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1 • • • • • • • The Economy in Perspective FRB Cleveland • May 2000 Once upon a time . . . there lived a grasshopper named Lucky and an ant named Ernest. Like his ancestors, Lucky loved to live in the moment and rarely thought about tomorrow. Ernest, following his ancestral traditions, kept his nose to the grindstone and his eye on the future. Despite their differences, the two were the best of friends. By day, Lucky was a manufacturer’s rep for a pet-food company; on weekends, he played acoustic fiddle around town with a band called the Manic Mantises. The pay was lousy, but the bug juice was on the house. Ernest had worked for years as a mechanical engineer for an antcolony design firm. In his spare time, he gardened and read books on human psychology. The two friends met one evening at the Night Crawler, a local hangout. After gossiping a while about the ladybugs and lounge lizards on the scene, they settled into more serious conversation. “Lucky, “ Ernest said, “I’m worried about you. How long can you go on like this, jumping from one job to the next? I used to be afraid that you wouldn’t get through the winter, but now I’m even more worried that you aren’t storing up any food for your old age. When you drove up to the Crawler in that new Alpha Rodeo Spyder tonight, I knew you’d really gone buggy!” Lucky grinned. “Ernie,” he said affectionately, “You are such a pest! First off, I got a great deal on those wheels from Arachnid Motors: nothing down and only one saltine a month for 84 months. Besides, I can afford it—my investments have been doing great. My Manic Mantis buddies put me onto this start-up company that invented a new food-recognition system. You put these drops in your eyes and you can actually see the food through walls and stuff. It’s awesome! I gave the termites who invented it two grams of wood shavings so they could spend all their time perfecting the drops. They’ll sell the drops for one saltine per dram, and I get a share of everything they rake in. And then there’s a research team of carpenter ants who think they’ve discovered a way to neutralize Raid; I gave them three grams of peanut butter for a share of all the saltines they get. Pretty soon I’ll be in clover and I can quit my day job! But hey, Ernie, you should know about all these new inventions, being an engineer yourself.” “I already know more than I want to. You should see what’s going on at my shop. We are prototyping a new colony design that provides more space and better security and can be built by fewer ants in less time than the conventional model. What’s more, we think the technology will transfer to beehives. Queen bees are shipping us honey like you wouldn’t believe, just for an opportunity to invest! The first colony won’t go live for years, if ever. These ladies could be stung deep, but when there’s a big buzz for the next new thing, they won’t listen to reason. I’m telling you, Lucky, I’m in the eye of this swarm and I don’t like what I see.” Lucky looked bug-eyed at his friend and replied, “Get with the program, Ernesto, it’s a nolose proposition! You can have your cake and eat it too. Just buy everything on credit, which is a snap to get because you have all these saltines coming to you down the road. You can enjoy life today and tomorrow! All the herbivores are doing it.” As sure as larvae become pupae, Ernest knew what would become of Lucky. “All I can tell you, my friend, is don’t count your crackers.” Months passed. One night, Ernest sat nursing a tall cool one at the Crawler when Lucky sauntered in, a ladybug on each arm and a fat ryegrass cigar in his mandible. “Wheatgrass shakes all around!” he called to the bartender. Seeing his old friend, Lucky hopped over and sat down. “You look like a million saltines!” exclaimed Ernest. “I guess that new eye-drop system really panned out. Or was it the Raid neutralizer?” “Ernie, all those schemes went bust. But my investments were structured as limited partnerships and, after court-supervised reorganization, I landed on my hind legs every time. Then I hit on another business plan. I knew this Internet thing was going to be huge for bugs, and there had to be a way to cash in big time. Then it came to me! Investors want to be sure that advertisers will bankroll the sites, and advertisers want the sites to attract lots of eyes. So I developed sites for compound eyes — you know how insects can see multiple images simultaneously. And I’m working on an infrared site for the honeybees. I got financing from a group of locusts who’ll wait another 17 years for a payback! What a stroke of genius, borrowing from that swarm! Needless to say, I expect the saltines will soon start pouring in.” Morals: Never consume tomorrow what you can consume today. A fool and her honey are soon parted. If at first you don’t suceed, reorganize, borrow, and try again. 2 • • • • • • • Monetary Policy Percent, weekly average 6.25 RESERVE MARKET RATES Percent 6.75 IMPLIED YIELDS ON FEDERAL FUNDS FUTURES April 3, 2000 6.00 Effective federal funds rate 5.75 April 26, 2000 6.50 Intended federal funds rate March 1, 2000 6.25 5.50 February 1, 2000 5.25 6.00 Discount rate 5.00 5.75 4.75 January 3, 2000 5.50 4.50 4.25 1996 1998 1997 1999 Billions of dollars 560 CURRENCY 540 520 500 5.25 January 2000 5% 4.7 4.5 10% 1% 3 0 1% 4.3 10% 5% 4.1 5% 10% 5% M2 growth, 1995–2000 a 9 5% 5% 440 October 6 480 460 July Trillions of dollars 4.9 THE M2 AGGREGATE 10% Currency growth, 1995–2000 a 12 10 8 6 4 2 0 April 1% 420 5% 3.9 5% 400 1% 380 3.7 1997 1998 1999 2000 1997 1998 1999 2000 FRB Cleveland • May 2000 a. Growth rates are percentage rates calculated on a fourth-quarter over fourth-quarter basis. The 2000 growth rates for currency and M2 are calculated on an estimated April over 1999:IVQ basis. NOTE: Data are seasonally adjusted. Last plots for currency and M2 are estimated for April 2000. Dotted lines for M2 are FOMC-determined provisional ranges. All other lines represent growth in levels and are for reference only. SOURCES: Board of Governors of the Federal Reserve System; and Chicago Board of Trade. The intended federal funds rate has been at 6.0% since the March 21 meeting of the Federal Open Market Committee (FOMC). Similarly, the discount rates at which banks can borrow balances from the Federal Reserve Banks’ discount windows all remain at 5.5%. The next FOMC meeting will be held May 16. Implied yields on federal funds futures