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Confidential (FR) Class III FOMC

Part 2

June 18, 2003

CURRENT ECONOMIC
AND FINANCIAL CONDITIONS
Recent Developments

Prepared for the Federal Open Market Committee
by the staff of the Board of Governors of the Federal Reserve System

Confidential (FR) Class III FOMC

March 13, 2003

Recent Developments

Prepared for the Federal Open Market Committee
by the staff of the Board of Governors of the Federal Reserve System

Domestic Nonfinancial
Developments

Domestic Nonfinancial Developments

Overview
The economy appears to have expanded at a subpar pace in the current quarter,
and the incoming data have provided mixed signals about the trajectory of
economic activity as we move toward the second half of the year. Businesses
still have been reluctant to hire, and we have seen no sign yet of any substantial
pickup in their capital spending. However, consumer confidence rebounded
substantially after the war with Iraq, and, adjusted for inflation, retail sales in
May more than reversed their drop in April. Homebuilding has flattened out,
albeit at a high level. In the public sector, federal defense outlays are up
sharply, outweighing by a significant margin the spending restraint of state and
local governments. Meanwhile the year-over-year change in core consumer
prices edged up in May after having moved lower during the early spring.
Labor Market Developments
The labor market showed some signs of stabilizing in April and May. After
having fallen 35,000 per month in the first quarter of the year, employment on
private nonfarm payrolls edged up 8,000 in May, after an upward-revised
increase of 2,000 in April. Employment in manufacturing continued to fall last
month, although employment in temporary help services—which supplies many
of its workers to manufacturing—picked up noticeably. Employment in
construction rose substantially for the third consecutive month, and financial
activities continued to add jobs. However, employment in services
industries—excluding temporary help supply—was essentially unchanged.
Aggregate hours of production or nonsupervisory workers were unchanged in
May after having fallen 0.3 percent in April.
In the survey of households, the unemployment rate, which is considered to be a
lagging indicator, edged up further to 6.1 percent in May. The recent rise in
joblessness has reflected an increase in both incidence and duration: The
numbers of short-term job losers and longer-term unemployed have both
increased. The labor force participation rate, which continues to be depressed
by the paucity of jobs, was essentially unchanged, at 66.4 percent.
In keeping with its usual practice, the May labor market report included the
BLS’s benchmark of payroll employment estimates to unemployment insurance
tax records for March 2002 as well as other annual updates to the payroll
employment estimates.1 In addition, the establishment survey program was
converted from the Standard Industrial Classification (SIC) system to the North

1. These changes include recalculation of seasonal factors, reweighting of sampled firms,
and reestimation of birth-death models.

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American Industrial Classification System (NAICS).2 As a result of these
changes, payroll employment is now estimated to have fallen more in 2002 than
previously reported but to have contracted less thus far this year. On net, in the
twelve months following the benchmark date of March 2002, the cumulative
decline in private payroll employment is now only 40,000 steeper than estimated
earlier. However, the revised figures now show a 0.1 hour decline in the
workweek over the period rather than a 0.1 hour increase.3
The revised data now show that the decline in aggregate hours of production or
nonsupervisory workers was more than 3/4 percentage point per year steeper in
2001 and 2002 than reported earlier. The change in aggregate hours (at an
annual rate) was also revised down 1-1/4 percentage points in the first quarter of
this year. The BLS will use these revised figures in estimating its broader
measure of hours of all persons for its productivity and costs measures.
However, because of the extent of the recent changes to both the household and
payroll estimates, considerable uncertainty exists as to how the hours data will
be revised. Currently, the BLS expects to update the hours series, and
associated productivity series, for release with its preliminary estimates of
second-quarter productivity and costs in August. Even if the BLS adheres to
that schedule, the productivity estimates will likely change further after the
benchmark revision to the output estimates in the national income and product
accounts in December.
Despite the better readings on payroll employment in April and May, initial
claims for unemployment insurance have shown little improvement over the
past couple of months. The four-week moving average of initial claims stood at
434,000 for the week ended June 7, nearly the same as the average level in early
April. Insured unemployment rose to 3.8 million for the week ended May 31
and now stands more than 400,000 above its recent lows in January.
Other labor market indicators have yielded mixed signals. After having
deteriorated in February and March, households’ perceptions of current labor
market conditions were little changed in April and May, according to the
Conference Board survey. Expectations of future labor market conditions
improved noticeably in May in both the Conference Board and Michigan
surveys but then deteriorated a bit in early June, according to the preliminary
release of the Michigan survey. Among firm-level indicators, the hiring plans of
small businesses, as reported by the National Federation of Independent

2. Other one-time changes included introduction of concurrent seasonal adjustment
procedures, changes to the method for measuring federal employment, and conversion of the
service sector to a probability-based survey design—the last sector to be converted.
3. In addition, after the incorporation of the new, probability-based sample estimates, the
level of the average workweek throughout most of published history was revised down.

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Businesses, were unchanged in May from their low level.4 In contrast, layoff
announcements tumbled in May, according to the outplacement firm Challenger,
Gray, and Christmas, Inc., although the Board staff’s tally so far for June
suggests that they have moved back up.
Productivity in the nonfarm business sector increased at an annual rate of
1.9 percent in the first quarter, bringing the change over the four quarters ending
in 2003:Q1 to 2.4 percent—down from its heady 4.4 percent pace over the
preceding four quarters. In the nonfinancial corporate sector, productivity rose
2.9 percent (annual rate) in the first quarter and 4.3 percent over the four
quarters ending in 2003:Q1—down from 5.2 percent over the preceding four
quarters.
Industrial Production
Activity in the industrial sector stabilized in May after sizable drops in the
preceding two months. Total industrial production edged up 0.1 percent in May,
and manufacturing output was up 0.2 percent. Nonetheless, the factory
operating rate was at 72.6 percent in May, the lowest level since 1983. As of
May, manufacturing production had eked out a cumulative gain of just
0.6 percent since the December 2001 trough in IP, by far the weakest recovery
since World War II.

4. Manpower, Inc.'s survey of hiring plans for the third quarter dropped to its lowest level in
twelve years; however, the survey was taken in early April, before the conclusion of the war with
Iraq. In general, this survey has provided more information about current labor market
conditions than prospective conditions.

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The improvement in manufacturing activity in May was broadly based. In the
transportation sector, motor vehicle assemblies dropped again but by less than in
the previous three months. An increase in the production of aircraft and parts in
May partially recouped a strike-induced decline in the output of military aircraft
in April. Industry contacts suggest that the remaining lost production will be
made up in June.
Manufacturing activity within the high-tech sector continued to expand, on
balance, although developments have been mixed. Steady gains in computer
output since the beginning of the year have boosted the production of highvalue-added semiconductor chips, such as microprocessor units, in recent
months, while the production of other semiconductors, particularly those used in
cell phones, softened significantly in April and May.5 Output of
communications equipment—cell phones, equipment used by
telecommunications service providers, and the routers, switches, and hubs used
in computer networks—dropped in May after having moved sideways, on
balance, since the beginning of the year.6
Apart from transportation and high-tech, factory production was up 0.3 percent
in May after having declined 0.8 percent in April. Among upstream market
groups, the output of construction supplies turned up in May after having
contracted in each month since September, and the output of materials also
moved up. However, the production of business supplies continued to be
lackluster. Among market groups that align with final demand categories,
production results were generally positive. The output of defense and space
equipment jumped another 2 percent in May, bringing the average gain so far
this year to 0.9 percent per month. In addition, the production of consumer
goods (excluding motor vehicles) rose in May. In contrast, restrained capital
spending continued to depress the production of business equipment, which was
unchanged in May and remained well below its level in May 2002.
Indicators of near-term manufacturing activity are generally consistent with a
further small rise in industrial production in June. The May readings on new
orders from the diffusion indexes from the Institute for Supply Management and
various regional surveys all improved in May and suggest modest gains in

5. Our contacts at both Motorola and the Semiconductor Industry Association reported that
cell phone sales in China—20 percent of the worldwide market—collapsed in April because of
the outbreak of SARS. The United States produces a large share of the processors and memory
chips used in cell phones, especially higher-value chips.
6. In February 2003, the Federal Communications Commission issued a ruling that changes
the terms under which the regional Bell operating companies must provide competitors access to
their networks. General regulatory uncertainty arising from the implementation of this ruling and
the prospect of court challenges may damp demand for communications equipment in the
coming months.

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manufacturing activity apart from motor vehicles and parts.7 The first glimpse
at June from the Empire State survey also showed a pickup. The three-month
moving average of real adjusted durable goods orders dipped in April and is
consistent with little change in IP. Based on the limited data in hand, motor
vehicle assemblies are on track to move up toward an annual rate of 12 million
units in June—which would add 0.1 percentage point to the rate of change in IP.
Apart from motor vehicle assemblies and electricity generation, scant available
data suggest that the weekly physical product aggregate will contribute a little to
IP in June.
Motor Vehicles
Sales of light motor vehicles declined slightly in May, to an annual rate of
16 million units. Taken together, April and May’s sales averaged 16.2 million
units, a bit above the sales pace of 15.8 million units in the first quarter. In an
attempt to bolster sales, automakers raised incentives during April and May,
offering a record high average of $2,200 per vehicle in May. However, the
surge in sales that has accompanied previous sweetenings of incentives has not

7. The diffusion index from FRB Kansas City is excluded, as it does not have a sufficient
history for seasonal adjustment.

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yet materialized. Perhaps because the window on these current deals is open
longer (through July), the sales response will be spread over several months.
Indeed, some industry contacts have reported a noticeable step-up in sales so far
in June.
The general softness in business demand for new capital has been reflected in
tepid gains in the sales of motor vehicles to businesses. Fleet sales of light
vehicles were little changed in April and May from their first quarter pace of
about 3 million units. However, sales of medium and heavy trucks turned up a
bit in April and May, and new orders for medium and heavy trucks rose in May.
Although production of light motor vehicles fell from an annual rate of
12.7 million units in January to an 11.3 million unit rate in May, inventories
remain high. With stocks of 3 million units at the end of May, dealers held
more than seventy days’ supply of light vehicles, well above the target range of
sixty to sixty-five days. Despite elevated inventories, manufacturers’ thirdquarter schedules call for a jump in assemblies to 12.6 million units, nearly
1 million units more than in the second quarter. As noted earlier, the partial data
for June suggest that assemblies are ramping up. However, an underbuild
relative to current plans would not be surprising, given that inventories are high
and that, over the last ten years, third-quarter assemblies have averaged
3 percent below the scheduled rate. That said, the higher schedules may instead
represent a hedge against possible production disruptions related to the
upcoming contract negotiations with the United Automobile Workers (UAW)
union.8
Consumer Spending
Real personal consumption expenditures are likely to post another modest gain
in the second quarter after a 2.0 percent (annual rate) increase in the first
quarter. Spending on motor vehicles has risen a bit, on net, relative to the first
quarter, while real consumer outlays excluding cars and trucks, which were flat
in April, rebounded in May. At the same time, the fundamentals underlying
household spending have become more favorable: Real disposable income has
posted solid gains (driven largely by the retreat in energy prices), and both the
stock market and consumer confidence have recovered smartly from earlier in
the year.

8. One factor arguing against a strike, according to an industry contact, is that both sides can
ill afford a labor stoppage: The Big Three automakers are in weak financial condition, and the
union, which has seen sharp declines in membership in recent years, has an incentive to help
them maintain their competitive position against non-union rivals. In addition, the UAW
reportedly is interested in enlisting the help of the Big Three in organizing the supplier sector.
They may therefore want negotiations to remain on friendly terms.

