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Federal Reserve Bank of Cleveland

Economic Trends
March 2007
(Covering February 9, 2006 - March 9, 2007)

In This Issue
Economy in Perspective
Liquidity
Inﬂation and Prices
January Price Statistics
The Cost of Labor as an Inﬂation Indicator
Money, Financial Markets, and Monetary Policy
Is Inﬂation Changing Its Ways?
The January 31 FOMC Meeting
What Is the Yield Curve Telling Us?
International Markets
Will the Euro Supplant the Dollar?
Economic Activity and Labor Markets
A Tale of Two Houses
A Mixed Message on Manufacturing
Job Creation and Job Destruction
Extended Mass Layoﬀs
Is Manufacturing Going the Way of Agriculture?
The Budget and Economic Outlook
Regional Activity
Regional Patenting Activity
The Metal Working Industry
Banking and Financial Institutions
A Close Look at Fourth District Community Banks

Economic Trends is published by the Research Department of the Federal Reserve Bank of Cleveland.
Views stated in Economic Trends are those of individuals in the Research Department and not necessarily those of the Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. Materials may be reprinted
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ISSN 0748-2922
2

The Economy in Perspective
03.09.07
by Mark S. Sniderman
Liquidity1...Lately, I’ve been hearing people say that the world is awash in liquidity. What they mean is that just
about anyone can raise money on the cheap to buy nearly anything they want—from a house to a portfolio of
commercial oﬃce buildings, or, if you prefer, from a cell phone to a cellular network. You want it? Someone will
lend you the money to buy it. Is this an apt description of ﬁnancial markets?
Financial conditions in the housing market no longer quite ﬁt this description, although they did until recently.
During the 1990s, housing prices increased at annual rates very near the overall inﬂation rate, about 3 percent per
year. With the recession and weak recovery came lower short-term interest rates that stayed low for a long time.
The federal funds rate sojourned in the range of 1 percent–1-1/2 percent from 2002 to mid-2004. When the
FOMC ﬁnally did move to raise its funds rate target in 2004, it did so at a measured pace. Short-term interest rates
rose, but longer-term rates did not increase proportionately; as a result, the yield curve ﬂattened out. Interest rates
in many other developed economies were relatively low as well.
The root cause of the low-rate environment may well be the global savings glut that is still being driven by developing economies and oil-producing nations. Simply put, some nations cannot absorb all of their domestic savings domestically, and therefore look for investment opportunities elsewhere. The global savings glut depresses the real rate
of interest and leads central banks to lower their interest rates lest their monetary policies become too restrictive.
Low interest rates made housing more aﬀordable, but several other circumstances undoubtedly helped. Financial
institutions have become more adept at marketing home equity lines of credit, and consumers have become more
willing to tap into these lines to meet their needs. Even if the house itself is not necessarily more liquid, the equity
in it is. The transaction costs of taking out these lines have fallen steeply over time, making the house a more attractive asset.
Another ﬁnancial innovation that has made houses more attractive to investors is ﬁnancial institutions’ ability to
price credit and duration risk more discretely. They can package mortgage loans in pools with speciﬁed risk proﬁles and match them with lenders who have similar risk proﬁles. Tailoring mortgage pools by risk proﬁle creates a
more eﬃcient mortgage market for homebuyers and investors, reducing funding costs and minimizing the outright
rationing of credit to risky borrowers. Other things equal, more credit will be extended, more housing demand will
be satisﬁed in the marketplace, and houses will command a higher price.
As measured by the OFHEO Index, house prices started increasing at a rate of about 5 percent in 2000, accelerated into the 6 percent–8 percent range for the next several years, and then really took oﬀ. House prices soared into
the 10 percent–15 percent range in 2004, 2005, and early 2006. And these national averages mask exceedingly
large price increases in the hottest housing markets in the country.
As with the stock market’s boom and bust in the second half of the 1990s, many people recognize that an asset’s
price can keep rising only as long as it keeps generating more income or more potential future income. At some
point, the asset’s ability to satisfy this condition becomes so doubtful that lenders pull back. When this happens,
a liquid market can become illiquid seemingly overnight, exposing highly leveraged market participants to loan
repayments and limiting their ability to sell the asset without sustaining a loss. The more people rush to the exits,
the more prices would have to fall to clear the market, thus exacerbating the situation.
We are in the midst of a substantial housing market correction, with no telling how long it will take for the sup3

ply of available houses—which swelled much faster than usual during the past few years—to become more closely
aligned with the diminished demand for them. It is not clear how much price adjustment will be required to restore
balance to the market. Nor is it clear which investors stand to lose, and how much. Most of the highest-risk mortgage credit advanced in the last few years originated outside the commercial banking system, so it is diﬃcult to know
where the defaults will occur.
The still-unﬁnished saga of the mortgage credit industry should give us pause about investments outside of the housing sector. Investors are paying increasingly handsome sums for commercial and industrial companies, but many of
these deals make economic sense only if the new owner can signiﬁcantly enhance the property’s value or if the asset’s
value appreciates greatly over time. These are risky propositions.
We are witnessing the deployment of global capital, intermediated through new forms of ﬁnancial institutions using
new kinds of ﬁnancial instruments. Capital markets may be increasingly able to match risk-taking investors with
equally risky ventures, and the inevitable failures may prove to be isolated and immaterial for the ﬁnancial system
as a whole. At the same time, the most recent declines in global equity markets and preferences for higher-quality
investments may signal a recognition that from time to time, too much liquidity can transform assets into liabilities.
1. As I completed this “Economy in Perspective,” Federal Reserve Board Governor Kevin M. Warsh delivered remarks on liquidity at a conference in
Washington, D.C. You can find his thoughtful remarks here. [Back to article]

Inﬂation and Prices

January Price Statistics
3.08.07
by Michael Bryan and Linsey Molloy

January Price Statistics
Percent change, last
1mo.a

3mo.a 6mo.a 12mo.

5yr.a

2006
avg.

All items

2.1

2.7

0.0

2.1

2.7

2.6

Less food and energy

3.1

2.0

2.2

2.7

2.0

2.6

Medianb

2.4

3.0

3.4

3.6

2.7

3.6

3.1

6.2

2.3

2.6

2.3

2.7

Finished goods

-7.2

8.7

-0.9

0.2

3.1

1.8

Less food and energy

2.3

2.4

2.8

1.8

1.3

2.2

Consumer Price Index

16% trimmed

meanb

Producer Price Index

Personal Consumption
Expenditure Price Index
All items

2.5

2.3

0.6

2.0

2.4

2.3

Less food and energy

3.1

1.8

2.2

2.3

1.9

2.2

Trimmed meanc

3.0

2.2

2.1

2.5

2.2

2.5

a. Annualized.
b. Calculated by the Federal Reserve Bank of Cleveland.
c. Calculated by the Federal Reserve Bank of Dallas.
Sources: U.S. Department of Labor, Bureau of Labor Statistics; the Federal Reserve Bank of Dallas; and Federal Reserve Bank of Cleveland.

Retail prices seemed to have spiked in January
following three months of moderate monthly
increases. While the Consumer Price Index rose 2.1
percent (annualized), the CPI excluding food and
energy and the 16% trimmed-mean each rose 3.1
percent (annualized). Both the CPI excluding food
and energy and the 16% trimmed-mean increased
at rates exceeding their 12-month trends, which
were between 2-1/2 and 2-3/4 percent.
The January price report revealed that the cost
of medical care posted its largest increase in 16
years—up 10.1 percent (annualized). According
to the Bureau of Labor Statistics, this component
alone accounted for about 60 percent of the acceleration in the core CPI in January, which followed
a string of very favorable reports. The surge in medical care reﬂected a jump in prescription drugs and
medical supplies, as well as a 15.1 percent climb
in physicians’ services. Medical care is generally a

CPI, Core CPI, and Trimmed-Mean CPI
Measures
12-month percent change
4.75
4.50
4.25
4.00
CPI
3.75
3.50
3.25
3.00
2.75
2.50
2.25
2.00
1.75
1.50
1.25
16% trimmed-mean CPI a
1.00
1995
1997
1999
2001

Median CPI a

Core CPI
2003

2005

2007

a. Calculated by the Federal Reserve Bank of Cleveland.
SOURCES: U.S. Department of Labor, Bureau of Labor Statistics, and Federal
Reserve Bank of Cleveland.

Medical Care Prices
1-month annualized percent change
11
10
9
8
7
6
5
4
3
2
1
0
1995

1997

1999

2001

2003

2005

2007

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

CPI Component Price Change
Distribution

more stable component of the CPI, so its sudden
surge is justiﬁably viewed with a little skepticism.
Medical care, which accounts for a bit over 6 percent of the overall weighted index, was not the only
component that grew at a rate exceeding the overall
inﬂation trend: About two-ﬁfths of the index’s
components grew at rates exceeding 3 percent. On
the other hand, owner’s equivalent rent of primary
residence (OER), which is the index’s single-largest component, grew at its slowest monthly rate
since October 2005, rising 2.4 percent during the
month. Some moderation in the OER component
has been expected by analysts, as the softening of
U.S. home sales (and prices) encourages greater
interest in home ownership and, as a result, typically puts downward pressure on rents (which are
reweighted to measure OER). However, what’s
curious about the moderation in OER growth
is that it has happened despite a rather stubborn
increase in rents. Could it be that a softer housing
market is aﬀecting only the rents of homes that
are most similar to the homes people own and not
the general rental market? It could, but we think
that it is equally likely that the moderation of OER
growth in January may be overstating the degree to
which the implied cost of home ownership is actually waning.
Meanwhile, market-based expectations for inﬂation
over the next 10 years continue to lie in the modest range in which they have ﬂuctuated over the
past several years. Market participants anticipate
that prices will generally grow between 2 and 2-3/4
percent over the next decade.