reveal that market participants continue to price in an increase of at least 25 basis points (bp) at the May meeting. Although the implied yield curve drifted downward in mid-April, the subse- quent increase suggests that market participants now consider it more likely that increases in the intended rate will occur later in the year. Surprisingly, yields on fed funds futures did not seem to react to the April 14 announcement of stronger-thanexpected increases in the consumer price index (CPI). Surging currency growth, driven by liquidity preparations for Y2K, received considerable attention at the end of last year. After the century date change came and went without a hitch, currency levels fell as liquidity drained out of the system. The use of fourth-quarter averages to calculate growth rates obscures the full extent of the acceleration and subsequent drop in these rates. It may be more revealing to consider instead the growth rate for December 1999 over December 1998 (12.2%) and the annualized rate for April 2000 over December 1999 (2.7%). Growth rates of the broader monetary aggregates (M2 and M3) appear to have accelerated recently. However, interpreting monetary aggregates in April is always fraught with difficulty, but especially so (continued on next page) 3 • • • • • • • Monetary Policy (cont.) Trillions of dollars 6.8 THE M3 AGGREGATE 5% M3 growth, 1995–2000 a 12 6.4 1% Billions of dollars 1,050 COMMERCIAL AND INDUSTRIAL LOANS 1,000 9 9 5% 6 6 950 3 6.0 C&I loan growth, 1995–2000 a 12 1% 3 0 0 900 5% 5.6 850 1% 5% 5.2 800 1% 750 4.8 1997 1998 1999 Percent, weekly average 6.75 SHORT-TERM INTEREST RATES 1998 1997 2000 1999 2000 Ratio 9 Percent, weekly average 9 LONG-TERM INTEREST RATES Conventional mortgage 6.25 1-year T-bill b 8 8 7 7 5.75 5.25 10-year Treasury b 3-month T-bill b 6 6 5 5 4.75 4.25 Earnings yield (E/P), one year forward 3.75 1996 1997 1998 1999 2000 4 1996 4 1997 1998 1999 2000 FRB Cleveland • May 2000 a. Growth rates are percentage rates calculated on a fourth-quarter over fourth-quarter basis. The 2000 growth rate for M3 is calculated on an estimated April over 1999:IVQ basis. The 2000 growth rate for C&I loans is calculated on a March over 1999:IVQ basis. b. Constant maturity. NOTE: Data are seasonally adjusted. Last plot for M3 is estimated for April 2000. Last plot for C&I loans is March 1999. Dotted lines for M3 are FOMCdetermined provisional ranges. SOURCES: Board of Governors of the Federal Reserve System; and I/B/E/S International Inc. following high year-end capital gains. Such gains typically result in large April tax payments, causing M2 to swell above seasonal levels. These increases are reversed as payments are processed and credited to the U.S. Treasury account (not included in the monetary aggregates). Because the M2 increase is transitory, it is not seen as inflationary. Strong M3 growth, coupled with steady growth in the narrower monetary aggregates, can often be explained by heavy demand for commercial and industrial (C&I) loans. Banks often finance these loans by issuing large-dollar-value certificates of deposit, which are counted in M3 but not in M2. Year-to-date M3 growth is estimated at 8.8% for April (compared to 7.4% in 1999). Through March, year-to-date growth in C&I loans had reached 10.4% (4.9% in 1999). One often-overlooked consequence of higher productivity is a higher real interest rate. As productivity increases, more investment projects become profitable and greater investment demand puts upward pressure on interest rates. This view provides an alternative to the commonly told story that the FOMC is using the interest rate as a “brake” to slow an overheating economy. Instead, market rates rise naturally and the FOMC must increase the intended federal funds rate in response. Since summer 1998, the FOMC has raised the intended rate 125 bp. During the same period, 3month and 1-year T-bills have risen 123 bp and 150 bp, respectively. Long-term interest rates show a similar pattern, although the wellpublicized budget issues surrounding both the issuance and buy-back (continued on next page) 4 • • • • • • • Monetary Policy (cont.) Index a 5,000 STOCK MARKET INDEXES Dollars per share 80 PRICE-TO-EARNINGS RATIO NASDAQ S&P 500, technology sector 4,000 65 3,000 50 2,000 S&P 500 35 1,000 S&P 500 20 Jan. April July 1998 Oct. Jan. April July 1999 Oct. Jan. April 2000 Billions of dollars 300 DEBIT BALANCES IN MARGIN ACCOUNTS 0 Jan. April July 1998 Oct. Jan. April July 1999 Oct. Jan. Billions of dollars 510 LOANS IN BANK CREDIT April 2000 Billions of dollars 118 AT BROKERS AND DEALERS 270 114 502 240 Consumer 210 110 494 106 180 486 102 Revolving home equity 150 120 Jan. April July 1998 Oct. Jan. April July 1999 Oct. Jan. April 2000 478 Jan. 98 April July 1998 Oct. Jan. April July 1999 Oct. Jan. April 2000 FRB Cleveland • May 2000 a. The S&P 500 Index was developed with a base level of 10 for the 1941–43 base period. The NASDAQ is indexed to 250 on February 1, 1985. SOURCES: Bloomberg Financial Information Services; and New York Stock Exchange. of long-term government debt have recently affected yields—most notably on the 30-year Treasury. Over the past two years, the stock market has produced stellar returns, primarily through price appreciation. These gains came on top of a market value that had already raised concerns about irrational exuberance. Unlike the earlier advance, this one lacked breadth. Indeed, in 1999 the majority of stocks declined in value. This phenomenon is often characterized as a bifurcation between oldand new-economy stocks. Neweconomy stocks are comprised largely of companies whose values reflect the promise that cutting-edge technology holds for future profits. Their price-to-earnings ratios tend to be high because their prices factor in higher earnings growth in outlying years. Moreover, new-economy firms typically pay small or no current dividends because internal investment opportunities are so good. This so-called bifurcation is evident in the difference between the levels of the NASDAQ and S&P 500 indexes. The NASDAQ reflects the phenomenon more clearly because it has a higher concentration of new- economy stocks than does the more broadly based S&P 500. Concerns about a speculative bubble were fueled last fall when the NASDAQ accelerated sharply, particularly because this last spurt coincided with a sharp increase in margin-account borrowing. Margin accounts allow investors to leverage—that is, to finance