminishing margin of spare capacity.”
The Federal Reserve left its policy
rate unchanged at the May 4 Federal
Open Market Committee meeting.
However, markets interpreted its statement that “policy accommodation can
be removed at a pace that is likely to

be measured” as indicating a greater
likelihood of a small move than was
suggested by its previous statement
that it “can be patient in removing its
policy accommodation.”
Amid further indications of a
broad-based economic recovery, the
Bank of Japan continues to maintain
the current “extremely easy monetary
policy” of quantitative easing. However, Governor Fukui has alluded to
the bank’s eventual need for an “exit
policy” to extricate itself from the
current procedure, but “avoid sharp

fluctuations in financial markets and
…prevent any sudden discontinuities
in market conditions.”
In China, inflation has been rising
relative to the 2004 target of 3% set
by the People’s Bank. Although the
bank has maintained a fixed nominal
exchange rate relative to the U.S. dollar, the real (inflation-adjusted) exchange rate has been appreciating.
The effects of monetary tightening
frequently have been apparent in
spikes in interbank loan rates, which
have not been controlled since 1996.

Full text of Economic Trends (Federal Reserve Bank of Cleveland) : Economic Trends - June 2004

FRASER