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In May, nominal sales in the retail control group of stores, which excludes
automotive dealers and building materials and supply stores, edged up
0.1 percent following a decrease in April of 1.0 percent. Falling prices pushed
down nominal sales at gasoline stations last month, but spending rose
substantially at most other categories of retail outlets. Factoring in the effect of
declining prices, we estimate that real retail control increased a robust
0.7 percent in May, more than reversing April’s decrease of 0.3 percent.
Real outlays on services rose moderately in April, the most recent month for
which data are available. Much of this increase was due to higher expenditures
on energy services. Spending on non-energy services has been tepid so far this
year—held down, in part, by weak outlays for airline travel and recreation.
After having posted a substantial rebound in April and May, consumer
sentiment retreated somewhat in early June, according to the Michigan SRC
index. The recent fallback occurred as households’ expectations for business
conditions—both twelve months and five years hence—reversed part of the
improvement registered in the preceding two months. Assessments of current
conditions were little changed in early June. Despite the latest decline in the
Michigan index, both the Michigan and Conference Board indexes remain well
above their low levels reached earlier in the year.
Housing Markets
Activity in the housing market has been reasonably well maintained in recent
months, as further declines in mortgage rates have offset much of the downward
pressure from the soft labor market. Homebuilding was likely held down a bit
last month by the unusually wet weather. Yet starts of single-family homes rose
to an annual rate of 1.38 million units, leaving the April-May average only a
little below the first-quarter pace. New permit issuance—adjusted for activity in
areas where permits are not required—was at an annual rate of 1.37 million
units in May, close to the first-quarter average; in addition, the backlog of
unused permits remained near its record high. Along with sharply lower
mortgage rates, these indicators suggest that single-family starts are likely to
remain strong in coming months. In the multifamily sector, starts rebounded
sharply from their April low and rose to an annual rate of 354,000 units in May,
a bit above the average over the preceding six months. With vacancy rates high
and rents declining, multifamily starts are unlikely to strengthen significantly
anytime soon.
New home sales, which have been exceptionally vigorous during the past year,
reached an annual rate of 1.03 million units in April, the third-highest level on
record. Existing home sales—adjusted by the staff to eliminate trading-day

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variation—were about unchanged in April at an annual rate of 5.76 million
units, also one of the highest levels on record.9
Other indicators of housing demand are also quite robust. The four-week
moving average of the Mortgage Bankers Association index of purchase
applications has moved up sharply since mid-May to a new record high. The
Michigan Survey’s early-June measure of household attitudes noted a slight
drop in homebuying attitudes that was mainly due to apprehension about
employment prospects. Nonetheless, the level of the index remains high, with
fully three-quarters of respondents mentioning low mortgage rates as a factor
contributing to favorable homebuying conditions.
House prices decelerated modestly in the first quarter but continued to post solid
gains. The quality-adjusted price of new homes sold last quarter was
2.6 percent higher than a year earlier after having posted a 5.9 percent gain
during the preceding year. The repeat-sales price of existing homes, which
provides a better reading of the value of the overall stock of housing, was
6.4 percent higher in the first quarter of 2003 than in the first quarter of 2002.
Although this increase was a bit smaller than the 7 percent increase seen during
the previous year and well below the outsized gains seen in 2000 and 2001,
prices of existing homes have continued to increase at a faster pace than they did
in the mid- and late-1990s.
Business Fixed Investment
Equipment and Software. Business demand for new capital has remained soft.
Real outlays on equipment and software (E&S) fell at an annual rate of
6.7 percent in the first quarter of 2003, more than reversing the increase posted
in the fourth quarter of last year. Excluding outlays for transportation
equipment, E&S spending rose on average 1-1/2 percent in both quarters, and
the data on new orders and shipments in April (the latest available) point to only
a moderate pickup in the current quarter. The fundamental drivers of business
investment are generally lackluster, with the four-quarter changes in business
output and real corporate cash flow early this year both smaller than in the
second half of last year. Nonetheless, the user cost of capital continues to fall.
In the high-tech sector, nominal shipments of computers soared 20.2 percent
(not at an annual rate) in April after two months of declines. Since the middle
of 2001, computer shipments have tended to spike in the first month of each
quarter and to fall back in the second and third months. Nevertheless,

9. The existing home sales series published by the National Association of Realtors (NAR)
increased 5.6 percent in April after having declined by about the same amount in March. The
NAR series is not adjusted adequately for trading-day variation.

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smoothing through the recent swings, computer shipments continue to trend
upward; and paired with double-digit decreases in prices, we expect a solid gain
in real computer outlays this quarter. Shipments of communications equipment
decreased 3.3 percent in April and have been essentially flat since the beginning
of the year. Orders for communications equipment also edged down in April,
although they remained above the level of shipments for the fourth consecutive
month. Orders and shipments of non-high-tech equipment both fell back in
April after strong showings in March. These two series have moved essentially
sideways over the past few months.
Business outlays for transportation equipment appear poised to make a modest
contribution to the overall increase in equipment spending this quarter. In
particular, business spending on autos and trucks seems to have edged up in
April and May, and the rise in new orders for medium and heavy trucks in May
suggests some impetus to transportation investment for the coming months. In
contrast, despite a slight increase in Boeing’s production schedules in May, the
most recent data on shipments and net exports of aircraft indicate that outlays
for aircraft by domestic carriers continue to languish at half the level of a year
ago.
Nonresidential construction. Real investment in nonresidential structures
continued to fall in the first quarter, although we estimate that the decline
slowed to an annual rate of 2-1/4 percent.10 Outlays for office buildings were
down roughly 13 percent (annual rate) in the first quarter, and the data for April

10. The BEA’s preliminary estimate of the first-quarter change in nonresidential
construction showed a slight increase, but recent data on construction put-in-place have led us to
estimate a small decline.

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suggest that a further drop is likely in the current quarter. With falling rents and
rising vacancy rates, the oversupply of office space has shown few signs of
abating. Spending on industrial buildings contracted at an annual rate of about
8 percent in the first quarter, and again the data for April point to another
decline in the current quarter. Outlays for institutional buildings fell at an
annual rate of nearly 7 percent in the first quarter, offsetting part of the fourthquarter rise, and investment in structures by public utilities contracted at an
annual rate of roughly 6 percent.
Real investment in two categories of nonresidential structures moved up in the
first quarter, but these gains seem unlikely to be repeated in the second quarter.
Spending in the other commercial sector rose at an annual rate of nearly
10 percent in the first quarter, but fell on a monthly basis in both March and
April. Moreover, rents for both retail space and warehouses fell again in the
first quarter, suggesting demand for such space remains very weak. Similarly,
spending for lodging and miscellaneous structures rose 3-1/2 percent in the first
quarter but edged down in April.
In the drilling and mining sector, outlays increased in the first quarter at an
annual rate of 18 percent. The sharp increase in the number of natural gas
drilling rigs in operation from April through mid-June indicates that drilling
activity has responded to higher natural gas prices, and suggests that spending
on drilling and mining structures will likely increase again in the second quarter.
Business Inventories
The book value of manufacturing and trade inventories excluding motor
vehicles rose at an annual rate of $25.6 billion in the first quarter. However, in
real terms, these stocks were little changed. Book-value stocks excluding motor
vehicles declined at an annual rate of $5.4 billion in April, and our guess is that
they again were little changed in real terms.
By industry, book-value manufacturing inventories were nearly unchanged in
April, as stock-building by manufacturers of nondurable goods was about offset
by a runoff at producers of durable goods. Non-auto wholesalers liquidated
inventories at an annual rate of $5.4 billion in April, in large part the result of a
runoff at wholesalers of professional and commercial equipment. Non-auto
retailers’ stocks edged down in April after large run-ups in the preceding five
months. Book-value inventories in all three categories stand at historically very
low levels relative to shipments and sales.
In May, days’ supply in the staff's flow-of-goods system pulled back a bit but
remained at an elevated level, primarily because of the high level of motor

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vehicle stocks.11 Excluding motor vehicles and parts, the inventoryconsumption ratio has, on balance, moved sideways at a low level since late
2002. Outside of motor vehicles, imbalances are few and include textile mill
products, paper, communications equipment, and electrical equipment.
Government Sector
Federal. According to the Monthly Treasury Statement, defense spending in
April jumped 30 percent above the year-earlier level. Although the more recent
daily data indicate much smaller year-over-year increases in these outlays, the
cumulative data indicate a large increase in defense spending this quarter.
Monthly data for April show that outlays excluding defense were essentially
flat, a reflection of persistent slowing in spending across many categories and of
one-time declines recorded for several loan programs due to revaluations of the
subsidy value of the loans.
At the same time, the monthly Treasury data for April and daily data through
June 17 continue to point to weakness in federal receipts. April collections were
2-1/2 percent below last year’s level, as a sharp drop in nonwithheld individual
income and self-employment taxes was only partially offset by a rebound in
corporate income tax receipts. While daily data through June 16 indicate that
corporate receipts continued to post strong gains relative to year-earlier figures,
the increased bonus depreciation provision of the Jobs And Growth Tax Relief
Reconciliation Act should begin to significantly damp increases in corporate
collections in coming quarters as a greater share of investment spending falls
under the new provision..
Principally because of the enactment of the new tax law, the Congressional
Budget Office now expects the fiscal year 2003 budget deficit to exceed
$400 billion. In addition, pending legislation, if enacted, would raise spending
on Medicare and several other nondefense programs.
The new tax legislation accelerates the phase-in of many of the key provisions
of the 2001 Tax Act, although on a temporary basis for some of the provisions.
The main changes affecting individuals include a boost to the child tax credit
effective for 2003, which will be delivered primarily through a round of advance

11. The FRB staff’s flow-of-goods system measures changes in inventories by tracking the
flow of goods in the economy. The system divides the output from the staff’s industrial
production indexes into more than sixty different product categories. For each product category,
the system estimates the supply of goods flowing into the economy—that is, domestic
production plus imports. The system then estimates how much of the supply flows out, whether
as final demand, including exports, or as inputs for other goods. The difference between the
amount flowing in and the amount flowing out represents that change in inventories.

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refund checks that will be sent out between July 25 and August 8. In addition,
the new act speeds up the scheduled reductions in marginal rates, cuts the
maximum tax rate on long-term capital gains realizations from 20 percent to
15 percent through 2008, and sets the tax rate on most dividend income equal to
the capital gains rate through 2008. Employers are slated to adjust withholding
by the beginning of July of this year. On the business side, the act bumps the
temporary 30 percent depreciation bonus enacted last year up to 50 percent and
extends its expiration date from September 11, 2004, until the end of 2004.
In addition to the tax bill, the Congress recently extended through December the
temporary unemployment benefits program that was slated to expire at the end
of May. The Senate and House have passed versions of a small expansion of the
child tax credit, while the Senate Finance and House Ways and Means
Committees have approved versions of a Medicare bill that adds a prescription
drug benefit beginning January 2006.
State and local governments. Indicators of state and local spending continued
to deteriorate in the second quarter. Employment fell 21,000 in May after a
small rise in April. The revised figures for employment now show a net decline
so far this year, with a sizable drop in employment at the state level dwarfing a
slight increase at local governments. Real construction spending edged down in
April after larger declines in the two preceding months, and it is now at its
lowest level since October 2001. Declines were concentrated in spending for
buildings and for highways.
Despite the recently enacted addition of $20 billion in federal aid, many state
governments are still scrambling to pass a balanced general fund budget for
fiscal year 2004, which begins in less than two weeks. Along with spending
cuts, many states are enacting tax increases. As they did in fiscal year 2003,
many jurisdictions will also likely plug budget gaps by borrowing both from
rainy day and other funds and by issuing bonds. And more states than in recent
years have employed other, one-time measures, such as moving payments into
the next fiscal year and selling assets.
A recent survey from the National League of Cities indicates that declining
income and sales tax receipts and reductions in state aid have led to sharply
deteriorating fiscal conditions in many cities. In the aggregate, about 20 percent
of city revenue comes from state aid, with another 17 percent from sales taxes
and income taxes. So far, property taxes, which account for around 20 percent
of city revenue, have held up fairly well, bolstered by continued strength in
housing markets. The weakness in revenues comes at a time of intensifying
pressure to spend for homeland security and public safety needs.