an investment by borrowing at an interest rate that is lower than the yield anticipated from that investment. Some analysts point to the surges in consumer and home equity loans (continued on next page) 5 • • • • • • • Monetary Policy (cont.) Ratio 120 STOCK INDEX VOLATILITY a Percent 1.7 S&P 500 DIVIDEND YIELD 100 1.6 80 1.5 1.4 60 NASDAQ 1.3 40 1.2 20 S&P 500 0 Jan. April July 1998 Oct. Jan. April July 1999 Oct. Jan. April 2000 1.1 Jan. April July 1998 Oct. Jan. April July 1999 Index, January 1994 = 100 400 EUROPEAN MARKET INDEXES Index, January 1994 = 100 350 DEVELOPING ECONOMY INDEXES 350 300 Oct. Jan. April 2000 Bovespa (Brazil) 250 300 Xetra DAX (Germany) 250 200 200 150 Hang Seng (Hong Kong) FT 100 (U.K.) 100 150 50 100 CAC 40 (France) 50 1994 1995 1996 1997 1998 Korea Composite EX (South Korea) 1999 2000 0 1994 1995 1996 1997 1998 1999 2000 FRB Cleveland • May 2000 a. The S&P 500 Index was developed with a base level of 10 for the 1941–43 base period. The NASDAQ is indexed to 250 on February 1, 1985. Implied volatility is a measure of the market’s current prediction of a security’s volatility, derived from a weighted average of the current volatilities of at-the-money options. (Volatility is the extent to which a price fluctuates over a period of time.) SOURCES: Standard & Poor’s Corporation; Wall Street Journal; and Financial Times. posted late last year as sources of additional leverage. Although margin accounts create a potential for speculative excesses, the data do not provide definitive evidence that these accounts are, in fact, producing such effects. Nonetheless, many analysts argue that recent precipitous declines in the NASDAQ represent an unwinding of former excesses. On the other hand, the declines may reflect changing economic fundamentals, such as expected earnings in outlying years, which are not observable. These sharp declines could also portend a permanently higher level of volatility. Formal approaches to stock valuation, based on economic fundamentals, reveal that stock market volatility increases when the dividend-to-price ratio declines. The intuition behind this result is straightforward: Stock returns take two forms, dividend payments and price appreciation, of which the former component is the less volatile. Thus, the greater the dividend (relative to total return), the more stable the return—and hence the value— of the stock. The decline in the aggregate dividend-to-price ratio is consistent with rising volatility. Although equity values around the world have generally appreciated in the past few years, stock price increases have been temperate. To some extent, the European indexes reflect the greater vulnerability of their economies to the Russian default late in the summer of 1998. Similarly, developing-economy indexes are making up losses that resulted from the Asian crises of 1997. 6 • • • • • • • Interest Rates Percent, weekly average 7.0 YIELD CURVES a Percent, monthly average 5 TREASURY SPREAD a March 31, 2000 6.5 4 10-year, 3-month spread April 28, 2000 6.0 3 5.5 2 April 30, 1999 5.0 1 4.5 0 4.0 0 5 10 15 20 Years to maturity –1 1/89 30 25 4/91 7/93 10/95 1/98 4/00 Percent 10 INTEREST RATES AND EXPECTED INFLATION b Percent, end-of-day 4.5 TIPS SPREAD 30-day T-bill rate 4.0 8 10-year TIPS yield 3.5 6 3.0 2.5 4 Yield spread: 10-year Treasury bond–10-year TIPS Estimated expected inflation 2.0 2 1.5 Estimated real inflation 0 1.0 0.5 7/97 12/97 6/98 11/98 5/99 10/99 5/00 –2 1/88 7/89 1/91 7/92 1/94 7/95 1/97 7/98 1/00 FRB Cleveland • May 2000 a. All yields are from constant-maturity series. b. The estimated expected inflation rate and the estimated real rate are calculated using the Pennacchi model of inflation estimation and the median forecast for the GDP implicit price deflator from the Survey of Professional Forecasters. Monthly data. SOURCES: Board of Governors of the Federal Reserve System, “Selected Interest Rates,” Federal Reserve Statistical Releases, H.15; Federal Reserve Bank of Philadelphia, Survey of Professional Forecasters; and Bloomberg Financial Information Services. Do interest rates tell us if inflation— or expected inflation — has increased? One approach is to look at the slope of the yield curve, noting that higher expected inflation will increase long-term interest rates. There has not been much movement in either short- or long-term rates since last month, though both have moved higher since last year, short rates more so. This is confirmed by the 10-year, 3-month spread, now down to 37 basis points from 75 bp at the same time last year. While consistent with a story about inflation fears increasing long rates, leading to a Federal Reserve response that increases short rates, the term spread is an unreliable predictor of future inflation, confounding as it does a variety of real factors. A different spread gives a more direct view of inflationary expectations. Since much of the difference between nominal and real interest rates is expected inflation, the spread between the yields on nominal Treasury bonds and the yields on Treasury inflation-protection securities (TIPS) measures the market’s inflation expectation. That spread has been rising recently, from 1.85% on April 14 to 2.26% on April 28. Lastly, a more sophisticated, if somewhat stylized, measure comes from combining market rates with survey forecasts of inflation to produce estimates of expected inflation and real interest rates, though for a much shorter maturity (30 days) than the TIPS yield. This number has also moved up. 7 • • • • • • • Inflation and Prices 12-month percent change 3.75 TRENDS IN THE CPI March Price Statistics 3.50 Percent change, last: 1 mo.a 3 mo.a 12 mo. 1999 5 yr.a avg. All items 3.25 Median CPI b Consumer prices FOMC central tendency as of July 1999 c 3.00 8.8 5.8 3.7 2.5 2.7 2.75 Less food and energy Median b 5.5 3.2 2.4 2.4 1.9 2.50 3.4 3.4 2.6 2.9 2.3 2.25 CPI, all items Producer prices 2.00 Finished goods 12.1 8.2 4.6 1.6 3.0 1.1 1.2 1.2 0.8 1.75 Less food and energy 1.6 1.50 1.25 1995 12-month percent change 3.75 CPI AND PCE CHAIN-TYPE PRICE INDEX CPI, all items 3.00 FOMC central tendency projections as of February 2000 c 2.75 2.50 2.25 2.00 1.75 PCE Chain-Type Price Index 1.25 1.00 0.75 1996 1997 1998 1998 1999 2000 1999 3.25 0.50 1995 1997 1999 2001 Selected Chain-Type Price Indexes from the National Income and Product Accounts 3.50 1.50 1996 2000 Gross domestic product Personal consumption expenditures Durable goods Nondurable