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1 • • • • • • • The Economy in Perspective (with apologies to William Shakespeare) To cut, or not to cut—that is the question: Whether ’tis nobler in the end to suffer The slings and arrows of a slow expansion, Or aim policy against a sea of troubles, And by opposing end them? To cut: to reduce A quarter point or more; and thereby strive to end The heartache and the thousand natural shocks Th’economy is heir to. ’Tis a consummation Devoutly to be wish’d. To cut, t’offset— T’offset—perchance to dream: ay, there’s the rub; For in th’attempt to counteract, what else may come When we provide still more liquidity Must give us pause. There’s the respect That makes calamity of too much money. And who’d deny that commerce now doth wax, Tho’ it be slow and without equal measure, Despite pangs of consumer sentiment, The dearth of capital spending, and the ills That linger over trade with foreign lands? Cannot the Fed e’en now provide its aid By means of actions previously taken? Or must it spur the markets further yet, Hoping that rates beneath today’s will be The fulcrum whence our commerce may rebound? Are interest rates not now too low to last, Or must we step once back to step twice forward? Will more liquidity buoy up the argonaut Or drown his patience, that most undervalued virtue? Such thoughts do tempt the will, But should we rather bear those ills we have Than fly to others that we know not of? Thus conscience makes hard choices for us all. Messengers bring news of pith and moment And we parse their reports ten-fold, nay, more, Examining each meaning in our councils.—Soft you now! Tho’ in their balance stars may point to weakness Our policy’s accommodative still. Transcripts of history!—In thy report FRB Cleveland • September 2000 Will our intentions gain transparency. 2 • • • • • • • Inflation and Prices 12-month percent change 4.00 CPI AND CPI EXCLUDING FOOD AND ENERGY July Price Statistics 3.75 Percent change, last: 2001 a a a 1 mo. 3 mo. 12 mo. 5 yr. avg. 3.50 CPI 3.25 Consumer prices 3.00 All items 1.3 0.9 1.5 2.3 1.5 Less food and energy 1.9 1.5 2.3 2.3 2.7 2.50 Medianb 3.0 2.8 3.4 3.1 3.9 2.25 2.75 Producer prices 2.00 Finished goods –2.6 –2.0 –1.1 –1.1 –1.7 Less food and energy –3.9 –0.5 –0.2 1.1 0.9 CPI excluding food and energy 1.75 1.50 1.25 1.00 1995 12-month percent change 4.25 CPI AND TRIMMED-MEAN CPI MEASURES 1996 1997 1998 1999 2000 2001 2002 12-month percent change 4.5 CHAINED CPI AND CPI 4.00 4.0 3.75 3.5 3.50 CPI 3.25 3.0 Median CPI b 3.00 2.5 2.75 2.50 2.0 2.25 1.5 2.00 Chained CPI CPI 1.75 1.0 1.50 CPI, 16% trimmed mean b 1.25 1.00 1995 0.5 0 1996 1997 1998 1999 2000 2001 2002 2001 2002 FRB Cleveland • September 2002 a. Annualized. b. Calculated by the Federal Reserve Bank of Cleveland. SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; and Federal Reserve Bank of Cleveland. The Consumer Price Index rose 0.1% (1.3% annual rate) in July, the same rate of increase it posted in June. According to the Labor Department, the CPI indexes for food and energy, which were unchanged in June, rose 0.2% for food (2.1% annual rate) and 0.4% for energy (5.0% annual rate) in July. Moreover, the CPI communications index rose sharply during the month, partly because of a hike in postal rates. Over the most recent 12 months, the CPI has risen at a modest 1.5% rate. Core measures of inflation, by contrast, continue to rise more rapidly. The CPI excluding food and energy, for instance, rose at a 2.3% rate over the past 12 months. During the same period, the trimmed-mean inflation measures—the median CPI and the 16% trimmed-mean CPI— rose 3.4% and 2.1%, respectively. Despite the faster rate of increase, however, all core measures have been trending down throughout the course of this year. In July, the Labor Department issued a new index, the chained CPI, which is intended to improve on the conventional CPI by addressing the issue of substitution bias. Substitution bias arises when a price index fails to account for the way a change in (relative) prices might cause consumers to change how they allocate expenditures among the items in their market basket. The conventional CPI, for instance, assumes that the market basket remains fixed: No matter how much the price of one good may rise relative to others, consumers are assumed to continue buying these goods in the same relative quantities. The chained CPI, by contrast, uses a method that accounts for the fact (continued on next page) 3 • • • • • • • Inflation and Prices (cont.) 12-month percent change 3.5 CORE CHAINED CPI AND CORE CPI 12-month percent change 3.5 CHAINED CPI AND PCEPI 3.0 3.0 Chained CPI Core CPI 2.5 2.5 2.0 1.5 2.0 PCEPI a Core chained CPI 1.0 1.5 0.5 1.0 0 2001 2002 2001 Annualized quarterly percent change 5 ACTUAL CPI AND BLUE CHIP FORECAST b 2002 12-month percent change 5.5 HOUSEHOLD INFLATION EXPECTATIONS c 5.0 4 4.5 Highest 10% CPI 3 4.0 Five years ahead Consensus 3.5 2 3.0 Lowest 10% 1 2.5 One year ahead 2.0 0 1.5 –1 1995 1.0 1996 1997 1998 1999 2000 2001 2002 2003 2004 1995 1996 1997 1998 1999 2000 2001 2002 FRB Cleveland • September 2002 a. Personal Consumption Expenditures Price Index. b. Blue Chip panel of economists. c. Mean expected change in consumer prices as measured by the University of Michigan’s Survey of Consumers. SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; U.S Department of Commerce, Bureau of Economic Analysis; University of Michigan; and Blue Chip Economic Indicators, August 10, 2002. that the consumers’ market basket changes over time in response to changes in relative prices. Estimates of the substitution bias inherent in the conventional CPI calculation have generally been lower than +0.5% annually. Indeed, a commission convened by the Senate Finance Committee in the mid-1990s concluded that inflation was being overestimated by 0.2%–0.4% annually. The chained CPI has been available only for the last few years, but simulations by the Bureau of Labor Statistics indicate that these bias estimates were appropriate for most of the 1990s. During the current decade, the gap has become much more pronounced, often nearly a full percentage point. In recent months, however, the difference between the year-overyear differential has narrowed to about 0.4%. Chaining the core measure tells much the same story, with differences in annual growth between the chained and conventional indexes at or near a full percentage point in 2000 and 2001 and narrowing to 0.6% in the most recent several months. Interestingly, the measure that tracks the chained CPI most closely is the Personal Consumption Expenditures Price Index, which uses a similar chaining method. Economists’ consensus expectation of inflation is about 2.5% over the next 18 months. Households seem optimistic about the inflation outlook over the short run: Their year-ahead expectations of inflation have fallen for the third consecutive month. However, households are less sanguine about the inflation outlook for the next five years or so; these longerrun expectations have been trending up since the beginning of this year. 4 • • • • • • • Monetary Policy Percent 8 RESERVE MARKET RATES Percent 3.25 IMPLIED YIELDS ON FEDERAL FUNDS FUTURES 7 3.00 Effective federal funds rate a March 20, 2002 Intended federal funds rate b 6 2.75 May 8, 2002 2.50 5 2.25 4 June 28, 2002 2.00 Discount rate a 3 1.75 August 19, 2002 August 14, 2002 2 1.50 1 1998 1.25 1999 2000 2001 2002 Percent, quarterly 9 FEDERAL FUNDS RATE AND INFLATION TARGETS February June 2002 February October June 2003 Federal Funds Rate Policies, 1982–2002 8 7 6 Effective federal funds rate Avg. Max. Increase Number of months Percent change Min. 3.7 1.09 12.1 3.25 0.7 .125 Decrease Number of months Percent change 6.3 1.61 39.7 6.75 1.4 .25 Stationary Number of months 8.4 18.4 0.9 5 4 3 2 Inflation targets: 0% 1% 2% 3% 4% (federal funds rates implied by Taylor rules) c 1 0 1998 1999 2000 2001 2002 FRB Cleveland • September 2002 a. Weekly average of daily figures b. Daily c. The formula for the implied funds rate is taken from the Federal Reserve Bank of St. Louis, Monetary Trends, January 2002, which is adapted from John B. Taylor, “Discretion versus Policy Rules in Practice,” Carnegie–Rochester Conference Series on Public Policy, vol. 39 (1993), pp. 195–214. SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; Congressional Budget Office; Board of Governors of the Federal Reserve System; Federal Reserve Bank of New York; Haver Analytics; and Bloomberg Financial Information Services. At its August 13 meeting, the Federal Open Market Committee left the target federal funds rate unchanged, although it altered the balance-of-risk statement “towards conditions that may generate economic weakness.” The federal funds futures market now has built in a strong possibility of lower rates. With implied yields reaching a minimum of 1.59% in February 2003, the market seems quite confident of a 25 basis point cut by early next year. The Taylor rule, one gauge of monetary policy, posits that the FOMC chooses the target rate as a balanced response to weakness and inflation. The form of the Taylor rule depends on the weights given to inflation and output, and to the assumed inflation target. Recently, the rule has correctly predicted the direction of changes in the federal funds rate. Waiting can be the hardest part, but the eight and a half months since the target federal funds rate last moved is about the average period of no action over the past 20 years. The most recent rate reduction far exceeded the average, both in duration (11 months) and in the size of the decline (4.75%), although it set no records in either. Cumulative rate reductions have been larger and have taken longer to implement than cumulative rate increases. On average, however, periods when the FOMC has held rates steady have been the longest. 5 • • • • • • • Money and Financial Markets Percent, daily 5.0 TREASURY-BASED INFLATION INDICATORS Percent 8 PENNACCHI MODEL a 4.5 10-year TIIS yield 4.0 6 30-day Treasury bill 3.5 3.0 4 Estimated real interest rate 2.5 2.0 2 Estimated expected inflation rate 1.5 Yield spread: 10-year Treasury minus 10-year TIIS 1.0 0 0.5 0 1998 –2 1999 2000 2001 2002 1997 1999 2000 2001 2002 Dollars per troy ounce 500 CASH PRICE OF GOLD, HANDY AND HARMAN BASE c Trillions of dollars 5.9 THE M2 AGGREGATE 5% M2 growth, 1997–2002 b 12 450 10% 9 1% 400 6 5.2 1998 5% 3 350 0 5% 300 1% 5% 4.5 250 1% 5% 200 1% 3.8 10/97 10/98 10/99 10/00 10/01 10/02 150 1990 1992 1994 1996 1998 2000 2002 FRB Cleveland • September 2002 a. The estimated expected inflation rate and the estimated real rate are calculated using the Pennacchi model of inflation estimation and the median-forecast GDP implicit price deflator from the Survey of Professional Forecasters. Monthly data. b. Growth rates are calculated on a fourth-quarter over fourth-quarter basis. Data are seasonally adjusted. c. Wall Street Journal. SOURCES: Board of Governors of the Federal Reserve System, “Selected Interest Rates,” H.15; Bloomberg Financial Information Services; and Wall Street Journal. The Federal Open Market Committee’s August 13 statement indicated that the balance of risks for the economy tilted toward economic weakness, a change from its previous statement that economic weakness and inflation were evenly balanced. How do the financial markets view the current balance of risks? Put another way, do market participants