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1 • • • • • • • FRB Cleveland • May 2001 The Economy in Perspective The gravity of the situation…This morning the Bureau of Labor Statistics reported that payroll employment declined by more than 200,000 people in April, a much larger number than private analysts had expected. Not only had employment weakened further in the already beleaguered manufacturing sector, but it had also softened in the service sector. The unemployment rate drifted up from 4.3% to 4.5%. Market opinion cheered this development, sensing that it would spur the Federal Reserve to reduce the federal funds rate another 50 basis points at its May 15 meeting. Market sentiment had already anticipated a funds rate cut because the FOMC had reduced the funds rate 50 basis points in a surprise intermeeting move on April 18, and market participants reckoned that such an action signaled a predisposition to move again if economic data continued to be weak. The employment report was the coup de grace. We’ve gotten used to talking heads and do not begrudge them their pulpit. Someone, after all, has to supply “content” to an industry awash in bandwidth and column inches. Nor does the business public seem to mind the inaccuracy of economic forecasts. In fact, listening to some analysts is like watching WWF wrestling: You sense that the performers are winking at you as they launch a body slam against their opponent. Many analysts— though often wrong—are never in doubt. Humility doesn’t sell. We’ve also grown accustomed to analysts who base their policy recommendations on the difference between the economy’s actual and “potential” output. During the 1996–2000 period, most analysts confidently intoned that the U.S. economy was exceeding its potential and would generate inflation; this afternoon a radio show sound bite delivered the equally confident message that the economy was now operating far below its potential and carried no inflation threat. Terminology can get even more sophisticated in the major media markets. When the level of output is below potential but expanding rapidly, the Fed is asked to engineer a “soft landing”; when the level of output is above potential but its growth rate is slower than that of potential, the Fed is urged to perform a “reverse soft landing.” Close your eyes and you will see Alan Greenspan out on the ice, with Scott Hamilton commenting on his triple Lutz/double toe loop combination. We’ve even become inured to the market’s apparently perverse response to macroeconomic news, in which investors buy claims to earnings streams (stocks) after they find that earnings are likely to be poorer than they had thought. The attraction seems to arise from their belief that weakness begets easier monetary policy, which begets lower interest rates, which begets a smaller discount rate applied to the earnings stream, which begets greater willingness to pay for the stock. Hence, bad news is good news. Never mind that bad news may be the beginning of more bad news, including bankruptcy of the firm itself. What we can’t get used to, however, is people’s inability—or unwillingness—to differentiate between easier monetary conditions and inflationary monetary policy. The U.S. economy has sustained two shocks: an energy supply shock and a capitalgoods demand shock. Firms are slowing production and employment; inventories must be financed until they are liquidated. Firms and households still want credit, but many now are finding it more expensive if they can get it at all. The FOMC has provided the financial system with more liquidity, but markets are channeling these funds into short-term credit instruments because creditors have become more cautious about making loans with more than a few years’ maturity. Not surprisingly, then, the Fed’s actions have had little effect on long-term interest rates. Easier monetary conditions play the very positive role of aiding the financial restructuring of households and firms as they adjust to new circumstances. Creditworthy individuals and firms benefit from access to short-term loans as they pare current expenses and realign their spending with their income. But easier monetary conditions can neither correct nonviable business plans nor revive nonviable businesses. People who based their plans on the continuing value of those businesses must now make new plans. Monetary policy can facilitate this restructuring but not prevent it. History suggests that attempting to do otherwise could eventually promote inflation. One might as well try to defy gravity. It’s uncertain how much lower the FOMC will take the federal funds rate before it pauses or stops. This afternoon one analyst told a financial newscaster that the Fed is prepared to ease monetary conditions until all risks of a recession disappear. Policymakers who recognize the lags between actions and effects won’t wait that long; those who do not may press too hard. One thing seems certain: Performing the triple Lutz/double toe loop combination is much more difficult while weightless and in a vacuum. 2 • • • • • • • Inflation and Prices 12-month percent change 4.00 CPI AND CPI EXCLUDING FOOD AND ENERGY March Price Statistics Annualized percent change, last: 2000 a a a 1 mo. 3 mo. 12 mo. 5 yr. avg. 3.75 3.50 3.25 Consumer prices CPI All items 0.7 4.0 3.0 2.5 3.4 Less food and energy 2.6 3.5 2.7 2.4 2.5 Medianb 4.0 4.0 3.4 2.9 3.2 3.00 2.75 2.50 2.25 Producer prices CPI excluding food and energy Finished goods –0.8 4.9 3.1 1.7 3.6 Less food and energy 1.9 1.4 1.1 1.2 2.00 1.75 1.6 1.50 1.25 1995 12-month percent change 4.00 CPI AND MEDIAN CPI 1996 1997 1998 1999 2000 2001 Annualized quarterly, percent change 5 CPI AND BLUE CHIP FORECAST c 3.75 3.50 4 CPI 3.25 Median CPI b Highest 10% 3.00 3 2.75 Consensus 2.50 2 2.25 CPI 2.00 Lowest 10% 1 1.75 1.50 0 1.25 1995 1996 1997 1998 1999 2000 2001 1995 1996 1997 1998 1999 2000 2001 2002 2003 FRB Cleveland • May 2001 a. Annualized. b. Calculated by the Federal Reserve Bank of Cleveland. c. Blue Chip panel of economists. SOURCES: U.S. Department of Labor, Bureau of Labor Statistics, Federal Reserve Bank of Cleveland; and Blue Chip Economic Indicators, April 10, 2001. After large increases in the first two months of 2001, the Consumer Price Index (CPI) rose a very modest 0.1% (0.7% annualized) in March. Energy prices declined for