goods Services Private fixed investment Nonresidential Residential Exports of goods and services Imports of goods and services Government consumption expenditures and gross investment 2000:IQa 1.4 2.7 1.6 –2.6 2.3 2.1 0.0 –1.3 3.9 –0.4 0.4 3.2 –2.0 5.4 3.2 0.8 0.0 3.1 1.8 5.6 2.7 5.8 2001 FRB Cleveland • May 2000 a. Annualized. b. Calculated by the Federal Reserve Bank of Cleveland. c. Upper and lower bounds for inflation path as implied by the central tendency growth ranges issued by the FOMC and nonvoting Reserve Bank presidents. SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; U.S. Department of Commerce, Bureau of Economic Analysis; and Federal Reserve Bank of Cleveland. The Consumer Price Index (CPI) rose 0.7% in March (8.8% annualized), its largest monthly increase since August 1990. The increase was led by rising energy prices, which, according to the Department of Labor, accounted for more than half the monthly change in the measure. This statistic is certainly striking, but the breadth of price increases outside the energy sector may be even more noteworthy. Although the CPI posted a sizable increase (0.5%) in February, the CPI excluding food and energy rose a comparatively modest 0.2%. Many interpreted those price data as an indication that significant price pressures were still largely confined to the energy sector. However, this month’s CPI excluding food and energy suggests otherwise: The measure’s 0.4% increase is its largest monthly rise in more than seven years. The median CPI, another measure of core inflation, rose 0.3% in March, equal to its increases in each of the two previous months. While the influence of rising energy prices probably affected some non-energy items (public transportation costs, for example, rose 2.7% in March), energy’s impact on other items seems less obvious. Indeed, substantial increases in the indexes for medical care (0.5%), lodging away from home (3.2%), and education (0.4%) suggest that factors other than rising energy prices are behind greater price growth. (continued on next page) 8 • • • • • • • Inflation and Prices (cont.) Share of index 50 DISTRIBUTION OF COMPONENT PRICE CHANGES 11/98 to 10/99, annualized percent change 12 PRICE CHANGES OF SELECTED CPI COMPONENTS a 45 10 B 11/98 to 10/99 40 8 11/99 to 3/00 35 6 30 B B B BB B B B BB B 4 25 B B B 2 20 B 0 15 B B –2 10 0 B B B B B B B B B –4 5 B –6 Less than 0 0–1 2–3 1–2 Annualized percent change 3–4 Above 4 –6 –4 –2 8 0 6 2 4 11/99 to 3/00, annualized percent change Percent of forecasts 90 DISTRIBUTION OF 2000 CPI FORECASTS b Annualized quarterly percent change 4.5 ACTUAL CPI AND BLUE CHIP FORECAST b 80 4.0 Actual October 70 10 12 Top 10 average Blue Chip forecast 3.5 April 60 3.0 50 2.5 40 2.0 30 1.5 20 1.0 10 0.5 Bottom 10 average 0 0 Less than 1.5 1.5–1.9 2.0–2.4 2.5–3.0 Expected CPI growth, percent Above 3.0 IQ IIQ IIIQ 1999 IVQ IQ IIQ IIIQ 2000 IVQ IQ IIQ IIIQ 2001 IVQ FRB Cleveland • May 2000 a. Quadrants are defined by the median price changes in the two periods. b. Blue Chip panel of economists. SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; and Blue Chip Economic Indicators, October 10, 1999 and April 10, 2000. Since last fall, the distribution of price changes has shown a greater proportion above 4% (annualized). This reflects, in part, the sharp rise in energy prices between November 1999 and March 2000. However, a closer look at the distribution shows that the range in which most price changes are taking place is shifting. From November 1998 to October 1999, the greatest share of prices rose at annualized rates between 2% and 3%, while from November 1999 to March 2000, the greatest share rose at annualized rates of 3% to 4%. This upward shift in the pricechange distribution does not appear to show that a few components that previously restrained inflation are now fueling it. In the scatter diagram, this would be shown by activity in the lower-right quadrant. Most items, however, are found in the upper-right and lower-left quadrants, indicating that nearly all components remained on the same side of the distribution in both periods. This suggests that the overall distribution—rather than only a few components—has shifted higher. As a re- sult, recent increases in the CPI are not likely to be transitory. A greater proportion of economists’ recent inflation forecasts for 2000 indicate CPI growth above 2½%. This probably reflects the spike in energy prices over the last few months. However, longer-term forecasts suggest that even after these effects have worn off, the inflation trend will remain higher than in the recent past (around 2½% for 2001, which is 1% more than in 1998). 9 • • • • • • • Economic Activity Annualized percent change from previous quarter 8 GDP AND BLUE CHIP FORECAST a,b Real GDP and Its Components, 2000:IQ Actual percent change (Advance estimate) Change, billions of 1996 $ Real GDP Consumer spending Durables Nondurables Services Business fixed investment Equipment Structures Residential investment Government spending National defense Net exports Exports Imports Change in private inventories Percent change, last: Four Quarter quarters 119.4 122.3 51.4 30.4 45.9 5.4 8.3 26.6 6.9 5.4 5.0 6.0 13.9 5.3 4.8 61.4 55.0 7.8 6.1 –4.4 –23.2 –33.0 – 0.5 32.5 21.3 23.7 13.3 6.6 –1.1 –23.3 — –0.2 9.5 –16.2 13.4 0.7 2.5 3.4 –0.6 — 6.3 11.8 –35.6 — — 7 Blue Chip forecast, April 10, 2000 6 5 30-year average 4 3 2 1 0 IQ Percent 8 ACTUAL VS. FORECASTED GDP GROWTH IIQ IIIQ 1999 IVQ IQ IIQ IIIQ IVQ 2000 Portion of GDP growth rate (percentage points) 8 CONTRIBUTIONS TO PERCENT CHANGE IN REAL GDP c 7 7 Real GDP Actual 6 6 5 5 4 3 4 Personal consumption expenditure 2 3 Nonresidential fixed investment Residential investment 1 2 Blue Chip forecast 0 1 –1 Inventory Government 0 1995:IQ 1996:IQ 1997:IQ 1998:IQ 1999:IQ 2000:IQ –2 1991: IVQ 1992: IVQ 1993: IVQ 1994: IVQ 1995: IVQ Net exports 1996: IVQ 1997: IVQ 1998: IVQ 1999: IVQ 2000: IQ FRB Cleveland • May 2000 a. Chain-weighted data in billions of 1996 dollars. b. Components of real GDP need not add to totals because current dollar values are deflated at the most detailed level for which all required data are available. c. Data are annual for 1991–99; data for 2000 are quarterly. NOTE: All data are seasonally adjusted. SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; and Blue Chip Economic Indicators, various issues. Gross domestic product increased at a 5.4% annual rate in 2000:IQ, according to the