Weighted frequency
50
45
40
35
30
25

Motor fuel, fuel oil,
and other fuels

20
15

OER

Gas (piped)
and electricity

10
5
0
<0

0 to 1
1 to 2
2 to 3
3 to 4
4 to 5
Annualized monthly percent change, January

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

Housing Prices

Market-Based Inflation Expectations*

1-month annualized percent change
7.0
6.5
CPI: Rent of primary residence
6.0
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
CPI: Owner’s equivalent rent
1.0
of primary residence
0.5
0.0
1995
1997
1999
2001
2003
2005
2007

3.75
3.50
3.25
3.00
2.75
2.50
2.25
2.00
1.75
1.50
1.25
1.00
0.75
0.50
1997

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

Percent, monthly
Adjusted 10 -year TIPS-derived expected inflation b

10-year TIPS-derived expected inflation

1999

2001

2003

2005

2007

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

Inﬂation and Prices

The Cost of Labor as an Inﬂation Indicator
02.15.07
by Michael F. Bryan and Linsey Molloy

Output and Compensation
4-quarter percent change
9
8

Compensation per hour

7
6
5
4
3
2
1

Output per hour (productivity)

0
-1
1990

1992

1994

1996

1998

2000

2002

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

2004

2006

Economists consider a broad range of economic
indicators to gauge inﬂationary pressures in the
economy. One indicator of potential inﬂation
pressure is the cost of labor. Higher labor costs, the
theory suggests, means that ﬁrms may boost prices.
In the Federal Reserve’s semiannual Monetary
Report to the Congress, Chairman Ben Bernanke
noted that “[u]pward pressure on inﬂation could
materialize if ﬁnal demand were to exceed the
underlying productive capacity of the economy for
a sustained period” and that “[m]easures of labor
compensation, though still growing at a moderate
pace, have shown some signs of acceleration over
the past year, likely in part the result of tight labor
market conditions.”
Turning to the data, labor compensation growth
has risen over the past couple years from about 3
percent in mid-2004 to nearly 5 percent at the end
of 2006. Moreover, labor productivity growth has
moderated signiﬁcantly from highs in 2002-2004
to roughly 2 percent. These two trends have pushed
up unit labor cost growth substantially over the past
couple of years, from about a 1-1/2 percent decline
to about a 3 percent rise by the end of 2006.

However, Chairman Bernanke also noted that
such “increases in compensation might be oﬀset by
higher labor productivity or absorbed by a narrowing of ﬁrms’ proﬁt margins rather than passed on to
consumers in the form of higher prices.”

Unit Labor Costs
4-quarter percent change
6
5
4
3
2
1
0
-1
-2
1990

1992

1994

1996

1998

2000

2002

2004

2006

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

Employment Cost Index*
4-quarter percent change
9
8
7

Total compensation

Benefits

6
5
4
3
2

Wages

1
0
-1
1990

1992

1994

1996

1998

2000

2002

*Employment Cost Index for all civilian workers.
Source: U.S. Department of Labor, Bureau of Labor Statistics.

2004

2006

It could be argued that the rising unit labor cost
growth measure may exaggerate the potential inﬂationary pressure in the economy: Some question
the labor compensation measure used to calculate unit labor costs because it does not control
for shifts in industry and occupation structure,
and it can be heavily inﬂuenced by variable and
infrequent factors such as large bonus payments.
Another labor cost measure, the Employment Cost
Index (ECI), computes total compensation based
on a ﬁxed mixture of industries and occupations
in order to distinguish labor cost growth from
growth caused by shifts in industrial and occupational structure over time. It also includes many
important elements of labor compensation, including beneﬁts such as paid leave, bonuses, insurance,
payroll taxes paid by employers, and retirement and
savings beneﬁts, which when combined, account
for nearly 30 percent of total compensation. The
ECI reveals a more sanguine labor compensation
trend than the compensation measure used to calculate unit labor costs. It suggests that while compensation growth has inched up a bit over the past
year, it has moderated since 2000.

Money, Financial Markets, and Monetary Policy

Is Inﬂation Changing Its Ways?
03.07.07
by Charles T. Carlstrom and Bethany Tinlin

Output Gap Coefficient*

Policymakers and academics have noticed that the
inﬂation process in the United States and other
countries has changed markedly since 2000. Two
formerly characteristic features of the process have
been deviating from their historical norms. First,
inﬂation persistence—the degree to which current
inﬂation depends on past inﬂations—has declined
dramatically. Second, an equally dramatic decline
has occurred in the degree to which the output gap
aﬀects inﬂation. The output gap is the percent by
which actual output deviates from its potential.

Coefficient
0.30
0.25
0.20
0.15
0.10
0.05
0.00
-0.05
-0.10
-0.15
1983

1986

1989

1992

1995

1998

2001

2004

*The output gap is defined as the natural log of real gross domestic product less
the natural log of potential gross domestic product, taken from the Congressional
Budget Office. The output gap coefficients are calculated using 10-year rolling
regressions of inflation on the output gap and 4-quarter lags of inflation.
Sources: U.S. Department of Commerce, Bureau of Economic Analysis; the Congressional Budget Office; and authors’ calculations.

Inflation Persistence Coefficient*
Coefficient
1.2

Historically, for every one percentage point increase
in output above its potential, inﬂation increased
0.15 percent. Since 2000, the point estimate is
actually negative. Although one should not necessarily conclude that the output gap and inﬂation
are negatively related, the decline is puzzling and
has important policy ramiﬁcations. It implies that
a larger output gap has to be opened up to lower
inﬂation.
The policy implications of the decline in inﬂation
persistence are mixed. When the value of inﬂation
persistence is 1.0, as it nearly was at the beginning
of 2000, it implies that all shocks to inﬂation are
permanent. If inﬂation shocks are permanent, it
suggests that the only way to oﬀset them is to widen the output gap. But now that inﬂation persistence has fallen to 0.4, it would appear that shocks
to inﬂation are temporary and policymakers can
potentially wait for inﬂation to return to normal.

1.0
0.8
0.6
0.4
0.2
0.0
1983

1986

1989

1992

1995

1998

2001

2004

* Inflation is based on core PCE. The coefficients are calculated using 10-year rolling regressions of inflation on the output gap and 4-quarter lags of inflation. Inflation persistence is defined as the sum of the 4-quarter lag coefficients.
Sources: U.S. Department of Commerce, Bureau of Economic Analysis; and authors’ calculations.

Less inﬂation persistence, however, has another
side. If one wants to permanently lower inﬂation
from its current level, less persistence implies that
an output gap has to be opened for an even longer
period of time than if persistence were higher. Consider the extreme case, where changes in inﬂation
are nearly permanent (persistence is close to 1.0).

In this case, an output gap need only be opened for
a short period of time because a gap today implies
less inﬂation both today and in the future. Less
inﬂation persistence works the other way.

Output Gap Standard Error*
Standard error
0.10
0.09
0.08
0.07
0.06
0.05
0.04
1983

1986

1989

1992

1995

1998

2001

2004

*The output gap is defined as the natural log of real Gross Domestic Product
less the natural log of potential Gross Domestic Product, taken from the Congressional Budget Office. The standard errors of the output gap coefficients are
calculated using 10-year rolling regressions of inflation on the output gap and
4-quarter lags of inflation.
Sources: U.S. Department of Commerce, Bureau of Economic Analysis; the
Congressional Budget Office; and authors calculations.

Inflation Persistence Standard Error
Standard error
0.80

0.75

0.70

0.65

0.60

0.55
1983

1986

1989

1992

1995

1998

2001

2004

*Inflation is based on core PCE. The standard errors of inflation persistence are
calculated using 10-year rolling regressions of inflation on the output gap and
4-quarter lags of inflation.
Sources: U.S. Department of Commerce, Bureau of Economic Analysis; and
authors’ calculations.