the second straight month (–22.4% annualized), as the prices of household fuels fell 8.4% and motor fuel prices dropped 36.4% (both annualized). Food prices (up an annualized 2.8% in March, compared to 5.8% in February) also contributed to March’s slower CPI growth. Still, even after excluding food and energy prices, the CPI’s March increase was less pronounced than earlier this year (an annualized rate of 2.6% versus 4.0% in each of the previous two months). Smaller price increases for apparel and medical care, along with price declines in tobacco, recreation, and household furnishings and operations, contributed to a slowdown in retail prices’ advance. Although these data suggest an improving inflation outlook, the median CPI provides a less sanguine reading. While a subset of items in the CPI helped restrain retail price growth, prices for a large share of goods con- tinued to advance strongly. In March, the median CPI rose at a 4.0% annualized pace—equal to its average increase for 2001 and up from the 3.2% average in 2000. Mixed signals from the price data help explain the wide range of opinions regarding the inflation outlook. The consensus forecast by the Blue Chip panel of economists shows the CPI rising about 2½% (annualized) through 2002. However, the most pessimistic of these forecasters expect inflation to hold at around a 3% rate over the next (continued on next page) 3 • • • • • • • Inflation and Prices (cont.) 12-month percent change 5.0 YEAR-AHEAD HOUSEHOLD INFLATION EXPECTATIONS a 4-quarter percent change 5.5 EMPLOYMENT COST INDEX 5.0 Benefits 4.5 4.5 Wages 4.0 4.0 3.5 3.5 3.0 Total compensation 2.5 3.0 2.0 2.5 1.5 1995 1996 1997 1998 1999 2000 2001 4-quarter percent change 10 EMPLOYMENT COST INDEX BY INDUSTRY 9 1995 1996 1997 1998 1999 2000 2001 P-STAR AND IMPLICIT PRICE DEFLATOR 2000 2001 8 7 6 5 4 3 2 1 0 FIRE b Wholesale Durable trade goods Retail Service Nondurable Construc- TPU c trade industries goods tion FRB Cleveland • May 2001 a. Mean expected change in consumer prices as measured by the University of Michigan’s Survey of Consumers. b. Finance, insurance, and real estate. c. Transportation and public utilities. SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; U.S. Department of Commerce, Bureau of Economic Analysis; Board of Governors of the Federal Reserve System; and University of Michigan. seven quarters, while their more optimistic counterparts see inflation of only about half that amount. Households’ inflation expectations rose to 3.7% in the most recent month, but remain marginally below the four-year high of 4.1% they set last October. Those who gauge the economy’s inflationary momentum by the patterns of wage growth are also receiving mixed signals. Overall, the trend in compensation growth has slowed slightly compared with 2000 for both wages and benefits. Still, that slowdown has been heavily concentrated in industries where business conditions were unusually soft— finance, trade, and durable goods manufacturing. In areas where business conditions are stronger, including general services, construction, and transportation, workers’ compensation growth has picked up since last year. But for economists who believe that inflation is ultimately caused by “too much money chasing too few goods,” the inflationary signs are more ominous. The P-star statistic is one gauge of the inflationary potential of money growth. This statistic shows the long-run price level implied by the trend rate of M2 growth relative to the economy’s long-run growth rate (among other things). Since 1998, the price level as measured by the implicit GDP price deflator has been below P-star, which means that this inflation predictor foretells acceleration. 4 • • • • • • • Monetary Policy Percent 7.25 RESERVE MARKET RATES Percent 5.75 IMPLIED YIELDS ON FEDERAL FUNDS FUTURES 5.50 6.75 Intended federal funds rate 5.25 6.25 February 1, 2001 Effective federal funds rate a 5.00 5.75 March 21, 2001 4.75 5.25 April 17, 2001 4.50 Discount rate 4.75 4.25 April 19, 2001 4.25 4.00 April 30, 2001 3.75 3.75 1996 1997 1998 1999 2000 2001 Feb. Mar. Apr. May June July 2001 Aug. Sept. Oct. Nov. Basis points 70 FEDERAL FUNDS RATE AVERAGE Basis points 150 FEDERAL FUNDS RATE INTRADAY STANDARD DEVIATION b INTRADAY STANDARD DEVIATION c,d 60 125 1994–present 1994–7/30/98 50 7/30/98–present 100 40 75 30 50 20 25 10 0 11/29 12/13 12/27 1/10 2000 0 1/24 2/7 2/21 3/7 2001 3/21 4/4 4/18 5/2 1 2 7 3 6 8 9 10 Days until next reserve maintenance period 13 14 FRB Cleveland • May 2001 a. Weekly average. b. Dashed lines indicate the final day of a reserve maintenance period. c. Averages are taken from January 3, 1994 to April 30, 2001 and exclude nontrading days. d. Required reserves are based on an average of transaction account balances over a two-week period. Before July 30, 1998, this period ended the Monday before the reserve maintenance period ended. Since that date, the two-week period has ended the Monday before the end of the preceding maintenance period. SOURCES: Board of Governors of the Federal Reserve System, “Selected Interest Rates,” Federal Reserve Statistical Releases, H.15; Federal Reserve Bank of New York; and Chicago Board of Trade. In an intermeeting action on April 18, 2001, the Federal Open Market Committee (FOMC) lowered the intended federal funds rate 50 basis points (bp) to 4.5%, its lowest level since August 1994. Its April 18 press release noted that lower capital spending and other factors threaten “to keep the pace of economic activity unacceptably weak.” Immediately after the April 18 action, implied yields on fed funds futures dropped 18–44 bp across the various maturity dates. As of April 30, the November contract traded at 4.1%, 40 bp below the current intended federal funds rate. The federal funds rate typically varies over the course of a day, even though the daily average (“effective”) rate tends to remain fairly close to its intended level. The rate’s intraday standard deviation rises markedly toward the end of a two-week reserve maintenance period. A bank satisfies its reserve requirement by averaging its end-of-day balances at a Federal Reserve Bank over a maintenance period. Intraday funds rate variations increase during a period as reserve managers enjoy less and less freedom in adjusting actual balances to meet their requirements. This effect lessened when the Fed switched to a system of lagged reserve accounting in July 1998, eliminating banks’ uncertainty about required balances. Intraday volatility also tends to rise at the end of each quarter and on corporate tax dates, when banks may have to scramble for balances to cover large payments flows. 