advance estimate released in late April. This is higher than the 3.7% average growth rate of the current expansion, which began in 1991:IIQ; the 4.5% average growth rate of the past four years; and the 4.7% early-April Blue Chip forecast. The forecast for the remainder of 2000 shows growth returning to its 30-year average value. This prediction can be taken with a grain of salt, however, for the actual advance estimate has exceeded the forecast in all but five of the past 21 quarters, by an average of 1.2 per- centage points (30%). For several years, forecasters seemed skeptical that this burst of high productivity growth would continue, but rising growth-rate forecasts have brought the average error down from –1.3 to –0.8 percentage points. The pattern of sectoral contributions to GDP growth in the first quarter changed only slightly from the experience of recent years. Personal consumption and nonresidential fixed investment spending continued to be the largest contributors to GDP growth, but both showed further increases in the most recent quarter. Government spending and inventory investment, on the other hand, accounted for noticeably smaller portions of GDP growth in 2000:IQ, while the contributions of residential investment and net exports were essentially unchanged. Major components of changes in sectoral contributions to GDP growth provide few clues to the durability of rapid GDP growth on the demand side. Without anecdotal evidence, there still may be a statistical basis for expecting components — and GDP growth — to regress to the average of prior values during (continued on next page) 10 • • • • • • • Economic Activity (cont.) Portion of GDP growth rate (percentage points) 1.5 CHANGE IN CONTRIBUTION OF PERSONAL CONSUMPTION Portion of GDP growth rate (percentage points) 3 CHANGE IN CONTRIBUTION OF INVENTORIES, NET EXPORTS, AND GOVERNMENT TO PERCENT CHANGE IN GDP a EXPENDITURES TO PERCENT CHANGE IN GDP a 1.0 — — — — 0.5 — Motor vehicles and parts Furniture Clothing and shoes — — 0 — — –1.0 — — +2 standard deviations — –2 standard deviations — 0 — –1 — — +2 standard deviations — –2 standard deviations — –3 — — 1.0 Portion of GDP growth rate (percentage points) 0.8 CONTRIBUTION OF COMPUTER AND SOFTWARE COMPONENTS TO PERCENT CHANGE IN GDP 0.7 Computers 0.6 0.5 — — 0.4 — — 0 — –1.0 Federal government defense consumption expenditures –2 COMPONENTS TO PERCENT CHANGE IN GDP a –0.5 — 1 — Portion of GDP growth rate (percentage points) 1.5 CHANGE IN CONTRIBUTION OF FIXED INVESTMENT 0.5 Nonfarm inventory investment Exports of goods and services Food Gasoline –0.5 2 — — +2 standard deviations — — –2 standard deviations — Structures Industrial equipment 0.3 0.2 0.1 Transportation equipment Other Information equipment and software Software 0 –0.1 1991: IIQ 1992: IIIQ 1993: IVQ 1995: IQ 1996: IIQ 1997: IIIQ 1998: IVQ 2000: IQ FRB Cleveland • May 2000 a. Difference between 2000:IQ and 1999:IVQ contribution rates. NOTE: All data are seasonally adjusted. SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis. the current expansion. This might be expected, for example, if dominant changes in demand were more than two standard deviations from the mean, a range that would include 67% of past observations. Spending on clothing and shoes showed an unusually large increase, contributing a full percentage point to GDP growth. This was offset, however, by unusually large decreases in expenditures on food and on gasoline, fuel oil, and other energy goods. Similar calculations for exports of goods and services, non- farm inventories, and federal government defense consumption spending suggest the latter two were unusually low. However, none of the dominant components of the strong increase in nonresidential fixed investment was outside its normal range. The total contribution of spending on computer and peripheral equipment and on software has not increased over the past two years, an indication of computers’ and computer chips’ growing intergration with other aspects of personal and commercial activities. Other investment in information-processing equipment and software (that is, other than computers and software) has been a source of substantial increase in this category’s contribution to GDP growth in recent years and in 2000:IQ. The “other” category includes communications equipment, instruments such as medical equipment, industrial process controls, and scientific instruments, photocopy and related equipment, optical-based equipment, and office equipment excluding computers, such as typewriters and mailhandling equipment. 11 • • • • • • • Labor Markets Change, thousands of workers 500 AVERAGE MONTHLY NONFARM EMPLOYMENT GROWTH Labor Market Conditions Average monthly change (thousands of employees) 450 1997 1998 1999 YTDa April 2000 Payroll employment 281 Goods-producing 48 Mining 2 Construction 21 Manufacturing 25 Durable goods 27 Nondurable goods –2 244 8 –3 30 –19 –9 –10 226 –6 –3 18 –21 –10 –11 305 37 3 32 3 7 –4 340 –40 4 –55 11 10 1 235 18 32 26 119 27 232 18 37 12 121 29 268 10 47 3 111 83 380 23 119 7 121 107 400 350 300 250 200 Service-producing b TPU Retail trade FIREc Services Government 150 100 233 16 24 20 141 17 Average for period (percent) 50 Civilian unemployment 4.9 4.5 4.3 4.0 3.9 0 1992 1993 1994 1995 1996 1997 1998 1999 Percent 65.0 Feb. Mar. Apr. 2000 IQ Percent 8.4 LABOR MARKET INDICATORS d 7.8 64.5 Year-over-year percent change 5.0 AVERAGE HOURLY EARNINGS 4.5 Employment-to-population ratio 64.0 7.2 63.5 6.6 4.0 Total 3.5 Service-producing 63.0 6.0 62.5 5.4 3.0 Civilian unemployment rate 2.5 4.8 62.0 Goods-producing 4.2 61.5 61.0 1992 1993 1994 1995 1996 1997 1998 1999 2000 3.6 2001 2.0 1.5 1992 1993 1994 1995 1996 1997 1998 1999 2000 FRB Cleveland • May 2000 a. Year to date. b. Transportation and public utilities. c. Finance, insurance, and real estate. d. Vertical line indicates break in data series due to survey redesign. NOTE: All data are seasonally adjusted. SOURCE: U.S. Department of Labor, Bureau of Labor Statistics. Employment showed strong growth in April (340,000 workers), following March’s upwardly revised gain of 458,000. About one-fourth of this increase reflects the hiring of temporary census takers (190,000 in the past two months). Another measure of labor market strength, the employment-to-population ratio, rose 0.2% to a record high of 64.9%. The unemployment rate fell to 3.9%, its lowest point since January 1970. The goods-producing sector showed a