Some argue that we should not read too much into
these declines because they are not statistically signiﬁcant, which implies that they could be the result
of pure chance. But policymakers may not have the
luxury of waiting to see if a change in the inﬂation
process is statistically signiﬁcant before reacting. A
researcher’s trigger point for starting to seriously
contemplate a possible change in the inﬂation process is not necessarily the same as a policymaker’s.
Others argue that the output gap is poorly measured, so we can’t be certain about how much
output is deviating from potential. If we can’t accurately measure the output gap, we can’t ascertain
the impact of the gap on inﬂation or know whether
it’s declining. While the recent declines in inﬂation
persistence and the impact of the output gap on
inﬂation are not necessarily statistically signiﬁcant,
it is worth noting that the eﬀects of lagged inﬂation
and the output gap on current inﬂation are being
estimated with more precision than before the declines. This suggests that the decline in the output
gap’s eﬀect on inﬂation is not because potential
output is being poorly measured.
To determine why inﬂation persistence is declining,
it might help to examine the relationship between
inﬂation and past inﬂations during the period over
which persistence changed most dramatically-from the ﬁrst quarter of 2000 to the third quarter
of 2002. (For this exercise, we ignore the impact
of the gap on inﬂation.) At the beginning of 2000,
every percentage point in the previous quarter’s inﬂation was associated with an 0.8 percentage point
increase in current inﬂation. Six quarters later, that
number had fallen to 0.4.
Just 10 years earlier, beginning in the ﬁrst quarter
of 1990, some economists believe that the longterm inﬂation target began to decrease. Such a decrease could artiﬁcially add in inﬂation persistence.
After 2000, long-term inﬂation was probably fairly
constant. If this explanation is correct, then inﬂation persistence will probably continue to stay low.
9

Inflation vs. Lagged Inflation:
1990:Q1 – 2000:Q1*

Inflation vs. Lagged Inflation:
1992:Q3–2002:Q3*

Inflation, percent

Inflation, percent
6

Slope = 0.41

Slope = 0.80

0
0

2
3
4
Lagged Inflation, percent

*Inflation represents Personal Consumption Expenditures less food and energy (core
PCE) in the previous quarter. Red dots represent observations that are not included
in the previous chart.
Source: U.S. Department of Commerce, Bureau of Economic Analysis.

*Inflation represents Personal Consumption Expenditures less food and
energy (core PCE) in the previous quarter. Green dots represent observations
that are not included in the following chart.
Sources U.S. Department of Commerce, Bureau of Economic Analysis.

Money, Financial Markets, and Monetary Policy

The January 31 FOMC Meeting
02.22.07
by Charles T. Carlstrom and Bethany Tinlin

Reserve Market Rates
Percent
8
7

Effective federal funds rate

6
5
Primary credit rate b
4
3
2
1

b
Intended federal funds rate

Discount rate b

0
2000

2001

2002

2003

2004

2005

2006

2007

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

On January 31, 2006, the Federal Open Market
Committee voted to leave the federal funds target
rate at 5.25 percent for the ﬁfth consecutive time.
The primary credit rate has also been maintained at
6.25 percent. In its press release, the Committee explained that its decision was based on the fact that
“readings on core inﬂation have improved modestly
in recent months, and inﬂation pressures seem
likely to moderate over time.” But it also noted that
“some inﬂation risks remain” due to a “high level of
resource utilization.” Because of these inﬂationary
pressures, the committee’s statement continues to
suggest that the next move might be up (“the extent
and timing of any additional ﬁrming”). The next
meeting is scheduled for March 21.
The monetary authorities’ decision to leave their
key interest rate unchanged did not surprise market
participants. At the close of business on the day
before the January 31 announcement, the Chicago
Board of Trade’s federal funds rate futures revealed
that investors judged that there was a 98 percent
probability that the Committee would leave the
target rate unchanged, and a mere 2 percent that
10

the Committee would decrease the rate by 25 basis
points, from 5-1/4 percent to 5 percent.

Implied Probabilities of Alternative
Target Federal Funds Rates January
Meeting Outcome*

Although the committee’s language suggests future
rate hikes, market participants have, if anything,
been predicting that the next move would be a rate
cut. In December, they expected the funds rate to
be just above 5 percent by midyear, a decrease of
nearly 25 basis points. Since then, however, their
expectations of the fed funds rate path have risen,
and they now anticipate a near-constant funds rate
going forward.

Implied probability
1.0
0.9
0.8
5.25%
0.7
0.6
0.5
0.4
5.50%

0.3

5.00%

0.2
0.1
0.0
09/22

10/06

10/20

11/03

11/17

12/01

12/15

12/29

01/12

01/26

*Probabilities are calculated using trading-day closing prices from options on January
2007 federal funds futures that trade on the Chicago Board of Trade.
Sources: Chicago Board of Trade and Bloomberg Financial Services.

Implied Yields on Federal Funds
Futures*
Percent
5.30
Feb 2, 2007

5.25
5.20

Oct 27, 2006

a
Feb 22, 2007

5.15
5.10
Dec 15, 2006

5.05
5.00
Oct
2006

Dec

Feb

Apr

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

Jun

Aug
2007

Although the committee continues to assert that
“some inﬂation risks may remain,” there is no
evidence that long-term inﬂation expectations
have crept up over the past several months. In fact,
anticipated inﬂation, as derived from the liquidity-adjusted, 10-year Treasury inﬂation-protected
securities (TIPS), has fallen from around 2.3
percent at the beginning of the year to just under
2 percent today. It appears that the Federal Reserve
has the credibility to keep long-term inﬂation at
bay despite short-term inﬂationary pressures.
This is undoubtedly why participants’ anticipation
of a rate cut has lessened. News on economic activity has generally been stronger than expected since
the beginning of the year. With a rate cut, this may
not be consistent with stable inﬂation; therefore,
market participants no longer feel that the committee will cut rates going forward.
Certainly, one reason that participants expected
the next move to be a cut was underlying uneasiness about the real economy. The fact that the yield
curve has been sloping downward over many maturities makes some people uneasy about the future
of the real economy; the reason is that yield-curve
inversions frequently portend a recession. Currently, the closely watched 10-year, 90-day spread
stands at –38 basis points.
The stance of monetary policy is shown not by the
funds rate and the future path of the funds rate but
by the real funds rate and its future path. The real
federal funds rate (deﬁned as the eﬀective federal
funds rate less core inﬂation in personal consumption expenditures) remains nearly steady at 3.0
percent. Since its trough in 2004, however, it has
gained more than 4 percentage points.
11

10-Year Real Interest Rate and
TIPS-Based Inflation Expectations
4.0

5.0
Corrected 10-year TIPS-derived expected inflation

3.0

4.0
3.0

2.5

2.0

1.0

1.5
1.0

Percent
6.0

Percent

3.5

Real Federal Funds Rate*

0.0
10-year TIPS-derived expected inflation a

0.5

-1.0
-2.0
2000

0.0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
a. Treasury inflation-protected securities (TIPS).
b. Ten-year TIPS-derived expected inflation adjusted for the liquidity premium on
the market for the 10-year Treasury note.
Sources: Bloomberg Financial Information Services; and Board of Governors of
the Federal Reserve System, “Selected Interest Rates,” Federal Reserve Statistical Releases, H.15.

2001

2002

2003

2004

2005

2006

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

10-year minus 90-day Yield Spread*

Percent

5
4

0.4
10 year – 90 day yield spread

0.3

10 year – 90 day yield spread

0.2
3
2

0.1
0.0
-0.1

1
0
-1

-0.2
-0.3
-0.4
-0.5

-2
1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003
*Quarterly observations. Shaded bars represent recessions.
Source: The National Bureau of Economic Research (NBER); and Board of
Governors of the Federal Reserve System.

-0.6
01/06

03/06

05/06

07/06

09/06

11/06

01/07

*Weekly observations. The last data point is for February 20, 2007.
Sources: National Bureau of Economic Research (NBER); and Board of Governors of the Federal Reserve System.

Money, Financial Markets, and Monetary Policy

What Is the Yield Curve Telling Us?
Yield Spread versus Real GDP Growth*

02.22.07
by Joseph G. Haubrich and Brent Meyer

Percent
12
10

Real GDP growth
(year-to-year
percent change)

8
6
4
2
0

10-year – 3-month
yield spread

-2
-4
1953

1963

1973

1983

1993

2003

*Shaded bars represent recessions.
Sources: U.S. Department of Commerce, Bureau of Economic Analysis;
Federal Reserve Board

Yield Spread versus
One-Year-Lagged Real GDP Growth
Percent

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

12
10

One-year-lagged real GDP growth
(year-to-year percent change)

8
6
4
2
0
10-year – 3-month
yield spread

-2
-4
1953

1963

1973

1983

1993

2003

Sources: U.S. Department of Commerce, Bureau of Economic Analysis;
and Federal Reserve Board.

Yield Spread versus
Predicted GDP Growth
Percent
6
5

Real GDP growth
(year-to-year percent change)

4
Predicted
GDP growth

3
2

10-year – 3-month
yield spread

1
0
-1
-2
12/01

12/02

12/03

12/04

12/05

12/06

12/07

Lately, the yield curve has some forecasters worried.
One reason for concern is that the spread is currently negative: with 10-year rate at 4.75 percent
and the 3-month rate at 5.17 percent (both for the
week ending February 16), the spread stands at a
negative 42 basis points, and indeed has been in
the negative range since August. Projecting forward
using past values of the spread and GDP growth
suggests that real GDP will grow at about a 1.8
percent rate over the next year.
While such an approach predicts when growth is
above or below average, it does not do so well in
predicting the actual number, especially in the case
of recessions. Thus, it is sometimes preferable to
focus on using the yield curve to predict a discrete
event: whether or not the economy is in recession.
Looking at that relationship, the expected chance
of a recession in the next year is 42 percent, barely
down from last month’s value of 43 percent.
Of course, it might not be advisable to take this
number quite so literally, for two reasons. First,
this probability is itself subject to error, as is the
case with all statistical estimates. Second, other
researchers have postulated that the underlying

Sources: U.S. Department of Commerce, Bureau of Economic Analysis;
and Federal Reserve Board.