see a 1.75% federal funds rate or an M2 growth rate of more than 5% as a sign of inflation? Over the long term, the answer seems to be no. One market measure of expected inflation, the spread between yields on 10-year nominal Treasury bonds and 10-year Treasury inflation-indexed bonds, has fallen. In late May, the spread implied expected inflation exceeding 2%; it now implies values closer to 1.75%. In the short term, the answer again appears to be no. A measure of expected inflation over the next 30 days, derived from surveys and Treasury bill rates, suggests a rate of only 2.4% A less favorable indicator of inflation risk comes from the gold market, where prices have increased 21% since April 2001 and 12% since the beginning of this year. However, the price of gold is not an infallible sign of inflation because often it is (continued on next page) 6 • • • • • • • Money and Financial Markets (cont.) Percent, weekly 1.5 TREASURY-TO-EURODOLLAR SPREAD a Percent, weekly 1.8 YIELD SPREAD: 90-DAY COMMERCIAL PAPER MINUS 3-MONTH TREASURY 1.2 1.4 0.9 1.0 0.6 0.6 0.3 0.2 0 1997 1998 1999 2000 2001 2002 Percent 12 SPREADS OF CORPORATE BOND YIELDS MINUS THE 10-YEAR TREASURY YIELD –0.2 1997 1998 1999 2000 2001 2002 Number of actions 2.0 U.S. CORPORATE CREDIT RATINGS REVISION, UPGRADES/DOWNGRADES c 10 1.6 High yield b 8 Speculative grade 1.2 6 4 0.8 BBB b 2 Investment grade 0.4 AAA b 0 –2 June December 2000 June December 2001 June 2002 0 1989 1991 1993 1995 1997 1999 2001 FRB Cleveland • September 2002 a. Three-month eurodollar minus three-month, constant-maturity Treasury bill yield. b. Merrill Lynch AA, BBB, and 175 indexes, each minus the yield on the 10-year, off-the-run Treasury yield. c. Moody’s Investors Services. SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; and Board of Governors of the Federal Reserve System, “Selected Interest Rates,” H.15; and Bloomberg Financial Information Services. affected by specific market factors such as central bank sales or jewelry demand. A rise in gold prices often reflects a flight to security when the economic or political outlook becomes uncertain, but other measures of risk in the financial world do not point to uncertainty. The TED spread, the yield difference between eurodollar deposits and Treasury bills, often picks up on such concerns because it measures credit risk at international banks without reflecting exchange rate risk; it remains very low. In the domestic market, the yield spread between 90-day commercial paper and three-month Treasury bills also remains quite low. At the lower end of the credit spectrum, things look less rosy. Spreads over Treasuries of both high-yield and BBB-rated bonds have increased substantially in recent months. Thus, credit concerns seem to be growing, at least for lower-rated borrowers. Such borrowers become more important if we turn from rates to ratings. In any given year, some firms get stronger and others get weaker, but a good measure of the overall trend is the ratio between ratings upgrades (receiving a higher—that is, better—rating, which suggests the company has become less risky) and downgrades. Not only have (continued on next page) 7 • • • • • • • Money and Financial Markets(cont.) Percent 10 REAL GDP GROWTH AND YIELD SPREADS 8 Real GDP, 4-quarter percent change 6 4 2 0 10-year Treasury minus 3-month T-bill, four quarters a –2 –4 1960 1965 1970 1975 1980 1985 1990 1995 2000 Percent, weekly 8 YIELDS ON TREASURY SECURITIES Percent, weekly 6 YIELD CURVE 7 10-year 5 6 August 17, 2001 4 5 August 16, 2002 4 3 2-year July 26, 2002 3 2 2 3-month 1 1 0 3-month 1-year 3-year Maturity 7-year 20-year 0 1997 1998 1999 2000 2001 2002 FRB Cleveland • September 2002 a. Ten-year constant maturity Treasury minus three-month, secondary-market Treasury bill yield. SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; and Board of Governors of the Federal Reserve System, “Selected Interest Rates,” H.15. downgrades outnumbered upgrades for the past several years, but the trend in the ratio has worsened as well. A classic measure of risk in the economy is the term structure of interest rates coming out of the Treasury yield curve. The yield curve has moved little since last month, although it has steepened noticeably since this time last year, mainly because short rates have fallen. For most of 2002, however, short rates have held steady, with longer-term rates dropping 120 basis points since late spring. In the past, a steep yield curve indicated robust economic growth. Plotting the 10-year, 3-month spread against GDP growth for the year ahead shows that the yield curve has been a fairly reliable signal since 1960, although periods of high growth occasionally are accompanied by a low spread. A negative spread (inverted yield curve) reliably indicates recessions, although, like many other signs, it was confused by the 1967 mini-recession. Thus, while the present steep yield curve may not guarantee a strong recovery, it suggests a low likelihood of a “double-dip” recession. 