net loss of 40,000 jobs in April. Construction employment alone posted a net loss of 55,000 workers last month, following an increase of 91,000 employees in March. The five weeks intervening between the February and March survey periods may have contributed to the significant gain in March and the sharp decline in April. Steady (though small) gains in durable-goods employment have given manufacturing a net gain of 16,000 employees since November. This follows a 20-month period in which manufacturing employment declined by more than 500,000 jobs. The largest job gains for April occurred in retail trade and business services, as the service-producing sector posted a net increase of 380,000 jobs. The government also showed solid employment gains due to the temporary addition of census workers and a large increase in local education employment. Growth in average hourly earnings of nonsupervisory workers has trended upward throughout much of the current expansion. In late 1998, however, earnings growth slowed, especially for goodsproducing workers, and only recently has it begun creeping back up toward peak 1997 levels. 12 • • • • • • • Ohio Business Openings and Closings AVERAGE ANNUAL NET CHANGE IN NUMBER OF BUSINESSES, 1989–98 AVERAGE ANNUAL NET CHANGE IN NUMBER OF BUSINESSES, 1979–88 –10 to 0 –10 to 0 1 to 20 21 to 100 101 or more 1 to 20 21 to 100 101 or more FOREIGN-OWNED BUSINESS OPENINGS IN OHIO, 1998–99 MANUFACTURING BUSINESS OPENINGS IN OHIO, 1998–99 Food processing Instruments Transportation equipment Electronic equipment Other U.K. Switzerland Sweden Norway Industrial machinery Fabricated metals Primary metals Stone, clay, and glass Netherlands Mexico Leather products Japan Rubber and plastics Petroleum Ireland Hong Kong Chemicals Printing Paper products France Germany Furniture Lumber and wood Apparel Textile products Canada Belgium Austria Australia Miscellaneous 0 20 40 80 60 100 120 Number of establishments 140 160 180 0 5 10 15 30 35 20 25 Number of establishments 40 45 50 FRB Cleveland • May 2000 SOURCES: Ohio Bureau of Workers’ Compensation, Risk Master File; and Ohio Department of Development. New businesses in Ohio opened at an average of 27,000 annually between 1988 and 1998. Since 1994, however, the number of starts has fallen every year; 1998 had the lowest number since 1992. Business closings over the same period averaged about 24,500, with 1997 and 1998 showing the highest numbers. Ohio counties’ average annual net gains (business openings minus closings) show several patterns. Over the past 20 years, the greatest gains have occurred in the Cleveland, Columbus, and Cincinnati metropolitan areas. In the first half of the sample, 1979–88, only one county posted more closings than openings. In the second half, 1989–98, closings outnumbered openings in 11 counties, most of them concentrated in northwest Ohio. For the past two years, openings of new manufacturing establishments or expansions of existing ones numbered slightly more than 1,000. Of that total, more than onethird can be attributed to three industries—industrial machinery, fabricated metals, and rubber and plastics — all large contributors to automobile manufacturing. Furthermore, many foreign countries have invested in these new or expanded firms in Ohio. The two investors with the largest number of sites are Japan and Germany, both major auto producers. 13 • • • • • • • Education and Earnings in the U.S. Percent 90 SHARE OF PERSONS 25 OR OLDER WHO HAVE Percent 30 SHARE OF PERSONS 25 OR OLDER WHO HAVE COMPLETED HIGH SCHOOL COMPLETED COLLEGE 80 25 70 Whites Whites 60 20 Women 50 Women Hispanics 15 40 Men and women Men and women 30 10 Hispanics 20 African Americans 5 10 African Americans 0 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 Percent 20 UNEMPLOYMENT RATES OF ALL PERSONS AGED 25–64 0 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 Thousands of dollars 40 REAL EARNINGS OF ALL PERSONS 18 OR OLDER BY EDUCATIONAL ATTAINMENT BY EDUCATIONAL ATTAINMENT 35 Advanced degree 16 Did not complete high school 30 12 25 Bachelor’s degree 20 High school graduate 8 15 Some college 4 High school graduate 10 Did not complete high school Bachelor’s degree or more 0 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 5 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 FRB Cleveland • May 2000 SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; and U.S. Deptartment of Commerce, Bureau of the Census. Americans have made remarkable gains in educational attainment over the last half-century. In 1940, only a quarter of the population aged 25–64 had graduated from high school; by 1998, over 80% had. Even more remarkable has been the proportional increase in the share of the population that attained a college or graduate degree—five times greater in 1998 than in 1940. Such attainment successes, however, have not been shared equally. While less than 10% of African Americans completed high school in 1940, roughly three-quarters graduated some 50 years later. Hispanics also raised their educational attainment, but at a substantially slower pace than African Americans. In 1972, the share graduating from high school was about the same for both groups; by 1998, however, only slightly more than 50% of Hispanics had a high school diploma, compared to 75% of African Americans. Moreover, it is evident that education affects both employment and income. In 1999, workers without high school diplomas were four times more likely to be unemployed than those with at least a bachelor’s degree—and twice as likely to be unemployed as those with a high school education. The cyclical variation in unemployment rates also differs significantly by education group. The employment status of individuals with at least a college degree is far less volatile than that of workers with less schooling. (continued on next page) 14 • • • • • • • Education and Earnings in the U.S.