Probability of Recession Based
On the Yield Spread*
Percent
100
90
Probability of
recession

Forecast

70
60
50
40

determinants of the yield spread today are materially diﬀerent from the determinants that generated
yield spreads during prior decades. Diﬀerences
could arise from changes in international capital
ﬂows and inﬂation expectations, for example. The
bottom line is that yield curves contain important
information for business cycle analysis, but, like
other indicators, should be interpreted with caution.

30
20
10
0
1960

1966

1972

1978

1984

1990

1996

2002

2008

For more detail on these and other issues related
to using the yield curve to predict recessions, see
the Economic Commentary “Does the Yield Curve
Signal Recession?”

*Estimated using probit model.
Sources: U.S. Department of Commerce, Bureau of Economic Analysis;
Federal Reserve Board; and authors’ calculations.

International Markets

Will the Euro Supplant the Dollar?
02.28.07
by Owen F. Humpage and Michael Shenk

Foreign Exchange Reserves
Ratio of reserves to trade
5
4.5
4
3.5

World

3
2.5

Developing
countries

2
1.5
1

Industrial countries

0.5
0
1971

1975

1979

1983

1987

1991

1995

1999

Source: International Monetary Fund, International Financial Statistics.

2003

Although the U.S. dollar has been the world’s key
international currency since at least the end of
World War II, some commentators believe that the
era of the dollar’s dominance is coming to an end.
Such claims are not new. We heard them in the
late 1970s and again in the 1980s when the dollar
depreciated broadly in foreign-exchange markets.
What makes these claims particularly interesting today is that for the ﬁrst time, the dollar has a viable
competitor for the role of key international currency—the euro.
The dollar plays a number of closely related, private and public international roles. The recent
controversy, however, focuses on the dollar’s oﬃcial
reserve currency role among developing countries.
The world witnessed a sharp run up in developing
countries’ oﬃcial foreign-exchange reserves beginning in the very late 1980s. The accumulation has
outpaced the growth in international trade, suggesting that these countries are building an insurance
fund against cross-boarder ﬁnancial ﬂows. Recently,
while still adding to their portfolios, these countries
also seem to be diversifying away from dollars.

Foreign Exchange Reserves
Ratio of reserves to trade
5
4.5
4
3.5

World

3
2.5

Developing
countries

2
1.5
1

Industrial countries

0.5
0
1971

1975

1979

1983

1987

1991

1995

1999

2003

Source: International Monetary Fund, International Financial Statistics.

Foreign Exchange Reserves
Developing Countries
Percent of allocated reserves
80
70

U.S. dollars

60
50
40
Euros
30
20
10

Japanese yen

All other

British pounds

0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Source: International Monetary Fund, COFER data.

The European Union

Countries using the euro
Countries not using the euro

IMF estimates suggest that since 2001 developing countries have reduced the share of dollar-denominated assets in their foreign-exchange reserves
from 70 percent to 60 percent, and that they have
increased the share of euro-denominated assets in
their portfolio by nearly an equal amount. The developing countries in the IMF survey, however, are
not dumping dollars. They continued to add dollars
to their portfolios, but they have acquired euros
and British pounds at a faster rate. Euros now account for slightly less than 30 percent of developing
countries’ portfolios, making the euro the second
most important oﬃcial reserve currency. The British pound and the Japanese yen remain a distant
third and fourth.
We need to be careful about how we characterize
this declining share. The dollar seems to have accounted for roughly 60 percent, or slightly more,
of oﬃcial foreign-exchange reserves on average over
the past 25 years or so, and the dollar’s share has
ﬂuctuated between 50 percent and 70 percent over
that interval.1 A 60 percent share does not seem
abnormally low, but what is changing are the growing network beneﬁts of holding euros.
Money reduces the costs of engaging in economic
exchange. The more widespread a single currency’s
use, the bigger are the gains from employing it and
the more valuable it becomes to any individual or
government holding it. If a currency is to serve as
an international currency, it must start with a large
domestic base.
On that score, the euro area certainly has potential to match the dollar. The United States has a
population of 301 million and produces a GDP
of slightly more than $13 trillion. The European
Union currently consists of 27 countries encompassing 490 million individuals and producing
approximately the same amount of output. Of the
EU member countries, 14 have adopted the euro.
The remaining countries—except for the United
Kingdom and Denmark—must eventually adopt
the euro.
As the domestic use of the euro broadens, so will
its international use. With the expansion of the
European Union, for example, more European
countries are denominating a greater share of their
15

Exchange Rate Pairs
Euro/all others
9.0%
U.S. dollars/
all others
29.9%

All others
2.4%

U.S. dollars/
euro 28.3%

U.S. dollars/
British pounds
13.8%
U.S. dollars/yen
16.7%

Source: Bank for International Settlements, Triennial Central Bank Survey,
Foreign Exchange and Derivatives Market Activity in 2004. March 2005.

Foreign Exchange Turnover
All others
30.8%

U.S. dollars
88.7%

Swiss francs
6.1%
Japanese
yen
20.3%

British
pounds
16.9%
Euros
37.2%
Source: Bank for International Settlements, Triennial Central Bank Survey,
Foreign Exchange and Derivatives Market Activity in 2004. March 2005.

trade in euros. This makes the euro more attractive
as a currency against which to peg and in which to
keep reserves to manage that peg. Similarly, euro
ﬁnancial markets are becoming broader and deeper,
and this trend will continue as more European
Union countries adopt the euro. As it does, foreign companies and governments will denominate
more of their securities in euros, and foreign banks
will make more loans and extend more deposits in
euros. Developing countries will denominate more
of their debt securities in euros and hold euros
in reserve to service that debt. A recent study by
economists Menzie Chinn and Jeﬀrey Frankel suggests that, all else constant, if the European Union
countries not currently using the euro—most critically the United Kingdom—adopt the euro, the
dollar would lose its dominance by 2020.2
The euro certainly has potential, but it still has
a long way to go before it surpasses the dollar’s
predominance as an international currency. Almost
90 percent of all foreign-exchange transactions
currently involve the U.S. dollar. The euro, with 37
percent of all transactions, ranks a distant second,
but well ahead of the Japanese yen and the British
pound. The most commonly traded foreign-currency pair—making up 28 percent of the transactions—is between dollars and euros. Very few
trades involve euros for other currencies.
While countries that adopt the euro reap considerable advantages, doing so has some potential
drawbacks that might slow the process. A common
currency prevents exchange-rate changes from helping a country adjust to economic shocks speciﬁc to
that country. Such adjustments are especially useful
in small, undiversiﬁed economies where domestic
wages and prices are inﬂexible or where the crossborder movement of goods, labor, and ﬁnancing
is limited. The single-market initiatives within the
European Union should improve the mobility of
goods, labor, and ﬁnancial ﬂows within the union
and may even encourage price and wage ﬂexibility,
but the process will take time.
References
1. Gabriele Galati and Philip Wooldridge. “The
Euro as a Reserve Currency: A Challenge to the
Pre-Eminence of the U.S. Dollar?” Bank for In16

ternational Settlements, Working Paper No. 218
(October 2006); and Malcolm D. Knight, “International Reserve Diversiﬁcation and Disclosure,”
speech to the Swiss National Bank/Institute for
International Economics Conference, Zurich, Switzerland (September 8, 2006).
2. Menzie Chinn and Jeﬀrey Frankel. “Will the
Euro Eventually Surpass the Dollar as Leading
International Reserve Currency?” paper presented
at the NBER conference on G7 Current Account
Imbalances: Sustainability and Adjustment, Newport RI, (June 1-2, 2005).

Economic Activity

A Tale of Two Houses
03.05.07
by Ed Nosal and Michael Shenk

Existing Single-Family Homes
Millions of units
7.0

Median sales price

Thousands of dollars
240

6.5

220

6.0

200
Sales

5.5

180

5.0

160

4.5

140

4.0

120

2000

2001

2002

2003

2004

2005

2006

2007

The shaded bar indicates a recession.
Source: National Association of Realtors.

New Single-Family Homes
Thousands of units

Thousands of dollars

1400

280

1300

260
Sales

1200

240

1100

220

1000

200
Median sales price

900

180

800

160

700
2000

140
2001

2002

2003

2004

2005

The shaded bar indicates a recession.
Source: U.S. Department of Commerce, Bureau of the Census.

2006

For those of us waiting patiently to see what is going on in the housing market, January’s numbers
oﬀer more of a headache than a relief. First, existing
single-family home sales increased 3.5 percent in
January, bringing some hope that perhaps the worst
is behind us. Then a day later, we learned that new
single-family home sales fell a whopping 16.6 percent during the same period. What does this imply
for the housing market? A look at some mediumterm trends may help us get a better grasp on what’s
going on.

2007

Even though the housing numbers are seasonally
adjusted, they still tend to be fairly volatile and
are often aﬀected by the weather. This can make it
diﬃcult to pick up an underlying trend by looking
at just a few months’ data. By looking at a threemonth moving average of the data, we are able
to reduce the volatility somewhat without greatly
disturbing the medium-term trend.
When adjusting new and existing single-family
home sales and prices this way, we get very similar patterns. From the end of the last recession to
midway through 2006, we see a fairly rapid increase
in the median price of both types of homes. From
there, prices have ﬂuctuated some but overall have
remained relatively ﬂat. At the same time, sales,
which previously had been increasing along with
17

prices, began to decline. In recent months, the sales
series seem to have bottomed out, and maybe even
have increased a little.