8 • • • • • • • International Trade Imports minus exports, billions of dollars 40 TRADE DEFICIT Billions of dollars 140 TRADE IN GOODS AND SERVICES 35 120 30 100 Imports 25 80 Exports 20 60 15 40 10 20 5 0 0 1992 1994 1996 1998 2000 2002 1992 1994 1996 Billions of dollars 120 TRADE IN GOODS Billions of dollars 30 TRADE IN SERVICES 100 25 1998 2000 2002 2000 2002 Exports Imports 20 80 60 15 Exports Imports 40 10 20 5 0 1992 0 1994 1996 1998 2000 2002 1992 1994 1996 1998 FRB Cleveland • September 2002 SOURCES: U.S. Department of Commerce, Bureau of the Census and Bureau of Economic Analysis. In June, the U.S. trade deficit—the difference between exports and imports of goods and services—fell $0.7 billion to $37.2 billion. A deficit occurs when imports exceed exports. Both exports and imports increased in June, but the deficit narrowed because exports increased more than imports. The U.S. trade deficit emerged in 1992 and grew steadily until 1998, but it has tripled since then, reaching an all-time high of $37.8 billion in May. In June, the goods deficit fell by $0.9 billion from May’s record level to $40.8 billion. Goods exports rose from $57.3 billion to $58.5 billion, and goods imports increased from $99.0 billion to $99.3 billion. The May-to-June change in the goods balance reflects increased trade in capital goods, consumer goods, and foods, feed, and beverages; and decreased trade in industrial supply and materials, and automotive vehicles, parts, and engines. While most people are aware of the trade deficit, not everyone realizes that the U.S. runs a surplus in services trade, perhaps because the surplus is relatively small. In June, the services surplus decreased $0.2 billion to $3.6 billion as services exports increased from $23.4 billion to $23.5 billion and services imports increased from $19.5 billion to $19.9 billion. The May-to-June change in the services balance reflected increased exports in travel and increased imports in royalties and license fees services. Rising imports suggest that U.S. domestic demand for goods and services remains strong. Rising exports also indicate strength in foreign demand for U.S. goods and services. 9 • • • • • • • International Markets Index, April 1 = 100 105 DOLLAR EXCHANGE RATES Index 140 DOLLAR INDEX Australian dollar 130 100 Broad Dollar Index 120 Canadian dollar 95 110 Euro 100 Swiss franc 90 Norwegian krone 90 Currency Index Japanese yen 85 80 80 70 1995 1996 1997 1998 1999 2000 2001 Index, April 1 =100 120 WORLD STOCK MARKETS April 2002 May June 2002 July August Index, April 1 = 100 110 TREASURY RATES 110 100 3-month NIKKEI 225 Dow 30 100 90 20-year FTSE 100 1-year 90 80 ` 10-year S&P 500 80 6-month 70 5-year Euro 500 70 60 NASDAQ 60 50 April May June 2002 July August April May June 2002 July August FRB Cleveland • September 2002 SOURCES: Board of Governors of the Federal Reserve System; and Bloomberg Financial Information Services. The Broad Dollar Index measures the average change in the dollar’s exchange rate against the currencies of our 36 most important trading partners. The Major Currency Index measures the average change against major international currencies such as the euro, the Australian and Canadian dollars, and the U.K. pound. Both of these indexes have increased in value between the last half of the 1990s and the beginning of this year. Both fell sharply in the first half of this year and have more or less stabilized since then. The values of other nations’ currencies against the U.S. dollar do not necessarily rise and fall together. In April and May, for example, the U.S. dollar depreciated against several currencies, including the Canadian dollar and the Japanese yen. Since June, the dollar has appreciated against the Canadian and Australian dollars and depreciated against the Japanese yen, the euro, the Swiss franc, and the Norwegian krone. In the last four weeks, stock market values around the world have risen. Since April, however, they have fallen significantly in many countries. One of the hardest hit markets is the NASDAQ, which has lost about 28.5% since April 1. Japan’s NIKKEI 225 has outperformed several important stock indexes but has still managed to lose about 12.8% of its value over the same period. The value of U.S. Treasuries at virtually all maturities has increased since April, as reflected by a decrease in their interest rates. In early August, the yield on a twoyear note dropped as far as 1.9%, its lowest level in almost 40 years. 10 • • • • • • • Economic Activity Percentage points 3.0 CONTRIBUTION TO PERCENT CHANGE IN REAL GDP b a,b Real GDP and Components, 2002:IIQ (Preliminary estimate) Percent change, last: Four Quarter quarters Change, billions of 1996 $ Real GDP 26.4 Personal consumption 30.0 Durables 5.3 Nondurables 0.5 Services 23.9 Business fixed investment –7.7 Equipment 7.3 Structures –11.6 Residential investment 2.1 Government spending 6.1 National defense 7.2 Net exports –47.5 Exports 30.3 Imports 77.9 Change in business inventories 36.2 1.1 1.9 2.2 0.1 2.7 2.1 3.1 7.5 3.2 2.1 –2.6 3.1 –17.7 2.3 1.4 7.6 __ 12.3 22.8 __ –6.4 –2.9 –15.6 3.1 4.0 9.5 __ –3.4 2.7 __ Annualized percent change from previous quarter 6 REAL GDP AND BLUE CHIP FORECAST b 2.0 Exports Residential investment 0 –1.0 Imports Change in inventories Business fixed investment –2.0 –3.0 –4.0 Index, 1985 = 100 120 Index, 1966:IQ = 100 100 CONSUMER ATTITUDES University of Michigan’s Consumer Sentiment Index Preliminary estimate Advance estimate 4 2002:IIQ Government spending 1.0 Final percent change 5 Last four quarters Personal consumption 96 112 92 104 Blue Chip forecast c 30-year average 3 2 88 1 96 Conference Board Consumer Confidence Index 0 84 88 –1 –2 IIQ IIIQ 2001 IVQ IQ IIQ IIIQ 2002 IVQ IQ 2003 80 Jan. 80 Feb. Mar. Apr. May June July Aug. 2002 FRB Cleveland • September 2002 a. Chain-weighted data in billions of 1996 dollars. Components of real GDP need not add to the total because the total and all components are deflated using independent chain-weighted price indexes. b. All data are seasonally adjusted and annualized. c. Blue Chip panel of economists. SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; Blue Chip Economic Indicators, August 10, 2002; Conference Board; and University of Michigan. Preliminary estimates of the national income and product accounts showed that real gross domestic product increased at an annual rate of 1.1% in 2002:IIQ. August’s preliminary estimate of