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Prices and Labor Costs
Overall consumer prices have been moved around in recent months by large
swings in energy prices. After having risen rapidly earlier this year, consumer
energy prices fell sharply in April and May in the wake of the drop in crude oil
prices in late March. The plunge in energy prices pushed the twelve-month
change in the overall consumer price index down to 2.1 percent in May from its
recent peak of 3.0 percent in March. Nonetheless, overall inflation remains
considerably higher than the 1.2 percent rate recorded a year earlier.
The CPI excluding food and energy rose 0.3 percent in May after no change in
March and April; the May increase reflected a 0.5 percent jump in the prices of
non-energy services. By contrast, the index for core commodities fell
0.4 percent last month, with price declines posted for most categories of goods.
The core CPI has increased only 1.6 percent over the last twelve months, well
below the 2.5 percent run-up during the comparable period a year earlier. The
most recent twelve-month change is about 3/4 percentage point above our point
estimate of 0.9 percentage point for the measurement bias in this series.
Core PCE prices edged up 0.1 percent in April (the latest available data) and
likely increased 0.1 percent again in May. We estimate that core PCE prices
rose 1.3 percent over the twelve months ending in May, compared with a
1.7 percent increase over the preceding year. The 1/2 percentage point
deceleration in the PCE measure of core inflation is noticeably less than the
1 percentage point deceleration in the core CPI over the same period, a
difference that largely reflects the wider scope of PCE prices. Over the past
year, the deceleration in the CPI-based portion of PCE has been in part offset by
a pickup in the prices of PCE items that are not included in the CPI and for
which no market-based prices are available. Most noticeable have been an
upswing in imputed service charges at financial institutions and a sizable
increase in prices for travel abroad. By contrast, the market-based component of
the core PCE price index is estimated to have risen only 3/4 percent over the
twelve months ending in May, down 3/4 percentage point from a year ago.12
The most recent twelve-month change is a touch above our point estimate of
0.5 percentage point for the measurement bias in this index. The core portion of
the chained CPI, which like the PCE price index uses a superlative aggregation
formula intended to take into account substitution by consumers in response to
changes in relative prices, rose 1.0 percent over the twelve months ending in
May, a deceleration of about 1 percentage point from the previous year.

12. The deceleration of market-based core PCE prices over the past year is slightly less
than the deceleration of the CPI; much of the reason is that the marked deceleration in the price
of housing services gets considerably more weight in the CPI.

II-34

II-35


Consumer energy prices fell 3.1 percent in May, as retail prices of gasoline and
fuel oil dropped sharply for the second consecutive month. Survey data for the
first half of June point to a small increase this month in the CPI for gasoline on a
seasonally adjusted basis. The May decline in consumer natural gas prices
reflected a dropoff in demand due to mild temperatures. Because the level of
natural gas inventories remains very low, natural gas prices are likely to remain
quite volatile in the months ahead. In contrast to the declines posted for other
energy prices, the CPI for electricity increased 1.5 percent in May, likely
reflecting the lagged effects of higher fuel input costs.
Consumer food prices increased 0.3 percent in May and have risen 1.7 percent
over the past twelve months. Fruit and vegetable prices turned up last month,
more than reversing their April decline, and food away from home (about
40 percent of the overall food category) posted a modest increase that is broadly
consistent with its long-run trend, tracking movement in the core CPI.
According to the PPI, capital equipment prices edged up in May after a large
decline in April. These prices have been quite volatile of late, owing primarily
to erratic movements in the PPI for light motor vehicles. Over the past twelve
months, the PPI for capital equipment edged up, on balance, compared with a
slight decline over the previous twelve months.
Prices at earlier stages of processing have decelerated recently, reflecting the
direct and indirect effects of the decline in energy prices. The PPI for
intermediate materials fell in both April and May, while prices for core
intermediate materials were about unchanged. The most noticeable of the
energy-related swings in core intermediate materials prices in recent months
occurred in the prices of plastics, fertilizers, and industrial chemicals.
Spot commodity prices have moved up somewhat since the previous Greenbook.
Both the Journal of Commerce and Commodity Research Bureau industrial
price indexes have risen about 1-1/2 to 2 percent over that period. In the
agricultural sector, corn and soybean crops are off to a good start; however, spot
prices for these commodities have fluctuated around levels that remain about
1/4 percent higher than a year earlier. In contrast, a bumper crop of wheat has
depressed spot prices of that crop. The Commodity Research Bureau’s index of
futures prices, which includes both food and other commodities, is up about
2-1/4 percent since the April Greenbook.
Median expected one-year inflation as measured by the Michigan Survey
dropped further, to 2.0 percent in May and early June, lower than any full month
since January 2002. Median expectations of inflation over the next five to ten
years edged down 0.2 percentage point in early June, to 2.6 percent.

II-36

II-37


Average hourly earnings increased 3.2 percent in the twelve months ended in
May—up from the 2.6 percent increase recorded a year earlier but still about
1 percentage point below the pre-recession peak.

II-38

II-39

II-40

Domestic Financial
Developments

III-T-1

Selected Financial Market Quotations
(One-day quotes in percent except as noted)
2000

2001

2003

2003

Instrument

Change to June 16 from
selected dates (percentage points)

June 26

Sept. 10

May 5

June 16

2000
June 26

2001
Sept. 10

2003
May 5

Short-term
FOMC intended federal funds rate

6.50

3.50

1.25

1.25

-5.25

-2.25

.00

Treasury bills 1
3-month
6-month

5.66
5.94

3.19
3.13

1.11
1.14

0.85
0.86

-4.81
-5.08

-2.34
-2.27

-.26
-.28

Commercial paper (A1/P1 rates)
1-month
3-month

6.56
6.56

3.42
3.24

1.21
1.20

1.00
0.95

-5.56
-5.61

-2.42
-2.29

-.21
-.25

Large negotiable CDs 1
1-month
3-month
6-month

6.64
6.73
6.89

3.46
3.26
3.24

1.26
1.24
1.22

1.05
0.96
0.93

-5.59
-5.77
-5.96

-2.41
-2.30
-2.31

-.21
-.28
-.29

Eurodollar deposits 2
1-month
3-month

6.63
6.69

3.41
3.26

1.25
1.21

1.02
0.95

-5.61
-5.74

-2.39
-2.31

-.23
-.26

Bank prime rate

9.50

6.50

4.25

4.25

-5.25

-2.25

.00

Intermediate- and long-term
U.S. Treasury3
2-year
10-year
30-year

6.54
6.35
6.22

3.59
5.14
5.55

1.56
4.09
4.97

1.17
3.36
4.41

-5.37
-2.99
-1.81

-2.42
-1.78
-1.14

-.39
-.73
-.56

U.S. Treasury 10-year indexed note

4.09

3.26

2.08

1.49

-2.60

-1.77

-.59

Municipal revenue (Bond Buyer) 4

5.99

5.25

5.09

4.78

-1.21

-.47

-.31

7.38
7.19
7.64
8.40
12.30

5.62
5.68
6.30
7.11
12.72

4.29
4.39
4.83
5.84
9.54

3.45
3.77
4.04
5.08
9.02

-3.93
-3.42
-3.60
-3.32
-3.28

-2.17
-1.91
-2.26
-2.03
-3.70

-.84
-.62
-.79
-.76
-.52

8.14
7.22

6.89
5.64

5.70
3.74

5.21
3.54

-2.93
-3.68

-1.68
-2.10

-.49
-.20

Private instruments
10-year swap
10-year FNMA 5
10-year AA 6
10-year BBB 6
High-yield 7
Home mortgages (FHLMC survey rate) 8
30-year fixed
1-year adjustable

Record high

2001

Change to June 16
from selected dates (percent)

2003

Stock exchange index
Level
Dow-Jones Industrial
S&P 500 Composite
Nasdaq (OTC)
Russell 2000
Wilshire 5000

Date

Sept. 10

May 5

June 16

Record
high

2001
Sept. 10

2003
May 5

11,723
1,527
5,049
606
14,752

1-14-00
3-24-00
3-10-00
3-9-00
3-24-00

9,606
1,093
1,695
441
10,104

8,532
927
1,504
410
8,817

9,319
1,011
1,667
457
9,654

-20.51
-33.83
-66.99
-24.52
-34.56

-2.98
-7.49
-1.70
3.80
-4.46

9.23
9.09
10.81
11.63
9.49

1. Secondary market.
2. Bid rates for eurodollar deposits collected around 9:30 a.m. Eastern time.
3. Derived from a smoothed Treasury yield curve estimated using off-the-run securities.
4. Most recent Thursday quote.
5. Constant maturity yields estimated from Fannie Mae domestic non-callable coupon securities.
6. Derived from smoothed corporate yield curves estimated using Merrill Lynch bond data.
7. Merrill Lynch Master II high-yield bond.
8. For week ending Friday previous to date shown.
_______________________________________________________________________
NOTES:

June 26, 2000, is the day before the FOMC meeting that ended the most recent period of policy tightening.

September 10, 2001 is the day before the terrorist attacks.

May 5, 2003, is the day before the most recent FOMC meetings.

_______________________________________________________________________________
BA:DAM

Selected Interest Rates

Expected Federal Funds Rates Estimated from
Financial Futures
Percent
3.5

Implied Distribution of Federal Funds Rate*
Probability

35


June 16, 2003

30


May 5, 2003

3.0

25


2.5

20

May 5, 2003

2.0

June 16, 2003

15

10


1.5

5


1.0

0
June

Nov.
2003

Apr.

Sept.
2004

Feb.

0.25

July
2005


Note. Estimates from federal funds and eurodollar futures rates with
an allowance for term premia and other adjustments.

Treasury Yield Curve


0.75

1.25

1.75

2.25

2.75

* Derived from options on eurodollar futures contracts, adjusted to
estimate expectations for the federal funds rate.

Short-Term Interest Rates
Percent


Percent
5


8


May 6
FOMC

Daily

4


6


May 5, 2003

3

4


2-year Treasury
June 16, 2003

2


Primary
credit rate

June
16

Fed. funds

2


1

Adjustment credit rate*

0

1

3

5

7

10


Maturity in years

Note. Smoothed yield curve estimated using off-the-run Treasury
coupon securities. Yields shown are those on notional par Treasury
securities with semiannual payments.

Long-Term Interest Rates


Aug.
2002

TIIS-based 5-year*
TIIS-based 5-year 5-years ahead*
Michigan Survey**

8


10-year BBB

Mar.

June
16

June

2003


Percent
3.5

May 6
FOMC

3.0

7

30-year municipal*

Jan.

*On Jan. 9, 2003, the primary credit discount window program
replaced the adjustment credit discount window program.