(cont.) Percent 30 SHARE OF POPULATION AGED 14–34 ENROLLED IN COLLEGE Advanced degree 25 Bachelor’s degree Percent 50 HIGH SCHOOL GRADUATES AGED 14–24 ENROLLED IN COLLEGE Women 45 Total Two-year college degree 20 40 Whites 15 35 10 30 Hispanics 5 African Americans 25 0 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 20 1967 1972 1977 1982 1987 1992 Percent 7 SHARE OF POPULATION AGED 20–24 ENROLLED PART TIME a 4-year colleges Percent 31 SHARE OF POPULATION AGED 20–24 ENROLLED FULL TIME a 6 26 5 21 1997 4-year colleges 4 16 3 11 2-year colleges 2 6 2-year colleges 1 1968 1972 1976 1980 1984 1988 1992 1996 2000 1 1968 1972 1976 1980 1984 1988 1992 1996 2000 FRB Cleveland • May 2000 a. Shaded areas indicate recessions. SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; and U.S. Department of Commerce, Bureau of the Census. Although real (inflation-adjusted) earnings of nearly all groups declined in the late 1970s and early 1980s, earnings of those with advanced degrees have risen markedly since. Earnings of individuals with a bachelor’s degree have risen more modestly. But real earnings of workers with less than a high school diploma declined until 1993 and still remain slightly below their 1974 levels. The share of the population aged 14–34 that was enrolled in four-year colleges and graduate schools held fairly constant between the mid1970s and the late 1980s. After 1985, enrollment rates began to climb, reaching 25% in 1997. College enrollment rates of those holding a high school diploma show variation among ethnic groups. While whites, African Americans, and Hispanics had roughly similar proportions enrolled in the mid-1970s to mid-1980s (with virtually no growth during that period), they diverged afterward. Whites’ enrollment rates rose substantially, while those of African Americans and Hispanics continued unchanged until 1990. In addition, the share attending two- and four-year colleges part time doubled over a span of 30 years. The same pattern does not hold for full-time students, whose shares remained fairly constant until the mid-1980s before rising to their current levels. 15 • • • • • • • Banking Conditions Billions of dollars 25 NET INCOME OF FDIC-INSURED BANKS Percent 1.6 RETURN ON ASSETS AND EQUITY OF FDIC-INSURED BANKS Securities and other gains 1.4 Quarterly return on assets Net operating income 20 Percent 24 15 10 21 Quarterly return on equity 1.2 18 1.0 15 0.8 12 0.6 9 0.4 6 0.2 3 5 0 0 0 IQ IIIQ 1995 IQ IIIQ 1996 IQ IIIQ 1997 IQ IIIQ 1998 IQ IIIQ 1999 Billions of dollars 3.5 NET INCOME OF FDIC-INSURED SAVINGS INSTITUTIONS IQ IIIQ 1995 IQ IIIQ 1996 IQ IIIQ 1997 IQ IIIQ 1998 IQ IIIQ 1999 Percent 1.2 RETURN ON EQUITY AND ASSETS OF FDIC-INSURED Percent 24 SAVINGS INSTITUTIONS Securities and other gains 21 3.0 1.0 Net operating income 18 2.5 0.8 15 2.0 0.6 12 0.4 9 1.5 1.0 6 0.2 0.5 3 0 0 Quarterly return on assets Quarterly return on equity –3 –0.2 –0.5 IQ IIIQ 1995 IQ IIIQ 1996 a IQ IIIQ 1997 IQ IIIQ 1998 IQ IIIQ 1999 IQ IIIQ 1995 IQ IIIQ 1996 a IQ IIIQ 1997 IQ IIIQ 1998 IQ IIIQ 1999 a. The sharp decline in 1996 was driven, in part, by a special insurance assessment on the deposits of savings institutions. SOURCE: Federal Deposit Insurance Corporation, Quarterly Banking Profile, 1999:IVQ. FRB Cleveland • May 2000 FDIC-insured commercial banks reported record profits of $71.7 billion for 1999 along with an unprecedented 1.3% rate of return on assets. An important factor in commercial banks’ strong profitability was a reduction in noninterest expenses relative to a year earlier. Although noninterest expenses rose in 1999:IVQ relative to 1999:IIIQ, they 0 were nonetheless lower than in the previous year. Noninterest income continues to play an increasingly important role, accounting for 44.1% of net operating revenues. Generally increasing interest rates during 1999:IVQ had a stronger effect on banks’ interest costs than on their asset yields, causing the industry’s interest margin to decline four basis points. FDIC-insured savings institutions also reported record profit levels of $10.9 billion for 1999. Their rate of return on assets for the year was 1.0%, slightly lower than 1998. Savings institutions continue to show improved asset quality, with decreases in provisions for loan losses and net charge-offs on loans. 16 • • • • • • • Household Financial Conditions Real dollars, 1982–84 6,000 AVERAGE CREDIT CARD DEBT PER U.S. HOUSEHOLD a Real dollars, 1982–84 18 AVERAGE MONTHLY CREDIT CARD LATE-PAYMENT FEE 16 5,000 14 12 4,000 10 3,000 8 6 2,000 4 1,000 2 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Percent of average loan balance 7 CONSUMER LOAN DELINQUENCY RATES 0 1994 1995 1996 1998 1997 1999 2000 Percent of credit HOLDERS OF CONSUMER CREDIT 100 6 80 5 Credit 60 4 40 3 Consumer 2 20 1 0 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Savings institutions Credit unions Securitized asset pools Nonfinancial businesses Finance companies Commercial banks 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 a. Average of households with at least one credit card. SOURCES: Board of Governors of the Federal Reserve System; and CardWeb, Inc., CardWeb News Release, March 21, 2000. FRB Cleveland • May 2000 The increased number of bankruptcy filings in recent years is often attributed to rising levels of consumer indebtedness. Since 1990, average credit card balances per household (adjusted for inflation) have more than doubled. Delinquency rates for consumer loans rose markedly in the mid-1990s but have remained stable in recent years. Holders of consumer debt have changed considerably over time. A decade ago, commercial banks held nearly 50% of all consumer credit. This proportion declined steadily throughout the 1990s, so that today banks hold only 35%. Savings institutions have also become less important as sources of consumer credit. Throughout the 1990s, pools of securitized assets absorbed an in- creasing proportion of outstanding consumer credit. The Bankruptcy Reform Act of 1994 increased the value of assets protected from seizure by creditors. This may have contributed to the upward trend in bankruptcy filings by individuals since its passage. Last year, however, their number declined, both across the U.S. and (continued on next page) 17 • • • • • • • Household Financial Conditions (cont.) Percent change 8 CHANGE IN BANKRUPTCY CASES, 1998–99 Number of filings 450 BANKRUPTCY FILINGS, 1999 6 400 40 350 35 Filed Terminated 4 Thousands of filings 45 Pending Pennsylvania 2 Total Kentucky West Virginia 300 30 Chapter 11 Chapter 7 Chapter 13 Ohio 0 250 25 –2 200 20 –4 150 15 –6 100 10 –8 50 5 –10 0 Chapter 12 0 Kentucky Thousands of filings 1,600 Thousands of filings 60 BANKRUPTCY FILINGS U.S.atotal Pennsylvania Ohio West Virginia Thousands of filings Thousands of filings 80 1,600 BUSINESS AND NONBUSINESS BANKRUPTCY FILINGS 1,400 1,400 70 1,200 1,200 60 1,000 1,000 50 Ohio 40 50 Nonbusiness Business 30 Pennsylvania Kentucky 800 800 40 600 600 30 400 400 20 200 200 10 20 10 West Virginia 0 1989 