5 • • • • • • • Money and Financial Markets Percent, daily 7.0 Percent, weekly average 7.0 SHORT-TERM INTEREST RATES Percent, weekly average 7.5 LONG-TERM INTEREST RATES Percent, daily 7.0 Intended federal funds rate Intended federal funds rate 6.5 6.5 7.0 6.5 30-year Treasury a 1-year T-bill a 6.0 6.0 6.5 6.0 5.5 5.5 6.0 5.5 5.0 5.0 5.5 5.0 4.5 4.5 5.0 4.5 4.0 4.5 3.5 4.0 1996 3-month T-bill a 10-year Treasury a 4.0 3.5 1996 1998 1997 1999 2000 2001 4.0 3.5 1998 1997 1999 2000 2001 Percent, weekly average 9.5 PRIVATE-SECTOR YIELDS Percent, weekly average 6.4 YIELD CURVES a Percent, daily 7.0 Intended federal funds rate 9.0 December 1, 2000 6.5 5.9 February 2, 2001 8.5 6.0 BAA corporate bond 5.4 8.0 5.5 7.5 5.0 7.0 4.5 January 5, 2001 March 2, 2001 4.9 AAA corporate bonds 4.4 6.5 4.0 April 20, 2001 Conventional mortgage 3.9 0 5 10 15 20 Years to maturity 25 30 35 6.0 1996 3.5 1997 1998 1999 2000 2001 FRB Cleveland • May 2001 a. Constant maturity. SOURCE: Board of Governors of the Federal Reserve System. Starting in mid-1999, the intended federal funds rate first was raised from 4.75% to 6.5% in six steps and then was cut sharply to 4.5% in four moves of 50 basis points (bp) each. When the FOMC changes the intended fed funds rate—the rate at which banks can borrow reserve balances from each other overnight— it is often said simply to be “lowering interest rates.” In fact, the entire array of other interest rates is determined by participants (lenders and borrowers) in a wide variety of financial markets, and individual rates can move with or opposite to the target rate. It is true that the intended funds rate and market interest rates, especially short-term rates, tend to follow the same general pattern. However, it is not uncommon to see some market rates moving in the opposite direction from the policy rate, even over fairly long periods. The 200 bp decline in the intended funds rate, which began on January 3, 2000, has been accompanied by a similar decline in 3-month and 1-year T-bill yields, which have fallen 188 bp and 171 bp to 3.96% and 4.02%, respectively, since the end of last year. However, this pattern does not hold for long-term interest rates. Since year’s end, yields on the 10-year and 30-year Treasury have risen 14 bp and 27 bp to 5.24% and 5.71%, respectively. The decline in short-term rates has completely eliminated the yield curve’s inversion for the first time since January 2000; we now have a traditional, upwardsloping yield curve. An inverted yield curve is often seen as a predictor of an economic slowdown or recession, presumably making yield curves with the current shape harbingers of future growth. (continued on next page) 6 • • • • • • • Money and Financial Markets (cont.) Billions of dollars 680 THE MONETARY BASE THE M1 AGGREGATE Sweep-adjusted base growth, 1996–2001 a 15 Sweep-adjusted base b 2% 5% 10 620 12% Sweep-adjusted M1 b 5 0 560 7% Monetary base 7% 500 M1 440 1997 1998 1999 2000 2001 Trillions of dollars 5.25 THE M2 AGGREGATE 5% M2 growth, 1996–2001 a 15 1998 1997 1999 2000 M3 10 2% 5% 6% 6.8 5 1% 0 2002 6% M3 growth, 1996–2001 a 15 1% 5 2001 Trillions of dollars 7.8 THE M3 AGGREGATE M2 10 4.75 2002 2% 0 5% 6% 1% 4.25 2% 5.8 5% 6% 2% 1% 6% 5% 2% 1% 3.75 4.8 1997 1998 1999 2000 2001 2002 1997 1998 1999 2000 2001 2002 FRB Cleveland • May 2001 a. Growth rates are percentage rates calculated on a fourth-quarter over fourth-quarter basis. The 2001 growth rates for the sweep-adjusted base and sweepadjusted M1 are calculated on a March over 2000:IVQ basis. The 2001 growth rates for M2 and M3 are calculated on an estimated April over 2000:IVQ basis. Data are seasonally adjusted. b. The sweep-adjusted base contains an estimate of required reserves saved when balances are shifted from reservable to nonreservable accounts. Sweepadjusted M1 contains an estimate of balances temporarily moved from M1 to non-M1 accounts. NOTE: Last plots for the monetary base, M1, M2, and M3 are estimated for April 2001. Last plots for the sweep-adjusted base and sweep-adjusted M1 are March 2001. Prior to November 2000, dotted lines for M2 and M3 are FOMC-determined provisional ranges. All other dotted lines represent growth rates and are for reference only. SOURCE: Board of Governors of the Federal Reserve System. Yields on AAA and the slightly lower-quality BAA corporate bonds also have risen somewhat over the course of the year, while conventional 30-year mortgage rates have been virtually unchanged. At first blush, money growth appears to be expanding rapidly across the spectrum of monetary aggregates. On closer inspection, however, a plausible case can be made that the narrow aggregates are not too far out of line with recent history after Y2K effects are accounted for, while much of the growth in the broad aggregates can be attributed to a few sources. Year-to-date growth of the sweepadjusted monetary base reached 5.5% and sweep-adjusted M1 hit 5.8% at annual rates through March (the most recent sweeps data available). Compared to last year’s annual growth, these rates appear very rapid indeed, but a longer view eliminates Y2Krelated volatility and reveals that rates are consistent with the growth experienced during the latter half of the current expansion. Although the broad monetary aggregates were largely insulated from Y2K-related fluctuations, they currently depict growth that is well above recent annual rates. Estimated year-to-date annual growth rates for April are 11.8% for M2 and 13.9% for M3. Keep in mind that uncertainty surrounding tax receipts and payments makes definitive interpretation of the broad aggregates difficult at this time of year. Transitory factors such as increased mortgage refinancing and stock market volatility can lead to temporary increases as (continued on next page) 7 • • • • • • • Money and Financial Markets (cont.) 12-month percent change 10 CONTRIBUTION TO PERCENT CHANGE IN M2 a 12-month percent change 12 CONTRIBUTION TO PERCENT CHANGE IN M3 b 8 M3 M2 9 6 Savings 4 6 M2 2 Retail money market funds Institutional money market funds 3 Large