9


May 6
FOMC

May
Oct.
2001

Inflation Expectations

Percent

Daily

0
Dec.
2000

June

2.5

6


2.0
5


10-year Treasury

1.5
4


3

Jan. May Sept. Jan. May Sept. Jan. May Sept.

2001
2002
2003

*Bond Buyer Revenue, weekly Thursday frequency.

1.0
June

Oct.
2001

Feb.

June Oct.
2002

Feb. June

2003


*Daily- the inflation rate at which the price of the indexed security
equals the value of a portfolio of zero-coupon securities that replicates
its payments. **Monthly- median 5 to 10-year inflation expectations.

Domestic Financial Developments

Overview
The May FOMC announcement pointing to the risks of “an unwelcome
substantial fall in inflation,” along with subsequent comments by the Chairman
and other Federal Reserve officials later in the intermeeting period, seemed to
convince investors that the FOMC would move policy aggressively and hold
rates lower for longer than previously expected to ward off any incipient
deflationary pressures. This sizable downward revision in the market’s expected
path for policy pulled down Treasury and private yields and boosted equity
prices.
The drop in longer-term interest rates spurred another wave of debt restructuring
in both the business and household sectors. Firms issued a large volume of
bonds, with the proceeds slated primarily to pay down commercial paper and
bank loans, and record numbers of households flocked to refinance home
mortgages. State and local government borrowing also picked up. Federal
borrowing was robust over recent weeks, reflecting somewhat weaker-thanexpected tax receipts and an increase in defense spending stemming from the
war in Iraq.
Policy Expectations and Interest Rates
Market participants largely anticipated the FOMC’s decision at the May 6
meeting to leave the target federal funds rate unchanged. But the accompanying
statement apparently surprised investors by signaling that the FOMC was
prepared to ease policy to guard against further substantial disinflation.
Subsequent comments from Federal Reserve officials were viewed as
reinforcing this message.
Investors marked down their expected path for policy substantially, and options
data suggest that uncertainty about the future path of policy has fallen
considerably as well. Options on federal funds futures now imply that investors
are virtually certain that the FOMC will ease at the June meeting; they are
placing about equal odds on a quarter-point versus a half-point easing. Further
ahead, eurodollar futures options suggest that investors revised up the
probability that they attach to target rates of less than 75 basis points by late this
year.
Despite incoming economic news that was close to market expectations, on
balance, and the deteriorating outlook for the federal budget, nominal Treasury
yields declined 32 to 65 basis points over the intermeeting period. Both marketand survey-based measures of longer-term inflation expectations edged a little
lower, but these indicators are well within the range observed over the last few
years. In fact, judging from the inflation-indexed yields, much of the drop in

III-2

III-3

longer-term nominal Treasury yields appears to reflect a decline in expected real
interest rates that, in turn, may be attributable to the change in policy outlook.
Stock Prices and Corporate Interest Rates
Major equity price indexes have risen between 9 and 11 percent since the last
FOMC meeting, with small cap, biotech, and Internet stocks outperforming the
broader indexes. Implied-volatility has remained low since the end of military
action in Iraq. In addition to the substantial fall in real interest rates, stock
prices have been bolstered by the most stable earnings outlook since early 2000;
over the past three months, almost no downward revisions have been made to
year-ahead forecasts of S&P 500 earnings per share. Also, the passage of the
fiscal stimulus package may have provided some additional lift for equity prices,
but there is scant evidence that investors have shifted their preferences toward
stocks with higher dividends. Despite the increase in share values, the equity
risk premium apparently has not narrowed, as the forward earnings-price ratio–a
proxy for the required return on equities–has fallen by about as much as real
long-term Treasury yields.
Yields on investment-grade corporate bonds fell along with those on comparable
Treasury securities over the intermeeting period, leaving their spreads roughly
unchanged. Yields on speculative-grade bonds fell by slightly less than those on
comparable Treasuries, and spreads widened modestly. Issuance of high-yield
bonds has been robust, and the onslaught of new bonds coming to market may
have put some upward pressure on speculative-grade spreads.
Business Finance
Low long-term yields proved quite alluring to many businesses, and gross
corporate bond issuance jumped last month to its highest monthly level in two
years, with gross junk bond issuance reaching a historical peak. Issuance so far
this month has not matched the pace in May but nonetheless has remained
strong. Many firms report that they have continued to use the bulk of the
proceeds from bond issuance to pay down existing debt, consistent with declines
in commercial paper outstanding and bank credit. The amount of net borrowing
this quarter is about roughly equal to its first quarter pace.
Gross public equity issuance by nonfinancial firms picked up some in May from
the extremely slow pace in March and April. Energy and utility firms continued
to account for most of the seasoned equity offerings, in many cases to pay down
debt. Also, although the nonfinancial IPO market finally ended its four-month
drought in May, the longest since 1975, the streak was broken by just a single
$10 million offering. However, an $80 million tech offering was well received
last week, and a number of IPOs are on the calendar for the near future,
developments that perhaps reflect the recent rise in stock prices. With the

III-4

III-5

III-6

III-7

exception of Oracle’s recent hostile, and quickly snubbed, bid for PeopleSoft,
talk of mergers remained sporadic even as financial market conditions have
improved. Announcements of share repurchases are likely to repeat last
quarter’s modest flow. Still, with gross new offerings remaining low, net equity
issuance should remain in solidly negative territory this quarter.
Corporate Earnings and Credit Quality
With the first-quarter earnings season essentially complete, S&P 500 operating
earnings per share are estimated to have risen 11 percent from last year’s levels.
However, the spike in oil prices resulted in the three largest oil companies
accounting for about two-thirds of that gain. Moreover, the rise in fuel costs
was not yet fully accounted for in the income statements of oil-consuming
industries last quarter. In the second quarter, the reversal in oil prices has
removed this boost to earnings, which accounts for a good part of the slowdown
in aggregate earnings growth expected by analysts for this quarter.
Measures of credit quality for nonfinancial firms either held steady or improved
somewhat of late. The six-month trailing default rate on corporate bonds has
changed little in recent months after dropping back around the turn of the year,
while the net pace of ratings downgrades continued to moderate in the second
quarter. In addition, delinquency rates on C&I bank loans fell somewhat in the
first quarter from elevated levels. The forecast of aggregate year-ahead default
rates based on the KMV model plunged in April and dropped again in May, a
reflection of higher stock prices and lower asset price volatility.
Commercial Real Estate
Despite continuing declines in construction activity, commercial mortgage debt
increased about 7 percent at an annual rate in the first quarter, a pace that is
likely to be exceeded in the second quarter. Gross CMBS issuance in April and
May was strong on average, and issues set to price in June suggest that issuance
this quarter will be comparable to the rapid pace of the fourth quarter of last
year. The CMBS delinquency rate has ticked up in recent months from low
historical levels. Nonetheless, investors continue to show little concern about
credit quality; spreads on CMBS over swaps contracted further over the
intermeeting period and are now at the low end of their ranges in recent years.
Household Finance
Household debt, which rose to a 10 percent pace in the first quarter, appears on
track to post another substantial gain in the current quarter; the increase stems
from a record amount of refinancing activity. Many households have refinanced
for the second or third time in as many years, and the average amount of home
equity extracted per dollar of mortgage refinanced has ebbed somewhat.
Nonetheless, the estimated volume of home equity extracted has risen to a very

III-8

III-9

III-10

III-11

high level because of the large number of mortgages being refinanced.
Meanwhile, consumer credit is likely to accelerate a bit from the modest growth
of recent quarters; in particular, nonrevolving credit expanded briskly in April,
an apparent response to the step-up in auto financing incentives during that
month.
The credit quality of the household sector has been holding steady on balance,
with limited pockets of distress. The delinquency rate on credit card loans at
commercial banks moved down in the first quarter, and rates on other types of
loans, such as credit card loans in securitized pools and nonrevolving consumer
loans at commercial banks, have continued to hover in fairly narrow ranges.
However, the bankruptcy rate remains quite elevated despite a small
improvement in the past few weeks.
Recent gains in share values have pushed the ratio of household assets to income
somewhat above its level at the end of last year. Consistently positive net
inflows to equity mutual funds since mid-March suggest that households have
renewed their confidence in the stock market, and inflows into high-yield bond
mutual funds have also remained sizable.
State and Local Government Finance
The underlying pace of gross municipal bond issuance remained quite strong,
reflecting efforts by state and local governments to cope with ongoing tax
shortfalls. A $10 billion taxable bond used to fund Illinois’s pension liability
augmented long-term issuance in June, and California’s rollover of $11 billion
in securities that had been issued to deal with the state’s fiscal crisis boosted
short-term issuance. At the same time, the substantial decline in yields
following the last FOMC meeting has bolstered issuance for advance
refundings, which remain near recent levels.
The recent dividend and capital gains tax cuts appeared to have had little visible
effect on municipal bond yields. After a sizable net downgrade in 2002,
municipal bond ratings upgrades and downgrades have been roughly balanced so
far this year, but the spread of BBB- over AAA-rated municipal bond yields has
widened since the last FOMC meeting and remains quite high by historical
levels.
Treasury and Agency Finance
The Congress raised the federal debt limit last month to a level that likely will
not bind Treasury borrowing until at least early next year. Faced with the
prospect of large deficits for some years, the Treasury is increasingly shifting
issuance patterns toward longer-term securities, a move that will appreciably

III-12

III-13

lengthen the average maturity of Treasury debt, which now stands at its lowest
level since 1985.
Fannie Mae and Freddie Mac have scaled back their reference and benchmark
note programs, in part because of renewed Treasury issuance and sluggish
growth of their on-balance-sheet mortgage portfolios. Demand for Freddie Mac
securities has been curtailed somewhat lately following revelations of alleged
accounting irregularities that led to the departure of its top three officers and
news of impending investigations by the SEC and Justice Department. The
price of Freddie Mac’s stock dropped, and credit default swap spreads on its
debt moved sharply higher in response. Although Fannie Mae’s stock price also
declined, and its credit default swap spreads rose a few basis points, there
appears to be little, if any, lasting spillover into broader financial markets.
Money and Bank Credit
M2 growth surged in May partly because of special factors. This year, total tax
payments were somewhat weaker than expected, so the April build-up and May
run-offs in balances were damped relative to the pattern embedded in seasonal
factors. Also, the recent spike in mortgage refinancing and the accompanying
bulge in escrow accounts that serve as temporary repositories of funds in
connection with prepayments on MBS likely contributed to the pickup in M2
growth last month.
Withdrawals from retail money funds over recent months have been associated
with a fall in money fund yields relative to rates paid on bank deposits. Low
yields on short-term securities have pressured some money market mutual funds
to reduce fees to keep investors' yields in positive territory, although the assets
under management in such funds represent less than 1 percent of total money
market fund assets.
Bank credit maintained its recent strong growth in May. Falling mortgage rates
spurred continued robust demand for home purchases and mortgage
refinancings, and banks continued to acquire MBS. But the ongoing contraction
in commercial and industrial lending partially offset these factors.
The May Survey of Terms of Business Lending indicates a downward shift of
the entire distribution of rate spreads, as the average spread on C&I loans over
comparable-maturity market rates at domestic banks declined from the previous
quarter. For loans not made under commitment, which are more representative
of recent pricing conditions, spreads declined for both higher-risk and lower-risk
loans, a trend that is largely consistent with the corporate bond market over the
same period.

III-14

III-15

International Developments

International Developments
U.S. International Transactions
Trade in Goods and Services
The U.S. international trade deficit in April was $42 billion, slightly smaller than
recorded in March (revised) as exports declined less than imports.