real GDP growth was essentially unchanged from July’s advance estimate. Personal consumption, residential investment, and government spending all increased. However, the growth rate for each of these categories was lower than in the previous four quarters. On a somewhat positive note, business fixed investment decreased only 2.6%—less than half its rate of decrease over the past year. The increase of $77.9 billion (chained 1996 dollars) in imports was more than double the increase in exports. Imports, the greatest drag on the economy, reduced real GDP growth by 2.8%. Changes in inventories gave GDP growth its biggest boost (1.4%). Forecasters and consumers have reassessed their outlook in recent months. After July’s modest advance estimate of real GDP growth in 2002:IIQ, Blue Chip forecasters changed their projections. Now they do not expect quarterly real GDP growth to surpass its long-term average until 2003:IQ (previously they had forecasted 2002:IIIQ). Consumer confidence measures likewise have remained depressed. In July, the Conference Board noted that falling stock prices, coupled with reports of corporate scandals, were damaging the Consumer Confidence Index. That index, as well as the University of Michigan’s Consumer Sentiment Index, declined further in August. They have moved in tandem throughout 2002. (continued on next page) 11 • • • • • • • Economic Activity (cont.) Thousands of units 1,050 HOME SALES a,b Thousands of units 6,500 Thousands of dollars 200 MEDIAN HOME PRICES 190 6,200 1,000 New homes 180 New homes 5,900 950 170 900 5,600 850 5,300 160 150 Existing homes 140 5,000 800 130 Existing homes 4,700 750 Jan. May 2000 Sept. Jan. May 2001 Sept. Jan. 120 May Jan. 2002 May Sept. Jan. 2000 Months' supply c 5.5 HOUSING INVENTORIES a May Sept. Jan. 2001 May 2002 Thousands of units 1,850 HOUSING STARTS a,b 1,800 Existing homes 5.0 1,750 1,700 4.5 1,650 1,600 4.0 1,550 New homes 1,500 3.5 1,450 1,400 3.0 Jan. May 2000 Sept. Jan. May 2001 Sept. Jan. May 2002 Jan. May 2000 Sept. Jan. May 2001 Sept. Jan. May 2002 FRB Cleveland • September 2002 a. Seasonally adjusted. b. Annualized. c. Months’ supply is the ratio of houses for sale to houses sold. It indicates how long the inventory currently for sale would last at the current sales rate if no additional houses were built. SOURCES: U.S. Department of Commerce, Bureau of the Census; and National Association of Realtors. After 2001, when sales of new and existing homes reached record highs, many observers expected the housing sector to cool off considerably, but events have not justified their fears. In July, new home sales rose nearly 7% to a record high of 1.02 million units (annual rate). Although existing home sales have retreated from the record high of 6.05 million units (annual rate) in January 2002, forecasters remain optimistic. Noting that existing home sales rose 4.5% in July, the National Association of Realtors projected that 2002 sales of existing homes would top the record set in 2001. Overall, home prices have gained momentum in recent months. The median price of existing homes rose between February and June. Even after July’s modest decline, their price was $11,100 higher than a year earlier. The median price of new homes rose to a record $191,900 in February 2002; however, after a series of staggered declines, by July the price level was $170,500—lower than in July 2001. But remember that there are only about one-fifth as many new home sales as existing home sales. High prices have prompted talk of a “housing bubble,” but whether recent prices warrant that label remains to be seen. As vigorous demand drove overall home sales up in July, housing inventories declined. Since January 2002, inventories of existing homes have risen and those of new homes have fallen. The level of housing starts appears more volatile in 2002 than in the previous year. Even after the most recent decline, July’s annualized rate of housing starts surpassed all but two months in 2000–2001. 12 • • • • • • • Labor Markets Change, thousands of workers 350 AVERAGE MONTHLY NONFARM EMPLOYMENT CHANGE Labor Market Conditions 300 Average monthly change (thousands of employees) Preliminary 250 2001 –119 –111 1 –3 –109 –79 –30 –8 –23 Jan.– July 2002 –12 –63 –2 –16 –45 –34 –10 51 –10 Aug. 2002 39 –33 1 34 –68 –46 –22 72 –13 –31 10 –2 27 –54 39 0 –2 47 22 13 16 –63 7 100 26 51 41 Revised 200 Payroll employment Goods-producing Mining Construction Manufacturing Durable goods Nondurable goods Service-producing TPUa Wholesale and retail trade FIREb Servicesc Health services Help supply Government 150 100 50 0 –50 –100 –150 –200 1999 259 8 –3 26 –16 –5 –11 252 19 2000 159 –1 1 8 –11 1 –12 161 17 60 7 132 9 32 35 25 5 92 15 0 22 –250 Average for period (percent) Civilian unemployment rate –300 –350 1998 Percent 65.0 1999 2000 2001 IVQ 2001 IQ IIQ 2002 June July 2002 4.2 4.0 4.8 5.8 5.7 Aug. Percent 8.2 LABOR MARKET INDICATORS 64.5 7.6 Percent 2.0 QUARTERLY PERCENT CHANGE IN EMPLOYMENT 1.5 Employment-to-population ratio Services, 1990 recession 64.0 7.0 1.0 Services, 2001 recession 0.5 63.5 6.4 63.0 5.8 0 Goods, 2001 recession –0.5 62.5 5.2 –1.0 Civilian unemployment rate 62.0 4.6 61.5 4.0 –2.0 61.0 1995 3.4 –2.5 –1.5 Goods, 1990 resession 1996 1997 1998 1999 2000 2001 2002 –12 –8 –4 0 4 Quarters from start of recession 8 12 FRB Cleveland • September 2002 NOTE: All data are seasonally adjusted. 