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 0 1989 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 FRB Cleveland • May 2000 SOURCE: Administrative Office of the U.S. Courts. within Fourth District states. In 1999, national consumer filings dropped more than 8% from their record levels of the previous year. Bankruptcy filings by businesses continue to follow the downward trend initiated in the early 1990s. Congress is now considering some changes in the bankruptcy laws. Legislators, alarmed by the increase in bankruptcy filings in recent years, proposed a law to reduce the number of filings by restricting the use of Chapter 7 provisions. On February 2, the Senate overwhelmingly passed a reform bill that would allow judges of bankruptcy cases to force Chapter 13 filing by debtors who can afford to pay $15,000 or 25% of unsecured credit over five years. Creditors could also ask judges to require debtors to file for Chapter 13 reorganization instead of Chapter 7. The House passed a similar, but stricter, version in May 1999. Under Chapter 13, debtors repay creditors in full or in part through installment payments. With Chapter 7, certain debtor assets are liquidated, creditors are paid from the proceeds, and the remaining debt is at least partially erased. Some assets are exempt from liquidation, and certain debts cannot be erased. Filers currently choose the heading under which they will file, and more than 72% of them opt for Chapter 7. The proposed changes would limit their degree of choice. 18 • • • • • • • The U.S.International Investment Position Trillions of dollars 9 INTERNATIONAL ASSETS Trillions of dollars 9 COMPOSITION OF ASSETS, 1998 8 8 Foreign-owned assets in U.S. 7 7 6 6 5 5 4 4 3 Direct investments Official reserves Other 3 U.S.-owned assets abroad 2 2 1 1 0 1984 1986 1988 1990 1992 1994 1996 1998 Percent of GDP 10 U.S. INTERNATIONAL INVESTMENT POSITION 2000 0 U.S.-owned assets abroad Foreign-owned assets in U.S. Factors Affecting the U.S. International Investment Position (Percent of GDP) 5 Total changea 0 1985–99 1985–96 1997–99 –23.3 –10.4 –13.0 –26.4 –7.5 Change attributable to: Trade and transfers –5 –10 –33.9 Statistical discrepancy –3.0 –1.0 –2.0 Net return 13.6 17.0 –3.4 40.9 30.6 10.3 Payments on foreignowned assets –27.3 –13.6 –13.7 Return on U.S.owned assets –15 –20 –25 1984 1986 1988 1990 1992 1994 1996 1998 FRB Cleveland • May 2000 a. Total change is the sum of trade and transfers, statistical discrepancy, and net return on assets. SOURCE: U.S. Department of Commerce, Bureau of Economic Analysis. The U.S. is the world’s largest debtor country, with net obligations exceeding $1.8 billion. Since 1989, the market value of foreign-owned assets in this country has exceeded the market value of U.S.-owned assets abroad. Not all foreign-owned assets in the U.S. are debt instruments. Almost 30% represent foreign direct investments in this country. These are equity shares in U.S. enterprises that confer decisionmaking authority on foreigners. Another 11% of our liabilities are the official dollar reserves of foreign governments. Nevertheless, all foreign investors, private or governmental, require a return on their investments. Economists often assess the burden of a country’s net international investment position by comparing it to GDP. U.S. international indebtedness currently stands at approximately 20% of GDP, a high but not unprecedented rate. Persistently large trade deficits account for the expanded U.S. debt burden. Traditionally, a rate of return that is higher on U.S.-owned assets abroad than on foreignowned assets in the U.S. has mitigated the trade deficit’s impact on our debt burden. Since 1993, however, this situation has reversed, and the net cost of servicing foreignowned assets in this country is now adding more than 3 percentage points annually to the debt burden. All else equal, the U.S. needs a trade surplus equivalent to 2% of GDP to prevent a further increase in its debtto-GDP ratio. 19 • • • • • • • International Market Volatility Equity-Index Volatility Measuresa 1996 1997 Exchange-Rate Volatility Measuresa 1998 1999 1996 2000 1997 1998 1999 2000 Nikkei 500 0.57 0.98 0.88 0.92 1.72 German mark 0.30 0.48 0.42 0.42 0.50 FT 100 0.48 0.74 1.01 0.89 0.74 British pound 0.27 0.41 0.34 0.33 0.34 Euro — — Yen 0.35 0.52 0.83 0.63 0.56 Broad Index 0.10 0.19 0.28 0.18 0.15 Major Currency Index 0.16 0.27 0.34 0.28 0.24 Xetra DAX 0.55 1.16 1.45 1.10 1.42 Hang Seng 0.76 1.53 1.99 1.31 1.79 S&P 500 0.57 0.87 0.94 0.92 1.25 NASDAQ 0.74 0.90 1.24 1.42 2.52 Index, January 1996 = 100 600 EQUITY INDEXES Index, January 1996 = 100 150 DOLLAR EXCHANGE RATES 500 140 NASDAQ Japanese yen — 0.42 0.50 Broad Dollar Index 130 German mark 400 120 S&P 500 300 110 Xetra DAX (Germany) 200 100 FT 100 (U.K.) 90 Nikkei 500 (Japan) 0 1/96 7/96 1/97 7/97 Major Currency Index British pound 100 Hang Seng (Hong Kong) 1/98 7/98 1/99 7/99 1/00 80 1/96 7/96 1/97 7/97 1/98 7/98 1/99 7/99 1/00 FRB Cleveland • May 2000 a. Volatility is measured as the average absolute interday percent change. SOURCES: Board of Governors of the Federal Reserve System; DRI/McGraw–Hill; Wall Street Journal; and Financial Times. The day-to-day volatility of U.S. equity markets has increased markedly this year. The average absolute percentage change in the NASDAQ has risen almost 80% so far this year compared with 1999. Moreover, the day-to-day volatilities of both the S&P 500 and the NASDAQ are higher than in any of the past four years. Market volatility is generally associated with uncertainty, which in this case may reflect apprehension about the valuation of high-tech stocks and concerns about future U.S. monetary policy. With the exception of London’s FT 100, the day-to-day volatility of foreign equity markets has also risen this year. The Japanese Nikkei Index showed the most pronounced increase. Recent volatility in the German (Xetra DAX) and Hong Kong (Hang Seng) indexes — although higher than in 1999 — remains below that recorded in 1998. Equity-market volatility is not reflected in the dollar’s foreign exchange rates. The Broad and Major Currency indexes seem calm. The day-to-day volatility of the German mark (and euro) exchange rate has increased this year relative to last year, which may be a sign of uncertainty about the prospect for monetary policy in Europe. Apart from this, the average volatility of foreign exchange markets is not atypical.
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