time deposits M1 0 Small time deposits –2 0 1996 1997 1998 1999 2000 2001 1996 Percent 8.0 M2 VELOCITY AND OPPORTUNITY COST Ratio 2.15 6.5 2.05 M2 opportunity cost 1997 1998 1999 2000 2001 8-quarter annualized percent change 12.5 MONEY GROWTH AND INFLATION M2 8.5 5.0 1.95 M2 velocity 3.5 1.85 4.5 2.0 1.75 CPI all items, lagged two years 0.5 1.65 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 0.5 1962 1967 1972 1977 1982 1987 1992 1997 2002 FRB Cleveland • May 2001 a. Weighted by share of M2. b. Weighted by share of M3. Overnight and term repurchases and overnight and term eurodollars not shown. SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; U.S. Department of Commerce, Bureau of Economic Analysis; and Board of Governors of the Federal Reserve System. funds are “parked” in savings and money market mutual funds. Examining individual components’ contributions to the growth rates of the broader aggregates supports this interpretation. The recent surge in M2 growth is due almost entirely to growth in savings deposits (1.4 of the 1.8 percentage point increase in year-over-year M2 growth between December 2000 and March 2001). In turn, M2 growth contributed 1.2 percentage points—and institutional money market mutual funds 1.3 percentage points—to the 1.0 percentage point increase in M3 growth, offsetting total declines of 1.5 percentage points concentrated in large time deposits. The monetary aggregates have featured less prominently in monetary policy since the widely recognized breakdown in many money-demand models during the early 1990s. An enduring shift in velocity (the ratio of economic activity to money) during this time made it hard to determine the quantity of money demanded. Thus, it was difficult to know whether observed money-supply growth exceeded the unpredictable noninflationary money-demand growth. Over long periods, however, inflation undoubtedly is related to money growth. Given the substantial lags associated with monetary policy, the 200 bp cut in the intended federal funds rate might result in continued rapid money growth, which could cause inflationary pressures. 8 • • • • • • • Foreign Exchange Rates Index, April 2000 = 100 130 FOREIGN EXCHANGE RATES, DEVELOPED NATIONS Index, April 2000 = 100 130 FOREIGN EXCHANGE RATES, DEVELOPING NATIONS 125 125 South Korea Australia 120 120 115 115 Thailand 110 110 U.K. India Mexico Canada 105 105 Euro area Japan 100 100 Singapore 95 95 4/4 6/4 8/4 2000 10/4 12/4 2/4 2001 4/4 4/4 6/4 8/4 2000 10/4 12/4 2/4 2001 4/4 Ratio 3.0 FOREIGN INFLATION/U.S. INFLATION, DEVELOPED NATIONS Ratio 16 FOREIGN INFLATION/U.S. INFLATION, DEVELOPING NATIONS 2.5 14 U.K. 12 2.0 Australia Mexico 10 1.5 8 Canada 1.0 Thailand 6 India 0.5 Euro area 0 4 2 Japan South Korea –0.5 0 –1.0 –2 12/97 10/98 8/99 5/00 3/01 Singapore 1/98 7/98 1/99 7/99 1/00 7/00 1/01 FRB Cleveland • May 2001 SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; Board of Governors of the Federal Reserve System; Banco de México; Bank Negara Malaysia; Bank of Japan; European Central Bank; Japan Ministry of Public Management, Home Affairs, Post, and Telecommunications; National Statistics Office of Korea; Organisation for Economic Co-operation and Development; Office for National Statistics U.K.; Reserve Bank of India; Singapore Department of Statistics; Statistical Office of the European Communities; Statistics Canada; and Thailand Ministry of Commerce. The S&P 500 has declined 18% in the past year, and the NASDAQ has fallen 52%. One might expect foreign investors to have liquidated some of their U.S. holdings and reinvested the proceeds abroad; such reinvestment would cause the U.S. dollar to depreciate against other national currencies. With the exception of the Hong Kong (Hang Seng) index, however, which dropped more than 90%, most major international stock markets significantly outperformed the NASDAQ and performed comparably to other U.S. stock indexes. Moreover, the U.S. dollar has appreciated greatly against most of the world’s currencies. The U.S. dollar has gained against a large set of developed nations’ currencies (Australia, Canada, euro area, Japan, and the U.K.). The Canadian dollar and the euro depreciated the least (slightly more than 5%) during this period, while the Australian dollar depreciated more than 15%. The story is similar for developing nations (India, Mexico, Singapore, South Korea, and Thailand), of which only Mexico’s currency did not depreciate. Comparative inflation rates cannot explain exchange rate movements over the past year. Since April 2000 (the dashed vertical line in the lower charts), the U.S. inflation rate has been comparable to or higher than most other countries, except Australia and Mexico. (In these charts, a higher U.S. inflation rate is associated with a number less than one.) Perhaps our strong fiscal position and prospects for future growth relative to other countries account for continued foreign capital inflows over the past year and a consequent appreciation. 9 • • • • • • • The U.S.Trade Balance Billions of dollars 140 U.S. TRADE BALANCE ON GOODS AND SERVICES Billions of dollars 5 U.S. TRADE BALANCE 0 120 –5 100 –10 Imports 80 –15 Exports –20 60 –25 40 –30 20 –35 –40 1/1/92 1/1/93 1/1/94 1/1/95 1/1/96 1/1/97 1/1/98 1/1/99 1/1/00 1/1/01 0 1/1/92 1/1/93 1/1/94 1/1/95 1/1/96 1/1/97 1/1/98 1/1/99 1/1/00 1/1/01 Percent 6 GDP GROWTH a Billions of dollars 40 THE CURRENT ACCOUNT AND ITS COMPONENTS 5 20 Top 15 trading partners U.S. Balance on investment income 0 4 Unilateral transfers –20 3 –40 Balance on goods and services 2 –60 1 –80 Current acccount 0 –100 –1 1990 1992 1994 1996 1998 2000 2002 –120 3/1/80 3/1/82 3/1/84 3/1/86 3/1/88 3/1/90 3/1/92 3/1/94 3/1/96 3/1/98 3/1/00 FRB Cleveland • May 2001 a. Data for 2000, 2001, and 2002 are forecasts. SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; International Monetary Fund, International Financial Statistics; Blue Chip Economic Indicators, April 10, 2001; Organisation for Economic Co-operation and Development, World Economic Outlook, May 2000; and Economist, April 14–20, 2001. The U.S. trade deficit in goods and services fell $6.3 billion in February to $27 billion as the result of a $0.9 billion increase in exports and a $5.4 billion decline in imports. The trade deficit (exports minus imports) rose rapidly between March 1998 and September 2000, then held