Existing Single-Family Homes
3-Month Moving Average
Millions of units
7.0

Thousands of dollars
240

The good news is that new-home builders have
been able to sell oﬀ inventory in the last six
months, well up through December at least. But
January’s abysmal sales number signiﬁcantly increased inventory. Even though inventory levels
remain high when compared to the current sales
pace, they should be more in line with demand going forward.

Median sales price
6.5

220

6.0

200
Sales

5.5

180

5.0

160

4.5

140

4.0

120

2000

2001

2002

2003

2004

2005

2006

2007

The shaded bar indicates a recession.
Source: National Association of Realtors.

Inventory of New Homes

New Single-Family Homes
3-Month Moving Average
Thousands of units

Thousands of units
Thousands of dollars
280

1400
1300

260

Sales

580

Months’ supply
7.5

570

7.0

560

6.5

550

6.0

540

5.5

1200

240

1100

220

530

5.0

1000

200

520

4.5

900

180

510

4.0

800

160

500

3.5

700

140

2000

Median sales price

2001

2002

2003

2004

2005

2006

490

3.0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan

2007
Source: U.S. Department of Commerce, Bureau of the Census.

The shaded bar indicates a recession.
Source: U.S. Department of Commerce, Bureau of the Census.

Economic Activity

A Mixed Message on Manufacturing
03.05.07
by Tim Dunne and Brent Meyer

ISM: Manufacturing
Index (50+=expansion)*

The recent data on manufacturing paint a mixed
picture of the health of the sector. The industrial
production index for manufacturing in January fell
by 0.7 percent, reﬂecting weakness across a broad
range of industries but with a particularly steep
drop in the motor vehicle sector (-6.0 percent).
On a year-over-year basis, industrial production in
manufacturing expanded by 1.8 percent, whereas
the motor vehicle sector declined by 7.6 percent.

75
70
New orders index
65

Production index

60
55
50

Diffusion index

45
40
2004

2005

*Seasonally adjusted.
Source: Institute for Supply Management.

2006

2007

The advanced report on durable goods showed
a marked decline in new orders in January (-7.8
18

percent), but shipments held steady. Two-thirds
of the decline in new orders is accounted for by
a steep drop in nondefense aircraft orders (-60.3
percent)—a particularly volatile component of the
new orders series. These data also show a relatively
weak performance in the motor vehicle sector, with
declines in shipments and orders in January of 4.4
percent and 5.1 percent, respectively.

Industrial Production: Manufacturing
Index (2002=100)*
120
115
IP manufacturing NAICS

110
105
100

IP motor vehicles and parts

95
90
2004

2005

2006

2007

*Seasonally adjusted.
Source: Federal Reserve Board.

Durable Goods
Millions of dollars*
220000

Millions of dollars*
240000
Shipments
220000

210000

200000

200000
New orders

180000

190000

160000

180000

140000
2004

2005

On the positive side, the ISM report on February
manufacturing activity oﬀers some encouragement. The ISM composite index for manufacturing
registered a rebound in February to 52.3, indicating
an improvement from January’s reading of 49.3.
The ISM uses a diﬀusion index, and a level above
50 indicates that the sector is expanding, while a
value below 50 indicates contraction. Both the new
orders and production components of the index
increased as well in February.
The bottom line is that manufacturing activity was
clearly soft in January, and there is conﬂicting information regarding the future path of manufacturing—the ISM report oﬀers some positive news, but
the new orders information from the durable goods
report suggests some weakness going forward.

170000
2007

2006

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

Economic Activity

Job Creation and Job Destruction
02.26.07
by Tim Dunne and Brent Meyer

Business Employment Dynamics:
Private Sector
Percent of employment
10

Job creation

8
Job destruction

6
4
2

Net change
0
-2
1992

1994

1996

1998

2000

2002

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

2004

The BLS recently reported that job gains in the second quarter of 2006 totaled 6.9 percent of private
sector employment, and job losses came in at 6.5
percent of employment. This represents 7.8 million
jobs created and 7.3 million jobs destroyed in the
quarter. Job creation is measured as the net employment change of establishments that are expanding
employment plus the employment at newly opened
establishments. Job destruction is measured as the
net employment change at establishments that are
reducing employment plus the employment loss
due to establishment closings. The diﬀerence between job creation and job destruction reﬂects the
net change in the number of jobs.
19

The 2001 recession shows both a dip in job creation and a jump in job destruction, resulting in
a net job loss for the private sector. But the net
change in jobs isn’t the only interesting feature of
the BLS employment dynamics series. The degree
of job churning is reﬂected there as well, in the
rates of job creation and job destruction themselves, and in recent years both of those rates have
declined noticeably. This drop in job creation and
destruction rates is part of an ongoing trend documented in a recent paper on job ﬂows by Steven J.
Davis, R. Jason Faberman, and John Haltiwanger.

Excess Reallocation
Percent of employment
20

18
Excess job reallocation
16

10
1992

1994

1996

1998

2000

2002

2004

To summarize the amount of job churning present
in an economy, economists sometimes use a measure called excess job reallocation, which measures
the amount of job creation and job destruction that
occurs above and beyond the adjustment necessary
to account for the net change in jobs. (That is, the
number of net jobs that were added or destroyed
is subtracted from the total number of jobs created
and destroyed.) Excess reallocation in the private
sector held steady through 1990s but has declined
in more recent years.

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

Share of Job Creation and Destruction
in Opening and Closing Establishments
Percent
27
Opening establishments
25
23
21
Closings establishments

19
17
15
1992

1994

1996

1998

2000

2002

2004

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

Excess Reallocation by Industry

Industry

Average excess
reallocation
Average excess Change in
1992:IIIQ-1999:
reallocation
excess
IVQ
2000:IQ-2006:IIQ reallocation

Natural resources and mining

39.1

34.3

Construction

27.0

22.9

-4.1

Manufacturing

9.6

8.2

-1.5

Wholesale trade

12.8

11.5

-1.3

Retail trade

15.4

13.8

-1.5

Transportation and
warehousing

12.9

11.8

-1.1

Utilities

-4.8

5.4

5.7

0.2

Information

12.1

11.0

-1.2

Financial activities

12.4

11.7

-0.7

Professional and business
services

17.4

16.9

-0.5

9.9

8.9

-1.0

16.8

15.8

-1.0

Education and health
services
Other services

Source: Department of Labor, Bureau of Labor Statistics.

The recent decline in excess reallocation occurs
across almost all industry groups and reﬂects an
overall decline in both job creation and job destruction rates. Job reallocation rates vary markedly
across industries, though. The natural resources
and construction industries experience job reallocation rates three to four times as high as those in
the manufacturing or education and health services
industries.
Job reallocation has declined, in part, due to a
disproportionately large fall in job creation and job
destruction in opening and closing establishments.
Although job creation and destruction by opening
and closing establishments typically make up about
21 percent of overall job creation and destruction,
they account for 35 percent of the decline in excess
reallocation that has occurred since 2000.

Economic Activity

Extended Mass Layoﬀs
02.23.07
by Murat Tasci and Cara Stepanczuk

Mass Layoff Activity in the
United States*
Layoffs, thousands
9
Layoffs
8

When 50 or more new claims for unemployment
beneﬁts are received from one establishment in
a given month, government statisticians call it a
mass layoﬀ. If the layoﬀ lasts more than 31 days,
it is designated an extended mass layoﬀ. There
were 1,444 such layoﬀs in the fourth quarter of
2006, according to preliminary estimates from the
Department of Labor’s Bureau of Labor Statistics,
and they caused the separation of 255,886 workers from their jobs. These numbers indicate a slight
increase over the fourth quarter of 2005. Among
those employers who reported extended layoﬀs, 57
percent indicated that they were expecting to recall
some of the workers. This was the lowest proportion for any fourth quarter since 2002.

Millions
1.6
1.4

Separations

1.2
Initial claimants

1.0

0.8

0.6

0.4

0.2
2000

2001

2002

2003

2004

2005

2006

*Data for third and fourth quarters of 2006 are preliminary.
Source: Department of Labor, Bureau of Labor Statistics.

Top Reasons for Layoffs
and Separations
Percent
45
40

The distribution of extended layoﬀs by the size
of the layoﬀ shows an interesting picture, too. A
mere 1.8 percent of the layoﬀs caused almost 20
percent of the separations that occurred in the
fourth quarter of 2006; such layoﬀs were of course
large, each involving more than 1000 separations.
On the other hand, many more mass layoﬀs (42.5
percent) involved fewer workers (50-99); however,
these smaller mass layoﬀs accounted for only 16.8
percent of the total number of worker separations
occurring during the quarter.

Layoffs from contract completion
Layoffs from seasonal work
Separations from seasonal work

Separations from contract
completion

30
25
20
15
10
5
2000

2001

2002

2003

2004

2005

2006

*Data for third and fourth quarters of 2006 are preliminary.
Source: Department of Labor, Bureau of Labor Statistics.