Exports of goods and services decreased 2.2 percent in April. There were
declines in most trade categories, with the largest in services (reduced foreign
travel in the United States) and capital equipment, both of which fell for the
second consecutive month. The value of exported industrial supplies eased
slightly from the high levels recorded during the first three months of the year,
largely accounted for by fuels and chemicals.
Imports of goods and services fell 2.1 percent in April, with declines
concentrated in petroleum and natural gas. The value of petroleum and natural
gas, which jumped up in March reflecting a run up in prices, fell in April as
prices declined. Imports of automotive products turned down in April,
continuing a pattern of declines begun in January. In contrast, imports of capital
goods rose in April, reversing part of the declines recorded during the previous
three months. Services payments fell for the third consecutive month, largely
because of reduced U.S. travel abroad.
All previously published trade data were revised beginning in 1992. The deficit
in net exports of goods and services in 2003:Q1 is now $486 billion at an annual
rate, $14 billion smaller than published previously. For the fourth quarter of last
year the deficit is $17 billion smaller. Small upward revisions were made to
exports (by $2-3 billion at an annual rate in both Q4 and Q1). The level of
imported goods and services was revised down significantly (by $15 billion at an

IV-2

IV-3

IV-4

IV-5

annual rate in Q4 and $11 billion in Q1), primarily because of services
transactions.
Prices of Internationally Traded Goods
Non-oil imports. In May, the price of imported non-oil goods declined slightly
(0.2 percent). Prices of imported computers and semiconductors fell moderately,
and prices of core goods showed a marginal decline (mostly foods and
unfinished metals). In April, non-oil import prices (and core goods prices) had
fallen sharply, reflecting a reversal of the sharp run up in prices of imported
natural gas in March. The price index for core goods in April-May, on average,
declined nearly 1 percent at an annual rate from the first quarter and followed a
jump of 5 percent in the first quarter. When natural gas and other fuels are
excluded from the index, prices of the remaining imported core goods rose
fractionally in April-May, on average, from the level in the first quarter, and the
increase in the first quarter was 1½ percent at an annual rate.
Oil. The BLS price of imported oil fell 1 percent in April following a revised
18 percent drop in March. The spot price of West Texas Intermediate (WTI)
crude oil fell more steeply in April than the BLS price, averaging about
$28.25 per barrel, down more than $5 per barrel from its March average. The
commencement of military action in Iraq and the relatively rapid conclusion of
the war led the spot price of WTI to fall to less than $26 per barrel by late-April.
Increased OPEC oil production, particularly by Saudi Arabia, Kuwait, and
Venezuela (where oil production recovered substantially from low first-quarter
levels), also contributed to the price decline. In May and June, delays in the
return of Iraqi exports, along with recent terrorist bombings in the Middle East,
have helped push the price of WTI to more than $30 per barrel. Spot WTI
closed on June 17 at $31.07 per barrel.
Exports. In May, the price of exported goods rose slightly. Most of the 0.2
percent increase in the price of exported core goods was from rising prices of
agricultural products (particularly soybeans, wheat, corn, and meat). Prices of
exported industrial supplies declined for the second consecutive month led by
decreasing prices of petroleum and precious metals. The price index for core
goods in April-May on average rose just over 1 percent at an annual rate from
the first quarter and followed an increase of nearly 4 percent in the first quarter.
U.S. International Financial Transactions
Treasury data recorded a $3 billion decrease in foreign official assets in the
United States in April, following a $9 billion increase in March (line 1 of the
Summary of U.S. International Transactions table). The first quarter as a whole
saw very strong official inflows of $37 billion, similar to the amount in the
fourth quarter of last year. Notwithstanding the $3 billion outflow in April,

IV-6

second quarter inflows should also be very strong: May data from custody
accounts at the Federal Reserve Bank of New York show a $37 billion increase
for the month, led by large increases for Japan (associated with its official
exchange intervention), Korea, China, and Russia.
Foreign private net purchases of U.S. securities (line 4) surged in March and
showed continued strength in April. The $65 billion in inflows in March
brought the total for the first quarter to $95 billion, in line with the quarterly
average from last year. In the quarter, strong inflows were recorded for all types
of U.S. debt securities, but especially corporate bonds. Robust purchases of debt
securities continued in April and comprised nearly all of the $47 billion in
inflows in the month, with inflows into corporate bonds again leading the way.
Purchases of other debt securities–Treasuries and agencies–were sizeable in
March and April, following only modest inflows in the first two months of the
year. Inflows into U.S. equities, while small, have been positive in the past two
months.
As is typical, about one-half of the securities inflows in the first quarter
originated in the United Kingdom, but purchases from Asia, especially China,
were also substantial. It should be noted, however, that given China’s severe
restrictions on outward portfolio investment, recorded inflows from China’s
private sector are likely made by public entities outside the official sector.
The first quarter marked a resumption of substantial U.S. acquisitions of foreign
equities, with $20 billion in straight purchases (line 5b) and another $14 billion
in a merger-related stock swap (line 5c). Although the equity acquisitions
ceased in April and U.S. investors have on net sold foreign bonds this year, the
year-to-date acquisitions of all foreign securities (line 5) totaled $26 billion in
the first four months of this year, consistent with levels of 2001 and previous
years.
Net capital flows in the banking sector (line 3) amounted to an outflow of $27
billion in the first quarter that was more than reversed by a $43 billion inflow in
April.
Full balance of payments data for the first quarter, including direct investment,
will be released on June 19 and discussed in the Greenbook Supplement.

IV-7

IV-8

Foreign Exchange Markets
The most salient developments in global financial markets over the intermeeting
period were the continued drop in the exchange value of the dollar and the sharp
fall in long-term interest rates in all major industrial economies. The drop in
yields began as a reaction to the concerns over disinflation expressed in the
May 6 statement of the FOMC. Further declines in long-term yields came in the
wake of statements by Federal Reserve officials about policy measures available
to head off deflation in a low short-term interest rate environment, such as
increasing purchases of long-term bonds or capping their yields. Despite the
lackluster pace of global economic activity, equity prices in major financial
markets rose substantially during the intermeeting period. Equity prices
appeared to be boosted by moderately upbeat earnings news in several sectors
and by the growing market perception that policy interest rates were likely to
remain at extremely low levels in the foreseeable future.

The exchange value of the dollar, as measured by the major currencies index,
dropped 3½ percent over the intermeeting period, continuing a trend that began
about a year ago. The dollar’s decline was particularly sharp in the first half of
the period. Continued concerns about the financing burden of the large and
growing U.S. current account deficit weighed on the dollar, as did statements by
Treasury Secretary Snow that seemed to signal a shift away from the U.S.
authorities’ long-standing but indeterminate “strong dollar” policy. The

IV-9
potential benefits to the United States of a weaker dollar – increased exports and
decreased deflationary pressures – were widely cited as reasons for the perceived
shift in policy. Later in the period, however, perhaps in part in reaction to
concerns expressed by several of our major trading partners, President Bush
reaffirmed on several occasions the administration’s commitment to a strong
dollar. During the intermeeting period, the dollar was little changed on net
against the currencies of our other important trading partners.
On balance, the dollar depreciated against all individual major foreign currencies
over the intermeeting period, falling 3¾ percent against the euro. The dollar’s
exchange value versus the euro retreated for the first time since early 1999
beyond its level at the time of the euro’s debut, reaching an all-time low above
1.19 $/L in late May before retracing slightly. The dollar depreciated
4½ percent against sterling. On June 9, the British government announced that it
would not hold a referendum this year on EMU entry, but that it may do so next
year; this “not yet” decision was not a surprise. During the period, the dollar
also depreciated 5½ percent against the Canadian dollar and 2 percent vis-a-vis
the Swiss franc.
In contrast, the dollar depreciated ¼ percent on balance versus the yen. Japan’s
Ministry of Finance continued to intervene heavily in an attempt to prevent its
currency’s appreciation. The MoF purchased nearly $38 billion dollars over the
intermeeting period, pushing Japan’s foreign currency reserves to more than
$500 billion.
In monetary policy actions, the European Central Bank lowered its minimum
refinancing rate 50 basis points to 2.0 percent, and the National Bank of
Denmark and Sweden’s Riksbank lowered rates by the same amount. Also
during the intermeeting period, the Reserve Bank of New Zealand lowered its
main policy rate 25 basis points and the Bank of Japan adjusted its target range
for current account balances up from ¥22–27 trillion to ¥27–30 trillion.
Reflecting the ECB’s action, three-month euro rates fell about 35 basis points
over the period. Canadian and Australian three-month rates declined more
modestly, while sterling rates rose slightly.
Long-term rates, as mentioned above, fell dramatically in all industrial countries
over the period, but have retraced somewhat in recent days. On balance,
ten-year sovereign yields fell about 45 basis points in the euro area and the
United Kingdom, somewhat less than the 60 to 70 basis point drop in the United
States and Canada. Japanese ten-year benchmark yields fell a further 6 basis
points, reaching multi-decade lows.

IV-10

Equity indexes registered gains over the intermeeting period in all major
industrial countries, ranging from 6¼ percent in Canada to about 11 percent in
Japan. Japanese banking sector shares rose more than 15 percent; the Japanese
government announced in mid-May that it would bail out Japan’s fifth-largest
financial institution, Resona Holdings, injecting the yen equivalent of about $17
billion.
Equity prices also rose in a number of emerging market economies, particularly
in Asia, where receding concerns over SARS and signs of recovery in the global
high-tech sector interacted to generate large gains. Share prices rose 19 percent
in Taiwan and Thailand, 13 percent in Korea, and 12 percent Hong Kong over
the period. Equity prices also rose in Latin America, although generally more
moderately than in Asia. The exception was Argentina, where equity prices rose
more than 21 percent. The Argentine peso was little changed, on net, over the
period. The Brazilian real appreciated about 3½ percent against the dollar, as
President Lula appeared to move closer to an agreement with Brazil’s Congress
on a reform of civil service pensions. The Mexican peso, in contrast,
depreciated about 3½ percent, in part on concerns about a slowdown in

IV-11
economic activity. Latin American sovereign bond spreads declined moderately
over the intermeeting period.