steady at around $33 billion until January 2001. February’s trade deficit is the smallest since December 1999. Exports of goods rose $0.6 billion; goods imports fell $5.5 billion (the largest monthly drop on record), reflecting a weak domestic economy. U.S. imports declined most significantly in consumer goods ($1.9 billion), industrial supplies and materials ($1.8 billion), and capital goods ($1.3 billion). Autos and auto parts, energy-related crude and petroleum products, and imports of food and beverages also contributed to the decline. The 2000 trade deficit exceeded that of 1999 by 39%. If monthly deficits stay at the current level for the rest of this year, the annual deficit will be 10.5% less than it was in 2000. Since 1997, the trade deficit has largely reflected a divergence between U.S. and foreign economic growth. Forecasters have been expecting foreign growth to be about 3% in 2001—one percentage point or so more than in the U.S. Such an outcome could trim some of the trade gap of the past four years and begin to correct the massive U.S. current account deficit. However, continued shading of foreign growth forecasts and the surprising strength of U.S. GDP growth in 2001:IQ caution against premature optimism about such an outcome. 10 • • • • • • • Economic Activity Annualized percent change from previous quarter 4.0 GDP AND BLUE CHIP FORECAST a a,b Real GDP and Components, 2000:IVQ (Advance estimate) Change, billions of 1996 $ Real GDP 46.2 Personal consumption 49.3 Durables 25.5 Nondurables 12.2 Services 15.1 Business fixed investment 3.9 Equipment –6.0 Structures 7.8 Residential investment 2.9 Government spending 15.5 National defense 4.2 Net exports 36.8 Exports –6.2 Imports –43.0 Change in business inventories –62.8 Percent change, last: Four Quarter quarters 2.0 3.1 11.9 2.6 1.7 2.7 3.4 2.6 3.0 3.7 1.1 –2.1 11.0 3.3 4.0 4.8 — –2.2 –10.4 5.6 4.2 10.1 –2.6 2.6 4.8 — 4.5 5.3 — — 30-year average 3.5 3.0 Blue Chip forecast c Advance estimate Final percent change 2.5 2.0 1.5 1.0 0.5 IIIQ IVQ IQ IIQ 2000 IIIQ IVQ 2001 Percentage point 6.0 CONTRIBUTION TO REAL GDP GROWTH Billions of dollars 4 CHANGE IN INVENTORY LEVELS 4.5 3 Manufacturing 3.0 2 2000:IQ 2001:IQ Business fixed investment Retail 1.5 1 Government spending Exports Change in inventories Retail automotive 0 0 –1 –1.5 Personal consumption Residential investment Imports Wholesalers –2 October –3.0 November 2000 December January February 2001 FRB Cleveland • May 2001 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. Projections for 2001:IQ–2001:IVQ are based on the issue of Blue Chip Economic Indicators dated April 10, 2001. Forecasts for previous quarters are based on the issues dated three months prior to the end of a quarter. NOTE: All data are seasonally adjusted and annualized. SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis and Bureau of the Census; and Blue Chip Economic Indicators, various issues. The advance estimate for the National Income and Product Accounts, released April 27, reported output growth of 2.0% in 2000:IQ—much stronger than had been expected. (The Blue Chip forecast for the first quarter was for less than 1% growth.) Some might interpret this surprising strength as a sign that further reductions in the Federal Open Market Committee’s intended federal funds rate will be unnecessary, or even that the target should be raised. More realistically, only time will tell whether the quarter was merely a pause or in fact was the floor of the recent economic slowdown. Given the unexpected strength of the first quarter, it will be interesting to see whether the Blue Chip forecast for the rest of the year is revised upward. The path previously projected was a gradual rise over the rest of the year to a trend growth rate of just over 3%. The first-quarter growth rate of 2% was higher than expected. It also was higher than in 2000:IVQ, but a year ago the economy was growing robustly at about 5% in 2000:IQ. Three major factors account for this year’s slowdown: personal consumption, business investment, and imports. Growth rates for all categories of consumer spending have declined relative to a year ago, while the decline in business investment growth is concentrated primarily in equipment and software. A widespread drop in inventories (negative inventory investment) also contributed to the economy’s weak performance over the past couple of quarters. Retail inventory investment (continued on next page) 11 • • • • • • • Economic Activity (cont.) Four-quarter percent change 20 CHANGE IN THE MOTOR VEHICLE INDUSTRY Billions of dollars 8 15 6 Production a Percent 5.5 MOTOR VEHICLES IN THE U.S. ECONOMY 5.0 Dealer sales 10 Share of GDP 4 4.5 5 2 4.0 0 0 –5 –2 3.5 Corporate profits b –10 –4 –6 –15 IQ IIIQ 1997 IQ IIIQ IQ 1998 IIIQ IQ 1999 IIIQ 3.0 Share of employment c 2.5 IQ 2001 2000 1967 1972 1977 1982 1987 1992 1997 Percent 7 MOTOR VEHICLE EARNINGS/TOTAL EARNINGS Percent 5.5 MOTOR VEHICLE EMPLOYMENT/TOTAL NONFARM EMPLOYMENT 5.0 6 Ohio Ohio 4.5 5 4.0 Kentucky 3.5 4 Kentucky 3.0 U.S. 3 2.5 U.S. 2 2.0 1970 1975 1980 1985 1990 1995 1970 1975 1980 1985 1990 1995 FRB Cleveland • May 2001 a. Industrial production of motor vehicles and parts. b. Corporate profits, adjusted for inventory valuation and capital consumption. c. Employment by motor vehicle manufacturers and retailers as a share of total nonfarm employment. NOTE: All data are seasonally adjusted and annualized. SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis and Bureau of the Census; U.S. Department of Labor, Bureau of Labor Statistics; and Board of Governors of the Federal Reserve System. has been on a downward path for several months. The assertion that “what’s good for General Motors is good for the U.S.A.” has been scoffed at for many years. Nonetheless, it remains true that the automotive industry is an important feature of the U.S. economy. For example, the drop in auto inventories and production is responsible for a substantial proportion of the fall in output growth over the past two quarters. While the auto industry’s share of total U.S. nonfarm employment has fallen since the 1970s, it is still about 2.5%. For the states of the Fourth District, the auto industry is somewhat more important; in Ohio and Kentucky, for example, automotive jobs account for about 3.5% of the total. Moreover, employment share may understate the importance of this sector, since automotive jobs tend to pay better than average. In Ohio and Kentucky, around 5% of total earnings, compared to 3.5% of all jobs, are due to the motor vehicle industry. Likewise, for the U.S. as a whole, the auto industry’s share of output is higher than its employment share. In the mid-1990s, the motor vehicle sector generated around 3.5% of total GDP, compared to 2.5% of total employment. For many communities, like the Toledo area, these figures understate the industry’s importance. Furthermore, these figures measure only the direct effects of the automotive sector, missing the indirect effects of autoworkers’ spending in their local communities. 