Layoff Activity by Size of Layoff
Regional Shares of Extended Mass Layoffs
Annual average 2000-2006 (percent)
Northeast

Total layoffs

Separations

Initial claims

19.8

18.0

21.1

South

24.3

23.1

23.6

Midwest

31.8

31.6

32.0

West

24.1

27.2

23.3

*Data for third and fourth quarters of 2006 are preliminary.

Source: Department of Labor, Bureau of Labor Statistics.

Extended mass layoﬀs constitute a major source
of job separations, especially during recessions,
when the need for major employment adjustment
is widespread. For instance, both extended mass
layoﬀs and resulting separations peaked in 2001, in
the midst of the most recent recession.
However, extended layoﬀs are not an atypical
feature of a healthy economy. The completion of
seasonal work caused 42 percent of the extended
layoﬀs in the fourth quarter of 2006, generating 45
percent of separations. Contract completion follows seasonal work as a major reason for extended
mass layoﬀs. These two factors, on average, have
accounted for 44 percent of extended mass layoﬀs
and 43 percent of separations annually since 2000.
21

Layoff Activity by Size of Layoff
(October-December 2006)
Layoffs
Size of
layoff

Separations

Number

Percent

Number

Percent

50-99

614

42.5

43,022

16.8

100-149

340

23.5

39,961

15.6

150-199

158

10.9

26,022

10.2

200-299

193

13.4

44,162

17.3

300-499

5.5

28,872

11.3

500-999

2.3

22,826

8.9

1000 or more

1.8

51,021 19.9

19.9

1444

100

255,886

100

Total

*Data for the third and fourth quarters of 2006 are preliminary.

Source: Department of Labor, Bureau of Labor Statistics.

Deviations from this pattern do occur, as in 2001,
when poor economic conditions forced businesses
to initiate mass layoﬀs, and the fraction of extended
mass layoﬀs accounted for by the completion of
seasonal work and contracts declined to 27 percent.
The geographical distribution of extended mass
layoﬀs shows that nearly a third of them (31.8
percent) have occurred in the Midwest since 2000,
causing 31.6 percent of the separations that have
resulted from such events. The Midwest separations were also responsible for 32 percent of all the
U.S. unemployment claims that have been initiated
on account of extended mass layoﬀs. (Initiating
a claim has a very speciﬁc meaning at the Bureau
of Labor Statistics: A person who ﬁles any notice
of unemployment to initiate a request either for a
determination of entitlement to and eligibility for
compensation, or for a subsequent period of unemployment within a beneﬁt year or period of eligibility is deﬁned as Initial claimant.)

Economic Activity

Is Manufacturing Going the Way of Agriculture?
02.15.07
by Ed Nosal and Michael Shenk
Average Monthly Job Growth
Thousands of workers
200

2006
2000-2006

175
150
125
100
75
50

Goods producing
ex manufacturing Manufacturing

25
0
-25

Total

Services

-50
Source: U.S. Department of Labor, Bureau of Labor Statistics.

On average, employment increased by 186,917
workers each month in 2006. The vast majority
of this employment growth came from the service
sector; manufacturing registered a small monthly
decline, while the remainder of the goods-producing sector experienced a small increase. The total
employment numbers for 2006 seem to dwarf
the average monthly job growth seen since the
start of this century. The average numbers for the
2000-2006 period are “small” owing to the March
2001-November 2001 recession and the so-called
jobless recovery which followed, where employment growth actually remained negative for nine of
the ﬁrst ten months after the recession’s oﬃcial end.
Since the beginning of 2000, the loss in manufacturing jobs has been signiﬁcant, averaging 37,524
per month.
The sluggish growth in manufacturing employment, however, is not a recent phenomenon. The
level of employment in manufacturing today is
22

Manufacturing Employment
Millions of workers
25

0
1947 1953 1959 1965 1971 1977 1983 1989 1995 2001
Source: U.S. Department of Labor, Bureau of Labor Statistics.

Agriculture Industry
Employment and Output
Percent
40
35
30

about the same as it was in 1947, while the U.S.
population has more than doubled over the same
period. Employment in manufacturing did experience growth during the 1960s; after that, employment growth was essentially zero until 2000, after
which it became negative.
Because the population and, hence, the labor force
has grown, the share of manufacturing employment
(to total employment) has been steadily falling
since the Korean War. Approximately one in every
three workers was employed in manufacturing after
the Second World War; today, that number is about
one in ten. Although the share of manufacturing
employment has steadily fallen over time, the share
of manufacturing output (to total output) has been
remarkably stable over the same period. Labor productivity growth in manufacturing over this period
can explain the falling employment share and the
constant output share.

25
20
Employment*
15
10
5

Output
0
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
*Percent of the labor force in agriculture as reported in the census.
Sources: U.S. Department of Commerce, Bureau of the Census Bureau;
Bureau of Economic Analysis; University of Minnesota, Minnesota Population
Center, Integrated Public Use Microdata Series (IPUMS-US).

Real Manufacturing Output and
Employment

Changes in manufacturing employment during
that last half of the twentieth century are remarkably similar to those in agriculture during the ﬁrst
half of the twentieth century. About a third of U.S.
workers were employed in agriculture at the beginning of the century, but by 1950 that number was
only a tenth. As with manufacturing, agriculture’s
share of employment consistently fell from 1947
into the 1980s, at which point it leveled oﬀ, but its
share of output remained relatively constant.

Percent
35
30
25

Manufacturing employment

20
15
10

Manufacturing output

5
0
1947 1953 1959 1965 1971 1977 1983 1989 1995 2001
Source: Bureau of Economic Analysis; Bureau of Labor Statistics.

Economic Activity

The Budget and Economic Outlook
02.09.07
by David E. Altig and Brent Meyer

Total Revenues and Outlays
1967–2017
Percent of GDP
26

Projected
Outlays

24
Surpluses
22
20
18
Revenues

Deficits
14
1967

1977

1987

1997

2007

Source: Congressional Budget Office, The Budget and Economic Outlook:
Fiscal Years 2008 to 2017.

Alternative Policy Assumptions:
Discretionary Appropriations
Percent of GDP
6

Projected

Freeze
appropriations at
2007 level

Total
deficit/surplus
baseline

2
0

Increase appropriations at
nominal GDP growth rate

-2
-4
1997

2000

2003

2006

2009

2012

2015

Source: Congressional Budget Office, The Budget and Economic Outlook:
Fiscal Years 2008 to 2017.

2017

This week President Bush released his proposal for
government spending, taxation, and borrowing for
ﬁscal years 2008-2017. Congress will now have its
say, and the ﬁnal fate of those proposals awaits the
outcome of the political push and pull that deﬁnes
our democracy. As part of that process, the Congressional Budget Oﬃce (CBO) will eventually
provide projections of the budgetary impact of the
president’s proposals, as well as the budget resolutions that eventually clear Congress. But we can get
some preliminary hints by looking at some of the
CBO’s baseline estimates, released on January 24,
of what things look like under current law.
“Current law,” of course, is not a completely unambiguous concept. Certain expenditures—classiﬁed
as “discretionary,” and accounting for roughly 40
percent of all federal spending—must be approved
annually, so the CBO has to make some assumption about how spending in that category will grow.
Because discretionary spending includes defense
and security-related outlays, this is particularly difﬁcult in the current environment. Following past
practice (which was previously mandated by law),
the CBO’s baseline projections assume that discretionary spending grows at the rate of inﬂation after
the current ﬁscal year (2007):
In fact, the president’s budget proposal calls for an
average annual growth rate in total discretionary
spending of just over 3 percent from 2007 through
2012, versus the 1.8 percent annual inﬂation rate
assumed by the CBO (measured by the chainweighted gross domestic product price index).
To get an idea of what diﬀerence this makes, we can
look to the CBO’s projections of the government’s
surplus under the alternative assumptions that discretionary spending is frozen at 2007 levels or that
discretionary spending grows at the rate of nominal
gross domestic product (GDP):
Mandatory spending—which includes Social Security, Medicare, and Medicaid expenditures—is, of
24

course, the bigger part of the spending picture. And
it is getting bigger:

Alternative Policy Assumptions:
Tax Code Policy Changes
Percent of GDP
6

Projected

Extend EGTRRA
and JGTRRA
plus interactive
effect with
indexing AMT

Total
deficit/surplus
baseline

2
0
-2

Index AMT
for inflation
-4
1997

2000

2003

2006

2009

Extend EGTRRA
and JGTRRA

2012

2015

Source: Congressional Budget Office, The Budget and Economic Outlook:
Fiscal Years 2008 to 2017.

Federal Outlays by Category
1967-2017
Percent of total spending
100
Net Interest

Projected

80
60

Discretionary

40
20

Mandatory

0
1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 2017
Source: Congressional Budget Office, The Budget and Economic Outlook:
Fiscal Years 2008 to 2017.