IV-12

Developments in Foreign Industrial Countries
On average, real GDP growth remained weak in the first quarter in major foreign
industrial countries, as external demand sagged amid heightened geopolitical
uncertainties and, in some countries, local currency appreciation that had taken
place over the previous year. Net exports contributed negatively to growth in all
major foreign industrial countries, but domestic demand remained strong in
Canada. Limited data for the second quarter do not inspire much optimism for
the near term, with no apparent bounceback in activity following the ebbing of
conflict in Iraq.
Twelve-month rates of consumer price inflation fell in recent months, reflecting
both declines in oil prices and local currency appreciations. Canadian headline
inflation dipped to 3 percent in April, while euro-area inflation fell below 2
percent in May for the first time since June 2002. Inflation fell below 1 percent
in Germany where recession is expected to continue. In Japan, deflation
continued.
Earlier this month the European Central Bank (ECB), the Reserve Bank of New
Zealand, the Swedish Riksbank, and Denmark’s central bank lowered official
interest rates. The Bank of Japan (BOJ) eased monetary policy in late May,
increasing its target range for the outstanding balance of reserve accounts held
by private financial institutions at the BOJ.
In Japan, real GDP growth slowed to a revised 0.6 percent (s.a.a.r.) in the first
quarter. Business fixed investment advanced for the fourth straight quarter,
increasing 2.8 percent, while private consumption expanded 0.8 percent. A
slowing in the pace of inventory decumulation added about ½ percentage point
to growth. However, public investment continued to contract sharply,
subtracting 0.8 percentage point from growth, and residential investment
declined nearly 5 percent. Net exports also contributed negatively to growth, as
exports fell and imports rose only slightly.
Most available indicators for the second quarter suggest that economic activity
remains sluggish. Industrial production fell 1.5 percent in April from the
previous month. Real exports continued to contract, declining 1.3 percent in
April from the previous month, while imports fell 0.8 percent. Household
expenditures rose 1.2 percent in April from March, but were up only slightly
from the first-quarter average. New car registrations rebounded in May, but the
average for April and May was about 6 percent below the first-quarter average.
Core machinery orders, a leading indicator of business fixed investment, fell

IV-13

Japanese Real GDP
(Percent change from previous period, except as noted, s.a.a.r.)
2002
Component

20011

20021

Q2

2003

Q3

Q4

Q1

GDP

-2.4

2.4

5.4

2.6

1.5

.6

Total domestic demand

-1.8

1.3

3.6

3.6

.0

.9

1.4

1.4

1.3

2.5

-.2

.8

Private investment

-10.6

2.2

4.3

4.4

7.6

1.5

Public investment

-1.2

-6.0

-11.0

-10.8

-9.8

-12.3

Government consumption

2.3

1.4

.3

3.1

.4

2.5

Inventories2

-.6

.3

2.6

1.5

-.7

.4

Exports

-11.0

17.7

30.0

.2

18.9

-1.6

Imports

-7.1

8.7

13.4

11.1

5.8

.5

-.6

1.1

1.9

-.9

1.5

-.2

Consumption

Net exports2

1. Q4/Q4.
2. Percentage point contribution to GDP growth, s.a.a.r.

1.8 percent in April. On the other hand, non-residential building starts were up
about 4 percent in April from the first-quarter average
The unemployment rate was unchanged at 5.4 percent in April, only a bit below
the record-high 5.5 percent rate in January. The job-offers-to-applicants ratio, a
leading indicator of employment, remained steady at 0.6 in April. Core
consumer goods prices in the Tokyo area (which exclude fresh food but include
energy) fell marginally in May and were down 0.4 percent from a year earlier.
Wholesale prices for domestic goods declined 1 percent in May from a year
earlier. Recently released data show that urban land prices were down 7.1
percent in March from a year earlier.
On May 20 the Bank of Japan raised its target range for the outstanding balance
of reserve accounts held by private financial institutions at the BOJ from
¥22-27 trillion to ¥27-30 trillion. In its announcement, the BOJ noted its
“determination to ensure financial market stability” in the wake of the
government's decision on May 17 to inject close to ¥2 trillion ($17 billion) into
Resona Holdings, Japan's fifth largest banking institution, to shore up its capital
position. Resona failed to meet Japanese minimum capital standards after

IV-14

Japanese Economic Indicators
(Percent change from previous period, except as noted, s.a.)
2002
Indicator

Q3
1

2003
Q4

Q1

Feb.

Mar.

Apr.

May

Industrial production

2.0

.4

.4

-1.6

.1

-1.5

n.a.

All-industries index

.3

-.3

.6

-.8

.7

n.a.

n.a.

-4.6

1.7

.7

-3.5

-4.8

5.6

n.a.

.1

-.1

5.8

-6.8

3.8

-1.8

n.a.

1.3

2.3

.2

-2.6

-1.4

1.2

n.a.

New car registrations

5.0

-1.0

1.5

.1

-.2

-11.1

12.2

Unemployment rate4

5.4

5.4

5.4

5.2

5.4

5.4

n.a.

Job offers ratio5

.54

.57

.60

.61

.60

.60

n.a.

Business sentiment6

-30

-28

-26

...

...

...

...

CPI (Core, Tokyo area)7

-.9

-.7

-.7

-.7

-.7

-.4

-.4

-2.0

-1.3

-.9

-.9

-.7

-.8

-1.0

Housing starts
Machinery orders2
Machinery shipments

Wholesale prices7

3

1. Mining and manufacturing.
2. Private sector, excluding ships and electric power.
3. Excluding ships and railway vehicles.
4. Percent.
5. Level of indicator.
6. Tankan survey, diffusion index.
7. Percent change from year earlier, n.s.a.
n.a. Not available. ... Not applicable.

auditors forced the bank to exclude from capital a substantial portion of deferred
tax assets. The government will hold ¥280 billion of common stock and nearly
¥2 billion of preferred shares (with voting rights) once the capital injection is
complete, giving it 70 percent of the voting rights at Resona.
On June 11, the BOJ announced details of its plan to purchase asset-backed
securities (ABS) issued to help finance small- and medium-sized enterprises. To
be eligible for BOJ consideration, longer-term ABS must be rated BB or higher,
while asset-backed commercial paper must meet a stricter A-1 rating hurdle. The
BOJ will purchase ABS from late July 2003 through March 2006, and will
initially limit its total purchases to ¥1 trillion ($8.5 billion) over this period.

IV-15

Euro-area real GDP was flat in the first quarter, as modest gains in private
consumption were offset by a steep fall in investment, the largest decline since
1996. In addition, exports fell while imports grew, resulting in a substantial
negative contribution from net exports. A slowing in the pace of inventory
decumulation helped to keep overall GDP growth from declining. German,
Italian and the Dutch growth rates were negative in the first quarter. Italian GDP
was pulled down by a decline in private consumption, while Germany and the
Netherlands suffered large declines in investment.
Euro-Area Real GDP1
(Percent change from previous period, except as noted, s.a.a.r.)
2002
Component

2001

2

2002

2

Q2

2003

Q3

Q4

Q1

GDP

.6

1.2

1.6

1.3

.3

.0

Total domestic demand

.1

.9

.7

1.0

1.8

2.0

1.6

.9

1.1

1.8

1.7

1.4

-2.4

-1.7

-5.1

.6

.3

-5.4

Government consumption

2.0

2.4

3.0

1.8

.7

.9

Inventories3

-.7

.2

.5

-.5

.5

2.1

Exports

-2.3

3.7

8.6

8.3

-.7

-2.5

Imports

-3.8

3.0

6.6

8.2

3.2

2.5

Net exports3

.5

.4

.9

.3

-1.4

-1.9

Memo:
France
Germany
Italy

.7
.1
.7

1.5
.7
.9

2.0
.6
1.4

1.3
1.2
.5

-.2
-.1
1.7

1.0
-.9
-.4

Consumption
Investment

1. Includes Greece as of 2001 Q1.
2. Q4/Q4.
3. Percentage point contribution to GDP growth, s.a.a.r.

Incoming data suggest continued stagnation in the second quarter. Although
euro-area industrial production rose in April, it has remained essentially falt since
the beginning of the year. The May euro-area purchasing managers’ index (PMI)
for manufacturing, a timely indicator of production, fell further below the 50
threshold for positive growth. The European Commission’s measure of
industrial confidence also declined in May. German industrial production ticked
down in April, while the volume of German industry orders rose 1.4 percent in

IV-16

April, recovering only part of the sharp decline in March, to a level of about 1
percent below the first-quarter average.
Surveys of consumer confidence in the euro area also have continued to fall,
primarily owing to increases in expectations of unemployment, particularly in
Germany. Consistent with the survey results, the April euro-area unemployment
rate was above the first-quarter average rate. In Germany, unemployment was
10.7 percent in May.
Euro-Area Economic Indicators
(Percent change from previous period except as noted, s.a.)
2002
Indicator

Q3

2003
Q4

Q1

Feb.

Mar.

Apr.

May

Industrial production1

.2

.1

.2

.3

-.7

.4

n.a.

Retail sales volume2

.8

-.4

.5

-.8

-1.2

n.a.

n.a.

Unemployment rate3

8.4

8.5

8.7

8.7

8.8

8.8

n.a.

Consumer confidence4

-10

-14

-19.3

-19

-21

-19

-20

Industrial confidence4

-11.3

-10.0

-11.3

-11

-12

-12

-13

Mfg. orders, Germany

-1.2

.3

.0

-.7

-3.2

1.4

n.a.

2.1

2.3

2.3

2.4

2.4

2.1

1.9

.0

1.2

2.4

2.6

2.4

1.7

n.a.

7.1

6.9

7.9

7.9

7.9

8.7

n.a.

CPI5
Producer prices5
M35

1. Excludes construction.
2. Excludes motor vehicles.
3. Percent. Euro area standardized to ILO definition. Includes Eurostat estimates in some
cases.
4. Diffusion index based on European Commission surveys in individual countries.
5. Eurostat harmonized definition. Percent change from year earlier.
n.a. Not available.

The European Central Bank (ECB) reduced its main policy rate, the minimum
bid rate for the refinancing tender, 50 basis points to 2 percent at its June
meeting. The move largely had been signaled by comments from ECB officials.
ECB President Duisenberg stressed that the ECB aims to keep inflation rates
“below but close to 2 percent over the medium term” and argued that “there are
currently no forecasts indicating any deflationary risks” for the euro area.
Implicitly addressing the concern that Germany could experience deflation, he

IV-17

stated that “within a monetary union, deflation is not a meaningful concept when
applied to individual regions.” Bank of France Governor Jean-Claude Trichet
was acquitted of charges in the Credit Lyonnais scandal. The verdict clears the
way for Mr. Trichet to take over as head of the ECB when Duisenberg steps
down, most likely during the summer.
Euro-area twelve-month consumer price inflation declined to 1.9 percent in May,
falling below the ECB’s target ceiling for the first time since June 2002,
according to the preliminary estimate. Excluding energy and unprocessed food,
inflation was 2.2 percent in April, up from the 2 percent rate it had maintained
throughout the first quarter of 2003. German twelve-month consumer price
inflation declined to 0.7 percent in May from 1.0 percent in April, as consumer
prices fell for the second month in a row.
In the United Kingdom, first-quarter real GDP growth was weak after lackluster
fourth-quarter growth. Substantial growth in government spending was offset by
a deceleration in consumer spending and a decline in gross fixed capital
formation. Net exports declined as imports rose considerably while exports were
flat.
U.K. Real GDP
(Percent change from previous period, except as noted, s.a.a.r.)
2002
Component

2001

1

2002

1

Q2

2003

Q3

Q4

Q1

GDP

1.9

2.2

2.4

4.3

1.5

.6

Total domestic demand

2.3

3.4

-.3

5.2

6.8

2.0

Consumption

4.3

3.6

4.5

3.1

4.3

1.6

-5.0

-1.1

3.6

-1.0

1.8

-.5

Government consumption

4.6

2.2

-5.3

1.5

4.2

5.8

Inventories2

-.4

.9

-3.1

3.2

3.0

.1

Exports

-4.6

-.7

16.9

-4.3

-13.6

.2

Imports

-2.5

3.0

5.5

.7

1.0

3.0

-.6

-1.4

3.1

-1.8

-5.2

-1.1

Investment

Net exports2

1. Q4/Q4.
2. Percentage point contribution to GDP growth, s.a.a.r.

IV-18

Data for the second quarter suggest that the pace of activity is recovering, but
remains sluggish. Whereas industrial production slid 0.4 percent in the first
quarter, it rose 0.2 percent in April, and business confidence recovered somewhat
in May. May’s Purchasing Managers Index (PMI) for manufacturing ticked
down after rebounding somewhat in April, and still suggests further contraction
in the sector.
Retail sales grew mildly in April after being unchanged in the first quarter. The
leading survey of retail sales points to further improvement in May. Consumer
confidence recovered for the second month in a row in May, though sentiment
remains below its level in late 2002.
U.K. Economic Indicators
(Percent change from previous period except as noted, s.a.)
2002
Indicator

Q3

2003
Q4

Q1

Feb.