12 • • • • • • • Labor Markets Change, thousands of workers 350 AVERAGE MONTHLY NONFARM EMPLOYMENT GROWTH Labor Market Conditions Average monthly change (thousands of employees) 300 250 200 150 100 50 0 –50 –100 1997 1998 1999 2000 April 2001 Payroll employment 280 Goods-producing 48 Mining 1 Construction 21 Manufacturing 25 Durable goods 27 Nondurable goods –2 Service-producing 232 16 TPUa Retail trade 24 b 21 FIRE 141 Servicesc Government 17 251 22 –3 37 –12 –2 –11 229 20 30 22 120 28 229 4 –3 25 –18 –6 –12 225 16 36 10 124 28 153 1 1 14 –14 –4 –10 153 15 26 4 91 11 –223 –164 4 –64 –104 –73 –31 –59 –2 22 8 –121 38 –150 Average for period (percent) Civilian unemployment rate –200 4.9 4.5 4.2 4.0 1999 2000 4.5 –250 1994 1995 1996 1997 1998 1999 2000 Jan. Feb. Mar. 2001 Percent 65.0 LABOR MARKET INDICATORS d Apr. Percent 8.2 64.5 7.6 Thousands of claims 425 INITIAL UNEMPLOYMENT CLAIMS e 400 Employment-to-population ratio 64.0 7.0 63.5 6.4 63.0 5.8 62.5 5.2 375 350 325 Civilian unemployment rate 300 62.0 4.6 61.5 4.0 275 3.4 250 61.0 1993 1994 1995 1996 1997 1998 1999 2000 2001 1994 1995 1996 1997 1998 2001 FRB Cleveland • May 2001 a. Transportation and public utilities b. Finance, insurance, and real estate. c. The services industry includes travel; business support; recreation and entertainment; private and/or parochial education; personal services; and health services. d. Dotted vertical line indicates break in data series due to survey redesign. e. Four-week moving average. NOTE: All data are seasonally adjusted. SOURCE: U.S. Department of Labor, Bureau of Labor Statistics. The downward trend in payroll employment continued in April, with a net loss of 223,000 jobs. As in March, large job losses occurred in manufacturing and help supply services. In a notable departure from previous trends, however, the overall service-producing sector lost 59,000 jobs; more specifically, the services industry lost more than 120,000 jobs. Construction also sustained large employment losses. The unemployment rate rose 0.2 percentage points in April, bringing the total increase over the last six months to 0.6 percentage points. Jobless rates for adult women (3.8%) and whites (4.0%) both registered a monthly increase, while unemployment rates for other major worker groups (adult men, teenagers, blacks, and Hispanics) remained relatively unchanged from March. Since October 2000, however, unemployment rates for all major worker groups have increased significantly. The employment-to-population ratio declined again in April. The civilian labor force remained about constant at 141.8 million, so the labor force participation rate stayed fairly stable at 67.1%. Initial unemployment claims, considered a leading economic indicator, continued to climb during the last week of April, with the four-week moving average (404,500) rising above 400,000 claims for the first time since August 1992. Since April 2000, when initial claims reached the lowest level in more than 25 years, there has been an increase of nearly 140,000 claims. 13 • • • • • • • Supplemental Appropriations Billions of dollars 60 MANDATORY AND DISCRETIONARY SPENDING Billions of dollars 60 SUPPLEMENTAL APPROPRIATIONS 50 50 Mandatory 40 Discretionary Supplemental spending only 40 30 30 20 10 20 0 10 Spending net of rescisions –10 0 –20 1990 1992 1994 1996 1998 1990 2000 1992 1994 1996 1998 2000 Billions of dollars 60 SUPPLEMENTAL REQUESTS AND ACTUALS Percent of total discretionary budget authority 12 DISCRETIONARY SUPPLEMENTAL APPROPRIATIONS 50 Requested by President 9 Enacted by Congress Domestic 40 International Defense 30 6 20 3 10 0 0 1990 1992 1994 1996 1998 2000 1990 1992 1994 1996 1998 2000 FRB Cleveland • May 2001 SOURCE: Congressional Budget Office, Supplemental Appropriations in the 1990s. Washington, D.C.: Government Printing Office, 2001. Although budget authority for discretionary federal outlays is established annually through the budgeting process, Congress enacts supplemental appropriations bills outside of the budget cycle. Attempts to offset supplemental spending by enacting coincident rescisions (downward revisions of budgeted monies for specified agencies or programs) were made throughout the 1990s, but only in 1995 was supplemental spending completely offset by rescisions. Supplemental appropriations for mandatory outlays are designated to accommodate revenue shortfalls in specific trust funds. Throughout the 1990s, only 9% of all supplemental appropriations were mandatory, whereas in the previous two decades, supplemental mandatory and discretionary spending were distributed fairly evenly. Most discretionary supplemental appropriations in 1991 were for military operations Desert Storm and Desert Shield. Domestic spending dominated discretionary supplemental appropriations from 1993 to 1998, but defense spending re-emerged as the largest category in 1999 and 2000 because of peacekeeping missions in Bosnia and Kosovo. Humanitarian relief for refugees of these crises also raised discretionary supplemental spending for international causes to the highest levels of the decade. Congress was unwilling to grant the full amount of supplemental appropriations requested by the President between 1993 and 1995, but the reverse held in all but one year since 1996. While Congress’s overall supplemental spending in the 1990s ($138 billion) was slightly larger than the President’s requests ($132 billion), the amount of total rescisions enacted by Congress was almost three times that requested by the President ($52 billion compared to $18 billion). 