The president’s budget proposal includes several
suggested reforms to mandatory spending programs, but they are designed to have most of their
impact beyond the ten-year horizon of the CBO
analysis: According to the Oﬃce of Management
and Budget (OMB), outlays on entitlement programs will be, under baseline assumptions, about
12 percent of GDP if the president’s proposals are
enacted, and 12.3 percent if they are not. The effects are, of course, much bigger in later decades,
when imbalances between expenditures and funding for these programs become more pronounced.
(See, for example, part II of the OMB’s Analytical
Perspectives, Budget of the United States Government, Fiscal Year 2008.)
The ﬁnal piece of the puzzle is on the revenue side,
and here the story gets a little trickier. The CBO’s
“current law” assumption includes the expiration
of tax cuts that were enacted in the Economic
Growth and Tax Relief Reconciliation Act of 2001
(EGTRRA) and the Jobs Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). In addition, it
does not assume relief for the increasing number of
taxpayers that are aﬀected by the Alternative Minimum Tax (AMT). There is fairly broad support for
reforming the AMT provisions, and the president’s
proposals would extend the major provisions of his
major earlier tax legislation. How much diﬀerence
does would that make? Again, the CBO provides a
glimpse:
These changes in the baseline tax assumptions
would, according the CBO’s analysis, eventually
convert a surplus of about 1.2 percent of GDP to a
deﬁcit of about 0.8 percent of GDP. We will leave it
to you to decide whether that is a big deal, or not.

Regional Activity

Regional Patenting Activity
03.08.07
by Brian Rudick and Mark Schweitzer

Utility Patents
Thousands
7

Thousands
90
80

5
Fourth District
4

50
40

2
U.S.

1
0
1975

20
1980

1985

1990

1995

2000

Sources: U.S. Department of Commerce, U. S. Patent and Trademark Office;
Cleveland State University, Center for Economic Development; and authors’
calculations.

Patenting in the Fourth District
Over the past 30 years, patenting activity in the
Fourth District has remained fairly steady; only 9
percent more patents were issued in 2003 than in
1975. By contrast, in the United States as a whole,
90 percent more utility patents were issued in 2003
than in 1975.

Patents per Capita
Patents, per million people
350
300
250
Fourth District
200
U.S.

150

In our Annual Report of last year, we reported
evidence that innovation is extremely important for
state economic development and that patenting activity can help explain diﬀerences in state per capita
incomes. Undoubtedly, patenting activity is important for the economic development of smaller areas
as well. Here we examine patenting activity in the
Fourth District and its metropolitan areas. (Note
that a patent’s origin is based on the inventor’s residence, not the company’s location.)

100
1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005
Sources: U.S. Department of Commerce, U. S. Patent and Trademark Office;
Cleveland State University, Center for Economic Development; and authors’
calculations.

Top Patenting Industries, 1999-2003
Description

Total district
patents

Professional and scientific instruments (38, except 3825)

3,813

Rubber and miscellaneous plastics products (30)

3,104

Fabricated metal products (34, except 3461, 3463, and
348)

3,041

General industrial machinery and equipment (356)

2,337

Electronic components and accessories and communications equipment (366, 367)

2,016

Note: Numbers in parentheses are SIC codes for the industry.

Sources: U.S. Department of Commerce, U. S. Patent and Trademark Office;
Cleveland State University, Center for Economic Development; and authors’
calculations.

The greater growth in U.S. patenting activity is
partly explained, however, by higher population
growth. If we look at the number of patents issued
on a per capita basis, we see that the District no
longer maintains the edge in per capita patent production that it had in 1975, but that the region still
produces about as many patents per million people
as the United States as a whole. From 1975 to
2003, per capita patents in the region grew 5 percent, to 286 patents per million people, compared
to 299 patents per million people for the nation.
In the last ﬁve years, the District has produced over
3,000 patents, which can be used in three industries: professional and scientiﬁc instruments, rubber
and miscellaneous plastics products, and fabricated
metal products. The District also produces a large
number of patents that have applications in industrial machinery and electronic components.
The industries for which the District produces the
most patents are not necessarily those in which
the District specializes. Over the past ﬁve years,
the District has produced over one-ﬁfth of all U.S.
26

District Industry’s Share of Patents, 1999-2003
Percent of
U.S. patents

Description
Railroad equipment (374)

21.1

Soaps, detergents, cleaners, perfumes, cosmetics, and toiletries
(284)

19.2

Primary ferrous products (331, 332, 3399, 3462)

18.4

Paints, varnishes, lacquers, enamels, and allied products (285)

18.4

Primary and secondary nonferrous metals (333-336, 3463, 339,
except 3399)

17.2

Note: Numbers in parentheses are SIC codes for the industry.

Sources: U.S. Department of Commerce, U. S. Patent and Trademark Office;
Cleveland State University, Center for Economic Development; and authors’
calculations.

Top Patenting Organizations by MSA,
1999-2003

MSA
rank

Cleveland

Cincinnati

Columbus

Pittsburgh

General Electric
(172)

Proctor and
Gamble (1,640)

Owens-Corning
Fiberglass (186)

PPG Industries
Ohio (338)

Lubrizol (149)

General Electric
(879)

Abbott Laboratories
(109)

Eaton (234)

Goodyear (100)

Ethicon EndoSurgery (170)

Arthrocare (69)

Alcoa (160)

patents relating to railroad equipment, with Delphi, Westinghouse Air Brake, and General Electric
leading the charge. The District also produces a
high concentration of patents that can be used for
household products (Proctor and Gamble, Steris),
paints and allied products (Goodyear, Bridgestone)
and metals (GE, Alcoa).
Patenting in District MSAs
Patenting activity at the metropolitan level varied
considerably. Columbus produces fewer patents
per million people than does the United States as a
whole. However, Cincinnati produces almost twice
as many patents per million people than the United
States. In general, per capita patenting activity has
been trending upward in the four District MSAs
since the early 1980s.
Similar to the District, the four largest MSAs all
have a large share of patents that can be used in
the professional and scientiﬁc instruments industry. Many patents are also produced for use in the
fabricated metals and rubber products industries.
Pittsburgh produces a considerable share (7.8
percent) of its patents for use in the electronics and
communications equipment industry.

Note: Number in parentheses is total utility patents for time period.
Sources: U.S. Department of Commerce, U. S. Patent and Trademark Office; and
authors’ calculations.

Top Patenting Industries by MSA,
1999-2003

Patents per Capita by MSA
Patents, per million people
600

MSA
rank
1

Cincinnati

Cleveland

Cincinnati

Columbus

Pittsburgh

Professional and Professional and Professional and Professional and
scientific instru- scientific instru- scientific instru- scientific instruments (11.1)
ments (12.2)
ments (11.7)
ments (11.3)
Fabricated metal Fabricated metal Rubber and
products (8.6)
products (7.6)
miscellaneous
plastics products
(8.7)
Rubber and
miscellaneous
plastics products
(8.6)

General industrial machinery
and equipment
(6.9)

Electronic
components and
accessories and
communications
equipment (7.8)

Fabricated metal Rubber and
products (7.7)
miscellaneous
plastics products
(7.7)

Cleveland
400
Pittsburgh

Columbus

200
U.S.

0
1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005
Sources: U.S. Department of Commerce, U. S. Patent and Trademark Office;
Cleveland State University, Center for Economic Development; and authors’
calculations.

Note: Number in parentheses is percent of total MSA patents during the time
period.

Sources: U.S. Department of Commerce, U. S. Patent and Trademark Office; Cleveland
State University, Center for Economic Development; and authors’ calculations.
27

Regional Activity

The Metal Working Industry
02.15.07
by Paul Bauer and Bethany Tinlin
Metal working has long been an important industry in the Fourth District. The ﬁrst blast furnace
west of the Allegheny Mountains opened in 1802
near Youngstown, and by 1880, 28 percent of
Cleveland’s workforce found employment in its
steel mills. Although the industry has undergone
substantial restructuring and lost some of its importance over the years, it maintains a signiﬁcant
economic presence in the District.

Real Wages in the Metal Industries
Real wages per hour, dollars

20
Ohio

19
Pennsylvania

U.S. total

16
1993

1995

1998

2001

2003

*Prior to 1997, data represent SIC Primary Metal Industries. After 1997, data
represent NAICS Primary Metal Manufacturing.
Source: U.S. Department of Commerce, Bureau of Economic Analysis, Survey of
Manufactures; and GDP price deflator.

Production Workers in Metal Industries
Number, thousands
120

Number, thousands
600

110
550
U.S. total

100

500

90
80

450

Ohio

70
60

400

50
350
Pennsylvania

40
30

300
1993

1995

1997

1999

2001

2003

2005

Most of the District’s primary metals industry is
located in Ohio and Pennsylvania. As recently as
1995, the industry employed 66,600 in Ohio, but
according to the most recent Census of Manufacturing, employment had fallen to 38,483 by 2005,
a drop of over 42 percent. Pennsylvania’s employment in the industry fared slightly better, dropping
from 55,600 in 1995 to 34,522 in 2005, a little less
than a 38 percent drop.
Despite plunging employment, the value of shipments has held up better, thanks to productivity
gains and a sharp rise in prices that began at the
outset of 2004. Output from 1995 to 2005 declined only 2.5 percent in Pennsylvania and 11.1
percent in Ohio. Nationally, shipment values fell
8.5 percent.
The surging international demand for steel, led in
part by China and India’s booming economies, has
changed the pricing dynamics of the industry. From
1980 to 2004, the real price of steel mill products
ﬂuctuated in a relatively narrow range, but from
the end of 2003 to the end of 2006 the real price
of those products rose about 59.8 percent. Not
surprisingly, the ﬁnancial health of U.S. steel producers, as measured by their share prices, increased
dramatically.
Workers in the industry have shared in some of
these gains. Real wages increased 10.3 percent and
7.0 percent in Ohio and Pennsylvania, respectively,
from 1995 to 2005. However, because fewer people
28

are employed in the industry, overall earnings are
still down in Ohio. In contrast, earnings in Pennsylvania have nearly reached their 2000 peak.