Mar.

Apr.

May

Industrial production

.4

-.9

-.4

.5

-.8

.2

n.a.

Retail sales volume1

.7

1.6

.0

.2

.7

.3

n.a.

3.1

3.1

3.1

3.1

3.1

3.1

3.1

5.2

5.1

5.1

5.1

5.1

n.a.

n.a.

10.7

3

-1.3

-1

-5

-10

-3

-3.0

-3

-10

-10

-11

-8

-6

2.0

2.6

2.9

3.0

3.0

3.0

2.9

-2.3
3.8

1.4
3.7

4.9
3.4

6.2
2.5

4.2
4.4

.7
2.6

1.1
n.a.

Unemployment rate

2

Claims-based
3

Labor force survey
Business confidence

4

Consumer confidence5
Retail prices

6

Producer input prices7
Average earnings

7

1. Excludes motor vehicles.
2. Percent
3. Three-month average centered on month shown.
4. Percentage of firms expecting output to increase in the next four months less percentage
expecting output to decrease.
5. Average of the percentage balance from consumers’ expectations of their financial
situation, general economic situation, unemployment, and savings over the next 12
months.
6. Excluding mortgage interest payments. Percent change from year earlier.
7. Percent change from year earlier.
... Not applicable. n.a. Not available.

The rate of increase in housing prices is slowing. The April/May average of
housing prices was 2 percent higher than the first-quarter average, down from an
increase of 4.4 percent in the first quarter. The deceleration in prices has spread

IV-19

beyond London to most other regions of the country. Net mortgage lending
remained elevated through April, while the growth of other consumer credit
slowed.
The labor market continues to be tight as both the official claims-based and the
labor force survey measures of the unemployment remain near record lows. The
twelve-month rate of retail price inflation (excluding mortgage interest payments)
ticked down in May but remained above the Bank of England’s 2½ percent
target. The harmonized index of consumer prices (HICP) rose 1.2 percent in the
twelve months ending in May. The twelve-month growth rate of average
earnings slid to 2.6 percent in April.
On June 9, Chancellor of the Exchequer Gordon Brown announced that the five
economic conditions for Britain joining the euro area have not been met. The
government will reassess the five tests with the release of next year’s budget,
expected in March. The tests are now to be reviewed annually in the budget. In
the meantime, legislation will be introduced this autumn to enable a referendum
on euro entry, should the tests be met. Further measures to promote convergence
will be enacted, including housing market reform and changing the Bank of
England’s target inflation rate to the HICP at the time of the Pre-Budget Report,
expected in November. Public opinion remains strongly against entry.
In Canada, real GDP increased 2.4 percent (s.a.a.r.) in the first quarter as final
domestic demand grew 3.9 percent led by robust growth in consumption and
residential construction. A record increase in the level of inventories also
provided a substantial boost to activity, with roughly half of the stockpiling
occurring among motor vehicle retailers and wholesalers. Net exports subtracted
from GDP growth, reflecting a decline in exports and strong import growth. The
data on monthly real GDP indicate that much of the first quarter’s growth
occurred in the beginning of the quarter.
Recent indicators suggest weak growth for the second quarter. Following robust
job growth throughout 2002 and early 2003 the labor market cooled in April and
May, partially reflecting the impact of SARS on accommodation and food service
employment in Toronto. Declining employment, in conjunction with continued
strong labor force growth, increased the unemployment rate to 7.8 percent in
May. Housing starts declined in both April and May, though they remain at a
level above the historical average. Manufacturing shipments dropped
significantly in April while inventories continued to increase, raising the
inventory-to-shipment ratio to its highest level in 14 months.
In April, the twelve-month rate of headline CPI inflation declined to 3 percent
from 4.3 percent in March, returning to the top of the Bank of Canada’s 1 to 3

IV-20

percent target band. The decline in the headline rate largely reflects lower energy
prices. Twelve-month core inflation, excluding food, energy prices, and indirect
taxes, decreased to 2.7 percent in April.
Canadian Real GDP
(Percent change from previous period, except as noted, s.a.a.r.)
2002
Component
GDP

2001

1

2002

1

Q2

Q3

2003
Q4

Q1

1.4

3.5

3.8

2.7

1.6

2.4

.8

5.7

10.5

1.5

4.5

6.5

Consumption

2.3

3.8

4.4

1.3

4.4

3.5

Investment

3.4

2.0

1.4

3.2

.1

5.0

Government consumption

3.5

2.8

3.7

4.2

2.4

4.0

Inventories2

-1.9

2.3

6.1

-.7

1.4

2.5

Exports

-5.4

.7

.5

8.5

-8.7

-5.7

Imports

-8.4

6.5

19.3

5.8

-1.4

2.6

.8

-2.0

-6.2

1.3

-3.2

-3.3

Total domestic demand

Net exports2

1. Q4/Q4.
2. Percentage point contribution to GDP growth, s.a.a.r.

IV-21

Canadian Economic Indicators
(Percent change from previous period except as noted, s.a.)
2002
Indicator

Q3

2003
Q4

Q1

Feb.

Mar.

Apr.

May

GDP by industry

1.0

.5

.7

.3

.0

n.a.

n.a.

Industrial production

1.0

-.1

.3

-.4

.0

n.a.

n.a.

New mfg. orders

.8

-2.5

1.9

2.2

.9

-4.5

n.a.

Retail sales

.7

.8

1.8

1.8

-.7

n.a.

n.a.

Employment

.9

.8

.5

.4

.1

-.1

-.1

Unemployment rate1

7.6

7.5

7.4

7.4

7.3

7.5

7.8

Consumer prices2

2.3

3.8

4.5

4.6

4.3

3.0

n.a.

Core Consumer Prices2,3

2.2

3.0

3.2

3.3

3.1

2.7

n.a.

Consumer attitudes4

124.4

121.8

114.3

...

...

...

...

Business confidence4

129.7

136

131.4

...

...

...

...

1. Percent.
2. Percent change from year earlier, n.s.a.
3. Excluding food, energy, and indirect taxes.
4. Level of index, 1991 = 100.
n.a. Not available. ... Not applicable.

IV-22

External Balances
(Billions of U.S. dollars, s.a.a.r.)
Country
and balance

2002

2003

Q3

Q4

Q1

Feb.

Mar.

Apr.

Trade
Current account

82.2
111.5

83.5
102.2

73.3
115.7

82.9
124.3

65.2
122.8

80.3
120.9

Euro area
Trade1
Current account1

128.5
90.4

106.2
98.1

26.5
-8.6

69.7
41.4

26.1
15.5

38.7
n.a.

136.3
42.6

124.3
77.4

125.8
41.7

130.8
56.6

110.6
85.2

124.6
40.9

France
Trade
Current account

1.8
3.9

1.2
4.6

.7
3.9

1.0
3.9

.2
2.7

1.2
n.a.

Italy
Trade
Current account1

7.8
11.5

5.2
-15.8

.9
-28.4

1.6
-16.3

-1.1
-19.4

-1.6
n.a.

United Kingdom
Trade
Current Account

-54.7
-6.6

-70.7
-19.3

-57.7
n.a.

-50.9
...

-64.2
...

-58.3
...

Canada
Trade
Current Account

37.1
13.6

34.7
12.4

39.6
21.3

36.7
...

43.1
...

33.7
...

Japan

Germany
Trade
Current account1

1. Not seasonally adjusted.
n.a. Not available. ... Not applicable.

IV-23

IV-24

IV-25

Economic Situation in Other Countries
Economic conditions in the developing world remain weak. Recent indicators
suggest that growth has continued to slow in much of developing Asia, with the
negative economic effects of SARS beginning to show up in data throughout the
region, particularly for Hong Kong. In Latin America, Mexican economic
growth turned negative in the first quarter, and Brazilian indicators suggest that
economic activity remains soft. The Venezuelan economy has contracted
sharply as a result of that country’s ongoing political crisis, while Argentina’s
recovery has continued.
Although the SARS outbreak in China appears to have been largely contained,
the economic effects are just now beginning to show through available data.
Twelve-month growth rates of retail sales and tourist arrivals both slowed
considerably in April. Industrial production growth also decreased to a
twelve-month growth rate of just under 14 percent in May from 17 percent in the
first quarter. Some deceleration was expected, however, as many producers who
drastically increased output in the first quarter to fill orders before the start of the
Iraq war have since cut back. Consumer prices continued to rise slowly on a
twelve-month basis, but month-to-month changes have turned negative again
due to lower oil prices and, possibly, weaker demand resulting from SARS.
Lower oil prices helped return the Chinese trade balance to surplus in April, but
rapid growth in non-oil imports narrowed the surplus in May.
Real GDP in Hong Kong fell just over 1 percent (s.a.a.r.) in the first quarter.
The outbreak of SARS has apparently been contained. The categories that were
expected to be hurt most by SARS, personal consumption and tourism, were
both down in the quarter. In contrast, both exports and imports grew strongly.
This, coupled with robust trade figures for April, lends support to anecdotal
reports that SARS has not significantly affected merchandise trade. Other
economic effects of SARS, however, were evident in April. Retail sales for that
month fell, and tourist arrivals plummeted. The unemployment rate rose in
April and May, as SARS-related layoffs began to show up in the data, and
consumer prices fell at a twelve-month rate of about 2 percent, partly reflecting
the anemic property market and weaker sales of goods due to SARS.

IV-26

Chinese Economic Indicators
(Percent change from previous period, s.a., except as noted)
2002
Indicator

2001

Q4
Real GDP1

2003

2002
Q1

Mar.

Apr.

May

7.5

Consumer prices

2

Trade balance3

6.8

16.3

...

...

...

8.9

11.8

14.5

17.0

16.9

14.9

13.7

-.3

-.4

-.6

.5

.9

1.0

.7

23.1

Industrial production2

8.0

30.3

45.6

-13.1

-2.6

23.8

13.1

1. Annual rate. Quarterly data estimated by staff from reported four-quarter growth rates.
Annual figures are Q4/Q4.
2. Percent change from year earlier. Annual figures are year over year.
3. Billions of U.S. dollars, annual rate. Imports are c.i.f.
... Not applicable.

Hong Kong Economic Indicators
(Percent change from previous period, s.a., except as noted)
2002
Indicator

2001

Q4
Real GDP1

Trade balance4

Q1

Mar.

Apr.

May

-1.3

Unemployment rate2
Consumer prices

2003

2002

3

5.2

7.0

-1.2

...

...

...

4.9

7.3

7.2

7.5

7.5

7.8

8.3

-3.7

-1.6

-2.9

-.9

-2.3

-1.9

n.a.

-11.4

-7.7

-10.2

-6.9

-5.3

-5.0

n.a.

1. Annual rate. Annual figures are Q4/Q4.
2. Percent. Monthly numbers are averages of the current and previous two months.
3. Percent change from year-earlier period, except annual figures, which are Dec./Dec.
4. Billions of U.S. dollars, annual rate. Imports are c.i.f.
n.a. Not available. ... Not applicable.