14 • • • • • • • The 2000 Census POPULATION GROWTH, 1990–2000 Greater than 39.5% 26.4%–39.5% 13.2%–26.3% Less than 13.2% (U.S. average) CENTERS OF U.S. POPULATION, 1800–2000 APPORTIONED NUMBER OF SEATS IN THE U.S. HOUSE OF REPRESENTATIVES, 2000 Gained 1 seat No change Lost 1 seat 2 Lost 2 seats 18 1 2 18 18 10 5 2 1800 1950 1900 19 5 1850 19 8 18 9 13 1 3 2000 9 6 9 11 13 FRB Cleveland • May 2001 SOURCE: U.S. Department of Commerce, Bureau of the Census. Preliminary data from Census 2000 show that the U.S. population grew 13.2% between 1990 and 2000. Every state’s population increased, but rapid growth was concentrated in the South and West. Growth rates in the Midwest and Northeast lagged the national trend. Kentucky posted the highest growth rate among Fourth District states (9.7%), while West Virginia reported the second-lowest growth rate in the nation (0.8%, slower than all but North Dakota). Ohio’s population growth over the decade was 4.7% and Pennsylvania’s was 3.4%. Following the fastest growth, the center of U.S. population continued its pattern of south- and westward movement since the previous census (in fact, the nation’s population center has shifted southwest in every census since the first). Calculated as the point of balance if the U.S. were a perfectly flat plane and each of its 281,421,906 residents weighed exactly the same, the current U.S. population center is in Phelps County, Missouri. Reflecting this southwesterly movement, Fourth District states’ populations, while increased, lagged growth rates of states such as California and Texas. As a result, the District lost three apportioned seats in the U.S. House of Representatives—two from Pennsylvania and one from Ohio—forcing these states’ congressional district lines to be redrawn sometime this year. For Kentucky and West Virginia, representation in the House was unchanged. Newly released county data confirm that the Fourth District’s population is concentrated around Cleveland, Cincinnati, Columbus, and (continued on next page) 15 • • • • • • • The 2000 Census (cont.) 2000 POPULATION POPULATION GROWTH RATES, 1990–2000 More than 750,000 Greater than 25% 250,000–749,999 15%–25% 100,000–249,999 50,000–99,999 10%–14.9% 0–9.9% Less than 50,000 Decline in population Fastest-Growing County Populations in the Fourth District National growth rate ranking County 40 Delaware, OH 2000 population 109,989 Most Populous Metropolitan Statistical Areas in the Fourth District 1990–2000 growth rate (percent) National population ranking Boone, KY 137 Grant, KY 161 Warren, OH 167 Scott, KY 85,991 1990– 2000 growth (percent) National growthrate ranking Cleveland–Akron CMSA 2,945,831 3.0 233 22 Pittsburgh MSA 2,394,811 –1.5 265 24 Cincinnati– Hamilton CMSA 1,979,202 8.9 172 33 Columbus MSA 1,540,157 14.5 109 53 Dayton–Springfield MSA 950,588 –0.1 257 49.3 22,384 42.2 158,383 39.0 33,061 2000 population 64.3 16 90 Metropolitan area 38.5 FRB Cleveland • May 2001 SOURCE: U.S. Department of Commerce, Bureau of the Census. Pittsburgh. Northeast Ohio has the highest density of people, while counties in the northwest corner of the state and in Kentucky, which are largely agricultural, have the lowest density. Counties with the fastest-growing populations are located along the western Kentucky boundary of the District and north of Columbus. Population in most counties in the eastern part of the District declined, with all District counties in West Virginia reporting losses and all but one District county in Pennsylvania reporting either losses or modest growth that lagged the national trend. Population growth rates in the District suggest continued migration from central cities in metropolitan statistical areas to surrounding counties. With few exceptions, the District’s fastest growth occurred in counties adjacent to a county containing an MSA’s central city. (The District’s five fastest-growing counties fall into this category.) Population in Cuyahoga, Allegheny, and Hamilton counties (containing central cities Cleveland, Pittsburgh, and Cincinnati, respectively) fell during the last decade. Among the District’s metropolitan statistical areas, Cleveland–Akron remained the largest, although its national rank fell from 13 to 16 between 1990 and 2000. Population growth rates in District MSAs were low compared to other MSAs: The highest-ranking MSA was Columbus (109 out of 280). With the exception of Columbus and Cincinnati, all of the District’s MSAs fell into the lowest third when ranked nationally according to population growth. 16 • • • • • • • Commercial Bank Lending to Small Businesses Billions of dollars 1,200 COMMERCIAL BANK LENDING AVERAGE ANNUAL GROWTH IN SMALL BUSINESS LOANS, 1995–2000 Percent 40 Commercial and industrial loans Small business loans 1,000 38 Small business loans/total business loans 800 36 600 34 400 32 8.7% to 32.7% 5.8% to 8.7% 0% to 5.8% –18.6% to 0% 200 30 1995 Percent 100 SHARE OF SMALL-BUSINESS-LOAN MARKET BY BANK ASSET SIZE 1996 1997 1998 1999 2000 Percent 100 SHARE OF SMALL BUSINESS LOANS IN TOTAL LOAN PORTFOLIO BY BANK ASSET SIZE 80 Less than $100 million 80 Less than $100 million Greater than $100 million to $1 billion Greater than $100 million to $1 billion Greater than $1 billion Greater than $1 billion 60 60 40 40 20 20 0 0 1995 1996 1997 1998 1999 2000 1995 1996 1997 1998 1999 2000 FRB Cleveland • May 2001 SOURCE: Federal Financial Institutions Examination Council, Report of Condition and Income, various issues. The U.S. Small Business Administration Office of Advocacy reports that in 1999, small businesses with fewer than 500 workers employed 53% of the private nonfarm workforce, made 47% of all sales in the U.S., and were responsible for 51% of the private gross domestic product. Lending by commercial banks reflects small businesses’ importance in the economy. With the exception of Florida and the northern parts of both coasts (11 states and the District of Columbia), small business lending (loans less than $1 million) grew at an average annual rate of 10.3% in 1995–2000. Within Fourth District states, growth rates reached 16.9% in Ohio, 5.0% in West Virginia, 4.4% in Kentucky, and 2.3% in Pennsylvania. Small business lending grew at a 7.4% rate nationwide in 1995–2000, but this figure is lower than the 8.6% growth rate in commercial and industrial lending. Consequently, the share of small business loans in commercial banks’ business loan portfolios fell from 36% to 31% over this period. Commercial banks with assets greater than $1 billion control over half the market for loans to small businesses. In 1995–2000, their market share grew from 54% to more than 60%. One-third of this gain came at the expense of midsize banks with assets of $100 million to $1 billion, whose market share dropped from 35% to 33% in the course of five years. Small banks with assets less than $100 million suffered the biggest loss in market share—from 11% to 7%. Although large banks dominate the small business market, in 2000 the share of small business loans in large banks’ total business loan portfolio was less than 25% and declining. Small banks, however, remained heavily engaged in this market. 