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. SOURCE: U.S. Department of Labor, Bureau of Labor Statistics. Nonfarm payroll employment grew by 39,000 jobs in August. Estimates for July employment growth were revised upward to 67,000, far higher than the previously estimated growth of 6,000 jobs. The revised July increase is well above the average monthly gain of 12,000 jobs in 2002:IIQ and the average monthly loss of 63,000 jobs in 2002:IQ, suggesting further improvement in the labor situation. The service-producing sector showed an increase in jobs, and the goods-producing sector posted a decrease. Although construction and mining reported a combined gain of 35,000 jobs, both durable and non- durable manufacturing declined. The goods-producing sector showed an average monthly loss of 63,000 jobs from January though July 2002. Services, government, and finance, insurance, and real estate gained jobs in August. Between January and July, monthly employment growth in wholesale and retail averaged zero, but this sector lost 63,000 jobs in August. Help supply services showed a net gain of 51,000 jobs in August, reinforcing the steady employment recovery. Between July and August, the unemployment rate dropped 0.2 percentage point to 5.7%, the lowest level since March of this year. The ratio of employment to population increased 0.2 percentage point to 62.8%, continuing the monthto-month volatility that has been evident since January 2002. During the recession that began in 2001:IQ, employment changes in goods-and service-producing industries have followed patterns similar to those of the 1990 recession. For service-producing sectors, the dip into negative employment change lasted less than four quarters during both recessions. The most recent data suggest continued progress toward resuming employment growth in the goods-producing sector. 13 • • • • • • • The Impact of 2001 Tax Cut Legislation Thousands of 2000 dollars 60 PROJECTED TAX-FREE LEVEL OF FAMILY INCOME AS EGTRRA PHASES IN Percent of cut 50 100 SHARE OF INCOME TAX CUT BY FAMILY INCOME, CALENDAR YEARS 2001–10 Income More than $200,000 $50,000– $200,000 Less than $50,000 Married, four children 80 40 Married, two children 60 30 Single, one child 20 40 10 20 0 2000 0 2002 2004 2006 2008 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2010 Billions of dollars 120 CHANGE IN AFTER-TAX INCOME DUE TO INCOME AND ESTATE TAX CHANGES, 2010 Percent 6 CHANGE IN AFTER-TAX INCOME AS A PERCENTAGE OF TOTAL AFTER-TAX INCOME, 2010 100 5 Total change Total change 80 4 60 3 All income tax changes 40 2 All income tax changes 20 1 All estate tax changes All estate tax changes 0 0 Less 10–20 than 10 20–30 30–40 40–50 50–75 75–100 100–200 More than 200 Family income, thousands of dollars Less 10–20 than 10 20–30 30–40 40–50 50–75 75–100 100–200 More than 200 Family income, thousands of dollars FRB Cleveland • September 2002 NOTE: Data are from the Urban–Brookings Tax Policy Center’s microsimulation model. SOURCE: Len Burman, Elaine Maag, and Jeff Rohaly, “EGTRRA: Which Provisions Spell the Most Relief?” Urban–Brookings Tax Policy Center Report no. 3, June 2002. The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 phases in tax cuts through 2010. Its provisions are “sunset” at the end of calendar year 2010, but few expect the cuts to be eliminated entirely. The version of the tax cut bill that Congress passed after strenuous debate contains benefits for households at all income levels. Modifications to the child tax credit, the child and dependent care tax credit, and the earned income tax credit benefit low-income groups the most. Overall, these changes will benefit households with children far more than households that have none. For example, tax-free income, one measure of the new provisions’ benefit, will increase most for households with four or more children. Reducing the marriage tax penalty will benefit both low- and middleincome groups, and the scheduled lowering of marginal income tax rates will benefit all income groups. However, the act’s failure to simultaneously increase the alternative minimum tax threshold means that benefits to middle-income households will shrink over time. Because elimination of the estate tax and most of the high-bracket marginal rate reductions will be phased in, the proportion of total benefits reaped by the highest-income taxpayers will gradually increase. The recent reemergence of federal budget deficits and the scheduled sunset of EGTRRA after 2010, however, render these projections highly uncertain. 14 • • • • • • • Housing in Ohio Percent 75 HOMEOWNERSHIP RATES RESIDENCES, OWNED VERSUS RENTED a Owned Rented U.S. U.S. Ohio 70 33.8 66.2 65 Northeast 37.6 62.4 60 Midwest b 70.2 29.8 South 68.4 31.6 West 61.5 38.5 55 50 45 40 0 20 40 60 80 Percent MEDIAN VALUES OF HOMES, 2000 100 1950 1960 1970 1980 1990 2000 REAL INCREASE IN MEDIAN VALUES OF HOMES, 1990-2000 State of Ohio: 29.0% State of Ohio: $103,700 Less than $60,000 $90,000–less than $120,000 Less than 20% 35%–less than 50% $60,000–less than $90,000 $120,000 or more 20%–less than 35% 50% or more FRB Cleveland • September 2002 a. Regions indicated are census regions. b. Includes Ohio. SOURCE: U.S. Department of Commerce, Bureau of the Census. Owning a home has long been regarded as a sound method of gaining financial stability because housing values tend to be less volatile than stock prices and resilient during economic downturns. Data from the 2000 census reveal that a higher share of individuals owned their homes in the Midwest (which includes Ohio) than in any other area of the U.S. Historically, Ohio’s homeownership rates have exceeded the national average. While the 2000 census reported the highest homeownership rate on record for the nation as a whole, Ohio’s historical high point was the 1980 census. For Ohio, the 2000 census showed a higher homeownership rate than the 1990 census, but the latest rate is still 2 percentage points lower than in 1980. The median value of homes in Ohio was $103,700 in 2000, with the highest concentration