Value of Shipments
Real dollars, millions
24

Real dollars, millions
260

Producer Price Index:
Steel Mill Products
Index, 1982 = 100
200

240
Ohio

180

220
Pennsylvania

160

200

180

140

160

120

140

U.S. total

100

120

1993

1995

1997

1999

2001

2003

2005

80
1980

1984

1988

1992

1996

2000

2004

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

Banking and Financial Institutions

A Close Look at Fourth District Community Banks
02.23.07
by O. Emre Ergungor and Cara Stepanczuk

Annual Asset Growth

Most of the 293 banks headquartered in the Fourth
District as of December 31, 2006, are community
banks—commercial banks with less than $1 billion
in total assets. There are 269 such banks headquartered in the District today, a number that, as
a result of bank mergers, has declined since 1998,
when there were 337.

Percent
5.0
4.0
3.0
2.0
1.0
0.0
-1.0
-2.0
-3.0
-4.0
-5.0
-6.0
1999

2000

2001

2002 2003

2004

2005

2006

Source: Authors’ calculation from Federal Financial Institutions
Examination Council, Quarterly Banking Reports of Condition and Income,
Fourth Quarter 2006.

Community banking assets declined most severely
in 2000 and 2004, which does not necessarily mean
that any banks closed shop or left the district. A
bank may disappear from our radar because it is
acquired by an out-of-state bank holding company
(which could change which Federal Reserve district
the bank and branch oﬃces belong to) or because it
merges with another Fourth District bank and the
total assets of the merged institution push it above
the $1 billion cutoﬀ.
29

The structure of the market with respect to asset
size has also changed since 2000. Before then, most
Fourth District community banks had less than
$100 million in total assets, but since then, banks
in the $100 million to $500 million category have
constituted the majority.

Fourth District Community Banks
by Asset Size
Number of community banks
200
Assets < $100 million
Assets $100 million – $500 million
Assets $500 million – $1 billion

175
150
125
100
75
50
25
0
1998

1999

2000

2001

2002

2003

2004

2005

2006

Source: Authors’ calculation from Federal Financial Institutions
Examination Council, Quarterly Banking Reports of Condition and Income,
Fourth Quarter 2006.

Income Stream
Percent

Percent of assets
1

5.0
4.5
Net interest margin

0.9

4.0
3.5

0.8

3.0
2.5

0.7

Income earned
but not received

ROA before tax and
2.0 extraordinary items

0.6

1.5
1.0

0.5

0.5
0.0

0.4
1998

1999

2000

2001

2002

2003

2004

2005

2006

Source: Authors’ calculation from Federal Financial Institutions
Examination Council, Quarterly Banking Reports of Condition and Income,
Fourth Quarter 2006.

Percent of assets
52
Real estate loans
42

Consumer loans
Mortgage-backed securities
Commercial loans
1998

1999

2000

2001

2002

2003

2004

2005

Source: Authors’ calculation from Federal Financial Institutions
Examination Council, Quarterly Banking Reports of Condition and Income,
Fourth Quarter 2006.

One issue which may become a cause for concern
in the future is the elevated level of income earned
but not received; at 0.63 percent in 2006, this
measure was at its highest since 2001. If a loan
agreement allows a borrower to pay an amount that
does not cover the interest accrued on the loan,
the uncollected interest is booked as income even
though there is no cash inﬂow. The assumption
is that the unpaid interest will eventually be paid
before the loan matures. However, if an economic
slowdown forces an unusually large number of borrowers to default on their loans, the bank’s capital
may be impaired unexpectedly.
Fourth District community banks are heavily
engaged in real-estate-related lending. At the end
of 2006, 51 percent of their assets were in loans
secured by real estate. Including mortgage-backedsecurities, the share of real-estate-related assets on
their balance sheets was 57.6 percent.

Balance Sheet Composition

The income streams of Fourth District community banks have shown some slight deterioration
in recent years. Return on assets (ROA) deteriorated from 1.7 percent in 1998 to 1.3 percent in
2006. (ROA is measured by income before tax and
extraordinary items, because one bank’s extraordinary items distort the averages in some years.)
The decline in ROA is due in part to weakening
net interest margins (interest income minus interest expense divided by earning assets). Currently at
3.68 percent, the net interest margin is at its lowest
level in eight years.

2006

Fourth District community banks ﬁnance their assets primarily through time deposits (76 percent of
total liabilities). Brokered deposits—a riskier type
of deposit for banks because it chases higher yields
and is not a dependable source of funding—are
seldom used. Federal Home Loan Bank (FHLB)
advances are loans from the FHLBs, which are
collateralized by banks’ small business loans and
home mortgages. Although they have gained some
30

popularity in recent years, FHLB advances are still
a small fraction of community banks’ liabilities (7.1
percent of total liabilities).

Liabilities
Percent of liabilities
90
Total time deposits

80
70
60
50
40
30
FHLB advances

a,b
Total demand deposits

10
0

Total brokered deposits
1998 1999 2000 2001 2002 2003 2004 2005 2006

a. Federal Home Loan Bank advances.
b. Data start in 2001.
Source: Authors’ calculation from Federal Financial Institutions Examination Council,
Quarterly Banking Reports of Condition and Income, Fourth Quarter 2006.

Problem Loans
Percent of loans

Problem loans include loans that are past due for
more than 90 days but are still receiving interest
payments as well as loans that are no longer accruing interest. Problem commercial loans rose sharply
in 2001 but returned to 1998-2000 levels in recent
years, thanks to the strong economy. Currently,
2.15 percent of all commercial loans are problem loans. Problem real estate loans are only 1.16
percent of all outstanding real-estate-related loans
but are at their highest level since 1998. Problem
consumer loans continued their decline in 2006.
Currently, 0.45 percent of all outstanding consumer loans (credit cards, installment loans, etc.)
are problem loans.

5.0
4.5
4.0

Commercial loans

3.5
3.0
2.5
2.0
1.5

Real estate loans

1.0

Consumer loans

0.5
0.0
1998

1999

2000

2001

2002

2003

2004

2005

2006

Source: Authors’ calculation from Federal Financial Institutions Examination Council,
Quarterly Banking Reports of Condition and Income, Fourth Quarter 2006.

Net charge-oﬀs are loans that are removed from the
balance sheet because they are deemed unrecoverable minus the loans that were deemed unrecoverable in the past but are recovered in the current
year. As with problem loans, net charge-oﬀs of
commercial loans increased sharply in 2001 and
2002. A similar but less pronounced trend is visible
in consumer loans. Fortunately, charge-oﬀ levels
have returned to their prerecession levels in recent
years. Net charge-oﬀs in 2006:IVQ were limited to
0.78 percent of outstanding commercial loans, 0.63
percent of outstanding consumer loans, and 0.08
percent of outstanding real estate loans.
Capital is a bank’s cushion against unexpected
losses. Recent trends in capital ratios indicate that
Fourth District community banks are protected by
a large cushion. The leverage ratio (balance sheet
capital over total assets) was above 10 percent, and
the risk-based capital ratio (a ratio determined by
assigning a larger capital charge on riskier assets)
was above 10.5 percent at the end of 2006. The
growing ratios are signs of strength for community
banks.

Net Charge-offs
Percent of loans
4.0
3.5
3.0
Commercial loans
2.5
2.0
1.5
Consumer loans
1.0
0.5

Real estate loans

0.0
1998

1999

2000

2001

2002

2003

2004

2005

2006

Source: Authors’ calculation from Federal Financial Institutions Examination Council,
Quarterly Banking Reports of Condition and Income, Fourth Quarter 2006.

An alternative measure of balance sheet strength is
the coverage ratio. The coverage ratio measures the
size of a bank’s capital and loan loss reserves relative to its problem assets. As of 2006:IVQ, Fourth
District community banks had $15 in capital and
reserves for each dollar of problem assets. While the
31

coverage ratio declined considerably following the
high charge-oﬀ periods of the early 2000s, balance
sheets are still strong.

Capitalization
Percent
12.0
11.5
11.0

Risk-based capital ratio

10.5
10.0
Leverage ratio
9.5
9.0
8.5
8.0
1998

1999

2000

2001

2002

2003

2004

2005

2006

Source: Authors’ calculation from Federal Financial Institutions Examination Council,
Quarterly Banking Reports of Condition and Income, Fourth Quarter 2006.

Coverage Ratio*
Dollars
25

0
1998 1999 2000 2001 2002 2003 2004 2005 2006
*Ratio of capital and loan loss reserves to problem assets.
Source: Authors’ calculation from Federal Financial Institutions Examination
Council, Quarterly Banking Reports of Condition and Income, Fourth Quarter
2006.

Full text of Economic Trends (Federal Reserve Bank of Cleveland) : Economic Trends - March 2007

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