17 • • • • • • • FHLB Advances to Depository Institutions Billions of dollars 300 FHLB ADVANCES Percent 5 FHLB ADVANCES/INTEREST-BEARING LIABILITIES 250 Percent 25 20 4 Savings institutions Savings institutions 200 13% 3 15 2 10 150 59% 100 Banks Banks 5 1 50 0 0 1992 1994 1996 1998 2000 0 1992 1994 1996 1998 2000 Basis points 40 Percent 8 FHLB ADVANCES AND RELATIVE COST Percent 90 DEPOSITS/INTEREST-BEARING LIABILITIES Rate spread: Six-month FHLB advance minus CD 85 6 30 FHLB advances/deposits 80 Banks 4 20 2 10 Savings institutions 75 70 0 65 1992 1994 1996 1998 2000 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 FRB Cleveland • May 2001 SOURCES: Board of Governors of the Federal Reserve System, “Selected Interest Rates,” Federal Reserve Statistical Releases, H.15; Federal Deposit Insurance Corporation, Quarterly Banking Profile, various issues; and Bloomberg Financial Information Services. Federal Home Loan Banks (FHLBs) were established to lend to federally chartered thrift institutions and member banks having at least 10% of their assets in mortgages. FHLB advances had to be collateralized by borrowing institutions’ mortgage portfolios. The Financial Modernization Act of 1999 enabled FHLBs to depart from their traditional role of providing housing finance. They now can lend outside the housing sector to community banks, accepting banks’ loans to small businesses, small farms, and small agribusinesses as collateral. FHLB advances to commercial banks increased from almost zero in the early 1990s to $175 billion in 2000. However, advances’ growth rate declined from 59% (annualized) in 1992–99 to 13% in 2000. During the same period, FHLB advances to savings institutions rose from $72 billion to $261 billion. As of 2000, these FHLB advances constituted 3.5% of banks’ and 23% of savings institutions’ interest-bearing liabilities. Banks and savings institutions increased the share of FHLB advances in their liabilities at the expense of interest-bearing deposits. In 1992, deposits constituted 87% of savings institutions’ liabilities, but this share fell to 66% in 2000. Similarly, commercial banks’ deposit-to-liability ratio dropped from 80% in 1992 to 69% in 2000. One explanation for this shift from deposits to FHLB advances is the decline in advances’ cost relative to deposit rates. The average rate spread between the six-month FHLB (New York) advance and the CD fell from 32 basis points (bp) in 1994 to 4 bp in 2000. Including the cost of deposit insurance, which varies between zero and 27 bp, the FHLB advance is clearly a lower-cost funding alternative. 18 • • • • • • • Foreign Central Banks Percent 25 THREE-MONTH GOVERNMENT SECURITY RATES Percent 8 MONETARY POLICY TARGET RATES a 7 Federal Reserve 20 Brazil 6 Bank of England Bank of Canada 5 15 4 Mexico European Central Bank 10 3 Argentina 2 5 Chile 1 0 1/1/00 0 4/1/00 7/1/00 10/1/00 1/1/01 Percent 0.8 JAPANESE MONETARY POLICY RATES 1/1/00 4/1/01 Trillions of yen 4.0 4/1/00 7/1/00 10/1/00 1/1/01 4/1/01 Percent 6.5 EURO ZONE MONETARY POLICY RATES 3.5 0.7 6.0 Current account balances excluding reserve balances Marginal lending facility 3.0 0.6 Official discount rate 5.5 0.5 2.5 0.4 2.0 Euro overnight interbank average b 5.0 Call money rate 1.5 0.3 4.5 0.2 1.0 0.1 0.5 Main refinancing operations 4.0 0 4/1/97 10/1/97 4/1/98 10/1/98 4/1/99 10/1/99 4/1/00 0 10/1/00 4/1/01 Deposit facility 3.5 1/1/01 1/29/01 2/20/01 3/26/01 4/20/01 FRB Cleveland • May 2001 a. Overnight interbank rates except for the European Central Bank, whose main refinancing rate is shown. b. The weighted average rate on all overnight unsecured lending transactions in the interbank market, initiated within the euro area by contributing panel banks. SOURCES: Board of Governors of the Federal Reserve System; Bank of Japan; and International Monetary Fund, International Financial Statistics. Reductions in the Federal Open Market Committee’s interest rate target this year have been paralleled by three other central banks of the G7, but not by the European Central Bank (ECB). While the economic outlook for all the G7 nations has dimmed at least somewhat, concern about above-target inflation has restrained the ECB from adjusting its policy rates. Experience in Latin and South America has been less uniform. Shortterm interest rates in Chile and Mexico have drifted down with those of the G7. Argentina and Brazil, however, have faced special challenges to monetary stability that have engendered substantial variations in their money market interest rates. In March, the Bank of Japan shifted its operating policy target from an overnight call rate “around 0.15%” to a quantity of current account balances on deposit with the bank “around Y5 trillion.” This quantity target (about Y1 trillion above required reserves) distinguishes current policy from the so-called zero interest rate target that prevailed between February 1999 and August 2000. The recent rough correspondence between the level of the call rate and the level of current account balances in excess of required reserves suggests that the call rate should average close to zero, as the Bank of Japan expects. Recent European experience illustrates the operation of a Lombardtype central bank lending facility, embodied in the ECB’s marginal lending facility. The ECB stands ready to make collateralized loans to approved institutions at a rate 100 basis points above the policy target. Normally, little borrowing takes place, but when the supply of base money is restricted relative to demand (as in February and April 2001) the lending facility serves to cap the market rate for overnight loans.
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