of more expensive homes in the counties bordering Cuyahoga, Franklin, and Hamilton counties (which contain Cleveland, Columbus, and Cincinnati, respectively). Residents continued to move further from the city in which they worked during the years between the 1990 census and the 2000 census. Over these 10 years, home values rose more than 50% (real dollars) in the counties directly north of Columbus and those along the I-71 corridor between Cincinnati and Columbus. Home values have continued to appreciate since the 2000 census. Nationally, the housing component of the CPI has risen steadily despite the recession that began in March 2001. Although the price of housing in Ohio shows very seasonal movements, it (continued on next page) 15 • • • • • • • Housing in Ohio (cont.) Index, January 2000 = 100 116 HOUSING PRICE INDEXES a Percent 9.0 MORTGAGE RATES Historical rates, percent 17 15 Existing homes 13 8.5 112 Ohio House Price Index b Existing homes 8.0 11 9 7 5 1972 1982 108 7.5 1992 2002 New homes 104 7.0 CPI housing component 100 6.5 96 6.0 1/00 7/00 1/01 7/01 1/02 7/02 Thousands, year to date 120 OHIO HOME SALES c 100 80 1/00 7/00 1/01 7/01 1/02 7/02 Thousands, year to date 40 NEW SINGLE-FAMILY UNITS GRANTED OHIO BUILDING PERMITS 2000 32 2001 2002 2000 2001 2002 24 60 16 40 8 20 0 0 Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. FRB Cleveland • September 2002 a. Not seasonally adjusted. b. Calculated by the Federal Reserve Bank of Cleveland based on figures from the Ohio Association of Realtors. c. New and existing homes. SOURCES: U.S. Department of Commerce, Bureau of the Census; and Ohio Association of Realtors. has trended up since 2000. Home prices tend to peak in the summer months, when demand is highest (favorable weather and the schoolyear cycle induce most families to move during the summer). Housing prices are on the rise, and mortgage rates for both new and existing homes are at 30-year lows. Since the start of 2000, rates have fallen more than a percentage point. Although mortgage rates for existing homes were near those for new homes during the second half of 2001, the spread has been increased in favor of new homebuyers since the beginning of 2002. Historically low mortgage rates have doubtless helped to boost Ohio home sales. Sales for the year to date are higher than both 2000 and 2001 levels. (Sales in 2001 reached a record high). The Fourth District’s Beige Book report noted that residential construction continued to be unaffected by the recession throughout 2001. After the terrorist attacks in September 2001, home investment accelerated; this trend has been sustained through 2002. In July 2002, Ohio home sales for the year to date (68,832 units) were 4.4% higher than July 2001 levels, and strong home sales are expected to continue. The number of housing units for which the state issues building permits is a leading indicator of housing construction activity. In early 2002, Ohio’s year-to-date permits for singlefamily units were notably greater than in 2002, suggesting that strength in residential housing construction will continue in the near future. Permit activity slowed to near 2001 levels in June and July, but whether this slowing proves to be temporary remains to be seen. 16 • • • • • • • Banking Conditions in the Recessions of 1990 and 2001 Percent, annualized 15 REAL ASSET GROWTH Percent, annualized 15 REAL TOTAL LOAN GROWTH Recession beginning 2001:IQ 10 10 5 5 Recession beginning 2001:IQ 0 0 Recession beginning 1990:IIIQ Recession beginning 1990:IIIQ –5 –5 –10 –10 –8 –7 –6 –5 –4 –3 –2 –1 0 1 2 3 Quarters from start of recession 4 5 6 7 8 –8 –7 –6 –5 –4 –3 –2 –1 0 1 2 3 Quarters from start of recession Percent 9.5 EQUITY CAPITAL/TOTAL ASSETS Percent 1.75 RETURN ON ASSETS 9.0 1.50 4 5 6 7 8 Recession beginning 2001:IQ Recession beginning 2001:IQ 8.7 1.3 1.25 8.5 1.00 8.0 Recession beginning 1990:IIIQ 0.75 7.5 0.50 0.4 7.0 0.25 Recession beginning 1990:IIIQ 6.5 6.5 0 6.0 –8 –7 –6 –5 0 –4 –3 –2 –1 Quarters from start of recession 1 2 3 4 –0.25 –8 –7 –6 –5 0 –4 –3 –2 –1 Quarters from start of recession 1 2 3 4 FRB Cleveland • September 2002 SOURCES: Board of Governors of the Federal Reserve System; and Federal Deposit Insurance Corporation, Quarterly Banking Report, various issues. Going into the 2001 recession, FDICinsured commercial banks’ real asset and loan growth was much stronger than in the late 1980s and early 1990. Both statistics dipped into negative territory when the 1990 recession began. Asset growth stayed there for five quarters, and loan growth was still negative after two years. In the 2001 recession, however, these statistics fell below zero only in 2002:IQ, largely because of a seasonal drop in balances due from depository institutions and a decline in commercial loans, residential mortgage loans, and consumer loans other than credit cards. Both growth numbers recovered in 2002:IIQ. Equity capital cushions banks against unexpected losses. When the 1990 recession began, the ratio of equity capital to total assets stood at 6.5%, much lower than its 2001 level of 8.7%. Most significantly, after the current recession started, the equity ratio increased 50 basis points (bp) while total assets continued to grow. In contrast, the increase of 30 bp in 1990 resulted mainly from a decline in total assets. The statistics for return on assets explain this healthy equity growth. Going into the 2001 recession, commercial banks’ income was much higher and considerably less volatile than in the late 1980s. In fact, commercial banks’ net income rose to a record high of $21.7 billion in 2002:IQ; for 64% of banks, net income was higher than in 2001:IQ, when the recession began (data not shown). The key factors were wider interest margins at large banks and slow growth in noninterest expense. Asset quality in FDIC-insured commercial banks has improved substantially since 1990. In 2001:IQ, banks’ (continued on next page) 17 • • • • • • • Banking Conditionsin the Recessions of 1990 and 2001 (cont.) Percent, seasonally adjusted 5 QUARTERLY NET CHARGE-OFFS (ANNUALIZED) FOR COMMERCIAL BANKS Percent 2.00 NET CHARGE-OFFS TO LOANS AND LEASES 1.75 4 Recession beginning 1990:IIIQ Consumer loans 1.50 3 1.25 1.2 2 C&I loans 1.00 Recession beginning 2001:IQ 0.75 Total loans and leases 1 0.7 Real estate loans 0 0.50 –8 –7 –6 –5 0 –4 –3 –2 –1 Quarters from start of recession 1 2 3 4 1985 1987 1989 1991 1993 1995 1997 1999 Percent, seasonally adjusted 8 QUARTERLY DELINQUENCY RATES (ANNUALIZED) Percent 16 PROBLEM COMMERCIAL BANKS AND THEIR SHARE OF TOTAL ASSETS 7 14 Share of total assets Real estate loans 6 12 5 10 Total loans and leases 4 2001 Consumer loans 8 3 6 2 4 Share of institutions C&I loans 2 1 0 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 FRB Cleveland • September 2002 SOURCES: Board of Governors of the Federal Reserve System; and Federal Deposit Insurance Corporation, Quarterly Banking Report, various issues. net charge-offs to total loans and leases stood at 0.7%, compared to 1.2% in 1990:IIIQ. However, the rate has recently increased to 1.1%, mainly because charge-offs rose sharply for credit cards and moderately for commercial loans. The decline in the quality of credit card loans results partly from the economic slowdown, but another important factor is the personal bankruptcy legislation pending in Congress. The legislation, which will make it more difficult to erase unsecured credit card debt, may have prompted some consumers to declare bankruptcy while they can. Although the current total chargeoff rate seems to have approached its early-1990s high, loan delinquencies are still very low. The commercial loan delinquency rate, 3.6% in 2002:IQ, is well below its high of 6.2% in 1991. Real estate loan portfolios are much healthier now than 10 years ago. The current delinquency rate of 2% is far lower than the 7.5% rate for 1991. Moreover, banks today are much better equipped to absorb potential losses that these problem loans could cause. For every dollar in problem loans, banks now hold $1.30 in loan loss reserves; in 1991, that number was only about 67 cents (data not shown). The number of problem banks— those that receive a poor rating from bank examiners—has been declining since the early 1990s and now constitutes 1.3% of all banks and only 0.6% of total banking assets. In 1991, 10% of banking assets were held by problem institutions. Overall, the data indicate that commercial banks are well prepared to weather the current recession. 18 • • • • • • • Foreign Central Banks Percent, daily 7 MONETARY POLICY TARGETS a Trillions of yen –35 Trillions of yen 30 BANK OF JAPAN b 6 –30 27 5 –25 24 Bank of England 4 3 –20 European Central Bank Federal Reserve Current account balances (daily) 21 –15 18 2 –10 1 –5 15 Current account balances 12 0 0 –1 5 Bank of Japan –2 10 –3 –4 4/1 7/1 2001 10/1 1/1 4/1 2002 7/1 9 Excess reserve balances 6 15 3 20 0 Current account less required reserves 4/1 7/1 2001 10/1 1/1 4/1 2002 7/1 CURRENCY AREAS Currency areas c Gulf Cooperative Council Ruble Amero Euro FRB Cleveland • September 2002 a. Bank of England and European Central Bank: two-week repo rate. Federal Reserve: overnight interbank rate. Bank of Japan: quantity of current account balances; since December 19, 2001: a range of the quantity of current account balances. b. Current account balances include balances at depository institutions subject to reserve requirements and balances at certain other financial institutions. c. The Gulf Cooperative Council includes the United Arab Emirates, Bahrain, Qatar, Kuwait, and Saudi Arabia; the euro area includes 12 current members plus Bulgaria, Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, Slovakia, and Slovenia; the amero area includes the U.S., Canada, and Mexico; and the ruble area includes Russia and Belarus. SOURCES: Board of Governors of the Federal Reserve System; Bank of Japan; European Central Bank; and Bank of England. None of the four major central banks changed its policy setting over the past month. At their most recent meetings, however, the Federal Reserve, Bank of England, and European Central Bank each shaded their outlooks for economic activity relative to those of previous meetings. The Bank of Japan has settled into a steady routine, having maintained about ¥15 trillion in current operating balances for the past several months, both as a monthly average for each maintenance period and on a daily basis. Several stories about currency unions have surfaced recently. President Putin has proposed introducing the Russian ruble as the common currency of Russia and Belarus at the beginning of 2004 rather than in 2005 as originally planned, but Belarus’ reaction has been cool. Twelve nations now are known to be waiting to join the European Union and European Monetary System; what EU requirements will be and how successfully each nation will meet them remains to be seen. Gulf Cooperative Council officials hope that their nations will form a monetary union in 2010, as planned. All six already have agreed to peg their currencies to the U.S. dollar, in which petroleum has been priced so far. Finally, Herbert Grubel, professor (emeritus) of economics at Simon Fraser University, has proposed creating a new currency, the amero, for use in Mexico, the U.S., and Canada. Though far from an official plan, this proposal has been receiving considerable press attention.
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