Real GDP in Taiwan contracted slightly in the first quarter reflecting declines in
investment spending and sluggish growth in private consumption. Exports,
however, were up sharply for that period on average. Since the first quarter
ended, the outbreak of SARS in Taiwan has worsened considerably, and its
economic effects are now being felt. Industrial production decreased in April,
and unemployment remained at a high level. Both exports and imports have
fallen sharply since February. Of most concern is the reduction in imports of
intermediate goods used in the production of high-tech goods, indicating a
potential further decline in future exports. Twelve-month inflation turned

IV-27

positive in May due to a base month effect, while the month-to-month change
was slightly negative.
Taiwan Economic Indicators
(Percent change from previous period, s.a., except as noted)
2002
Indicator

2001

Q4
Real GDP

1

2003

2002
Q1

Mar.

Apr.

May

-1.8

4.1

3.7

-.1

...

...

...

2

4.6

5.2

5.1

5.2

5.2

5.2

n.a.

Industrial production

-7.3

6.4

1.1

.0

-2.5

-.6

n.a.

-1.7

.8

-.5

-.2

-.2

-.1

.3

15.6

18.1

19.6

13.5

17.8

18.8

19.2

17.9

25.7

31.4

29.0

...

...

...

Unemployment rate
Consumer prices
Trade balance4
Current account

5

3

1. Annual rate. Annual figures are Q4/Q4.
2. Percent.
3. Percent change from year-earlier period, except annual figures, which are Dec./Dec.
4. Billions of U.S. dollars, annual rate. Imports are c.i.f.
5. Billions of U.S. dollars, n.s.a., annual rate.
n.a. Not available. ... Not applicable.

Incoming data for Korea since the last Greenbook have been generally weak.
GDP fell 1.4 percent at an annual rate in the first quarter, weighed down by a
sizeable decline in consumption and low export growth. Industrial production in
April dropped almost 2 percent, with the contraction concentrated in the
high-tech sectors. Consumer and business confidence indicators held steady or
lost ground in May, and recent measures of retail sales and service-sector
demand have also been anemic. Consumer prices were up 3.2 percent over the
twelve months ended in May, and the unemployment rate rose to 3.4 percent.
The trade balance jumped in April as exports climbed and imports dropped off,
in part due to lower oil prices. Early figures suggest that this improvement in
the trade balance is unlikely to be sustained in May. Concerns over weakening
demand led the Korean central bank to lower its target interest rate in May by
25 basis points to 4 percent. The government has also announced a fiscal
stimulus package of roughly ¾ percentage point of GDP for the rest of this year.

IV-28

Korean Economic Indicators
(Percent change from previous period, s.a., except as noted)
2002
Indicator

2001

Q4
Real GDP1

2003

2002
Q1

Mar.

Apr.

May

4.2

7.0

8.3

-1.4

...

...

...

Industrial production

1.0

7.4

2.7

.5

.6

-1.9

n.a.

2

3.8

3.1

3.0

3.1

3.1

3.2

3.4

3.2

3.8

3.4

4.1

4.6

3.8

3.2

13.5

14.2

15.5

9.6

-3.8

18.2

n.a.

8.2

6.1

7.9

-6.7

-14.3

-4.6

n.a.

Unemployment rate
Consumer prices3
Trade balance4
Current account

5

1. Annual rate. Annual figures are Q4/Q4.
2. Percent.
3. Percent change from year earlier, except annual changes, which are Dec./Dec.
4. Billions of U.S. dollars, annual rate.
5. Billions of U.S. dollars, n.s.a., annual rate.
n.a. Not available. ... Not applicable.

In the ASEAN region, data releases since the last Greenbook have generally
pointed to weak economic activity. In the first quarter, private consumption
contributed negatively to real GDP growth in Malaysia and Singapore but drove
the expansions in Indonesia and Thailand. Real GDP in the Philippines
contracted, owing to reduced agricultural output. With the exception of
Malaysia, recent industrial production data for these countries suggest a further
slowing in activity so far in the second quarter. Trade surpluses, however,
widened across the region, primarily reflecting rising exports, while inflation
remained benign.

IV-29

ASEAN Economic Indicators: Growth
(Percent change from previous period, s.a., except as noted)
2002
Indicator and country

2001

2003

2002
Q4

Real GDP1
Indonesia
Malaysia
Philippines
Singapore
Thailand

Q1

Feb.

Mar.

Apr.

1.8
-.9
3.6
-6.0
2.2

-.8
1.9
10.0
.4
8.7

5.6
.9
-2.0
1.1
6.3

...
...
...
...
...

...
...
...
...
...

...
...
...
...
...

.7
-4.1
-5.7
-11.6
1.3

Industrial production2
Indonesia3
Malaysia
Philippines
Singapore
Thailand

3.8
5.3
5.7
3.0
6.4
-1.1
4.2
-6.1
8.5
8.5

1.4
-1.0
2.4
-2.2
2.2

1.0
2.4
-.7
3.3
4.3

4.9
8.0
-2.4
-13.8
-2.0

-2.6
-4.1
4.4
11.5
4.6

n.a.
8.3
n.a.
-3.6
3.3

1. Annual rate. Annual figures are Q4/Q4.
2. Annual figures are annual averages.
3. Staff estimate.
n.a. Not available. ... Not applicable.

ASEAN Economic Indicators: Trade Balance
(Billions of U.S. dollars, s.a.a.r.)
2002
Country

2001

2003

2002
Q4

Q1

Mar.

Apr.

May

Indonesia

25.4

25.9

23.9

27.6

25.3

27.6

n.a.

Malaysia

14.2

13.4

14.3

19.6

17.7

21.8

n.a.

Philippines

-.9

-.2

-.8

-2.1

-1.4

n.a.

n.a.

Singapore

5.8

8.7

10.7

16.7

7.8

12.0

14.9

Thailand

2.5

3.5

4.0

5.5

4.1

5.4

n.a.

n.a. Not available.

IV-30

ASEAN Economic Indicators: CPI Inflation
(Percent change from year earlier, except as noted)
Country

20011

20021

2002
Q4

2003
Q1

Mar.

Apr.

May

Indonesia

12.5

10.0

10.3

7.7

7.1

7.5

6.9

Malaysia

1.2

1.7

1.8

1.3

.7

1.0

1.0

Philippines

4.1

2.6

2.6

2.9

2.9

2.8

2.7

Singapore

-.6

.4

.1

.7

.8

.9

n.a.

Thailand

.8

1.6

1.4

2.0

1.7

1.6

1.9

1. December/December.
n.a. Not available

In Mexico, data releases since the last Greenbook generally point to weakness in
the economy. Real GDP fell 2 percent (s.a.a.r.) in the first quarter, exports
declined in April, and business confidence was down in May. Industrial
production appears to have fared somewhat better, however, rising 0.8 percent in
April. The weakness in exports in April led to a sizeable widening of the trade
deficit in that month.
The twelve-month rate of consumer price inflation declined in April and May,
probably helped in part by the net appreciation of the Mexican peso since early
March. Survey measures of inflation expectations for end-2003 edged down a
bit to 4.1 percent in May, near the top of the central bank’s 2-4 percent target
range.
In Brazil, real GDP in the first quarter was roughly flat after having risen about
3½ percent over the second half of 2002 in the midst of considerable financial
turmoil. Data releases since the last Greenbook suggest that activity continued
to weaken into the second quarter. Monthly trade surpluses have remained
sizable, reflecting some trade adjustment from the large depreciation of the
currency in recent years.
The weak economy and the nominal appreciation of the real since March
contributed to a decline in monthly headline consumer price inflation in April
and May. The twelve-month inflation rate rose nevertheless. Inflation therefore
remains well above the 8.5 percent “adjusted inflation target” for 2003 that was
set by the central bank last January. In consequence, the central bank maintained
its overnight interest rate at 26.5 percent at its May policy meeting. Brazilian
asset prices have moved up significantly in recent weeks. The improvement

IV-31

most likely reflects investors’ approval of the fiscal performance of the Lula
government, including further progress towards pension reform.
Mexican Economic Indicators
(Percent change from previous period, s.a., except as noted)
2002
Indicator

2001

2003

2002
Q4

Real GDP1

Q1

Mar.

Apr.

May

-1.5

2.0

-.1

-2.0

...

...

...

-.1

.8

.1

.1

-.5

n.a.

n.a.

Industrial production

-3.3

-.2

-.4

.2

-1.0

.8

n.a.

Unemployment rate2

2.5

2.7

2.6

2.7

2.8

2.8

n.a.

4.4

5.7

5.3

5.4

5.6

5.2

4.7

-10.0

-7.9

-6.6

-4.4

-6.1

-10.7

n.a.

168.4

168.7

168.5

169.2

169.7

170.7

n.a.

158.4

160.8

161.9

164.8

163.5

159.9

n.a.

-18.0

-13.9

-18.6

-8.6

...

...

...

Overall economic activity

Consumer prices
Trade balance4
Imports

4

Exports4
Current account

5

3

1. Annual rate. Annual figures are Q4/Q4.
2. Percent; counts as unemployed those working one hour a week or less.
3. Percent change from year-earlier period, except annual figures, which are Dec./Dec.
4. Billions of U.S. dollars, annual rate.
5. Billions of U.S. dollars, n.s.a., annual rate.
n.a. Not available. ... Not applicable.

In Argentina, industrial production in May was up 16 percent from a year ago,
but it has edged down in the last two months. Inflation has continued to
decelerate considerably, and the consumer price index fell 0.3 percent in May
from April–the first decline since the peso’s devaluation in January 2002. The
peso continued to strengthen, and has appreciated nearly 20 percent against the
U.S. dollar since the beginning of the year, amid accumulation of foreign
reserves by the central bank. Federal tax collection in May increased 48 percent
year-on-year, exceeding expectations. While Argentina has so far met the fiscal
and monetary targets agreed with the IMF, the government is lagging in the
implementation of structural reforms. President Néstor Kirchner, who took
office in late May, has not yet fully articulated a program that addresses the
country’s fundamental economic problems, including the restructuring of the
banking system and the renegotiation of the country’s defaulted debt.

IV-32

Brazilian Economic Indicators
(Percent change from previous period, s.a., except as noted)
2002
Indicator

2001

Q4
Real GDP1

2003

2002
Q1

Mar.

Apr.

May

-.7

3.4

2.9

-.2

...

...

...

Industrial production

1.6

2.3

1.8

-1.0

-3.3

-.1

n.a.

2

12.4

11.7

12.0

11.1

11.1

11.6

n.a.

Consumer prices3

7.7

12.5

10.6

15.6

16.6

16.8

17.2

Trade balance4

2.6

13.1

23.9

17.0

18.6

20.5

25.5

-23.2

-7.6

-1.1

0.3

1.4

-11.6

n.a.

Unemployment rate

Current account5

1. Annual rate. Annual figures are Q4/Q4.
2. Percent. Break in October 2001 as a result of change in methodology. Thus, 2001 is
average for Q4 only.
3. Percent change from year-earlier period, except annual figures, which are Dec./Dec. Price
index is IPC-A.
4. Billions of U.S. dollars, annual rate.
5. Billions of U.S. dollars, n.s.a., annual rate.
n.a. Not available. ... Not applicable.

Argentine Economic Indicators
(Percent change from previous period, s.a., except as noted)
2002
Indicator

2001

Q4
Real GDP1

2003

2002
Q1

Mar.

Apr.

May

-10.3

-4.0

3.4

n.a.

...

...

...

Industrial production

-7.6

-10.7

5.8

7.6

1.6

-.8

-1.1

2

17.4

19.7

17.8

n.a.

...

...

...

-1.4

41.0

40.4

35.8

31.7

19.3

14.3

7.5

16.7

15.9

15.7

15.6

13.9

n.a.

-4.5

9.0

8.7

n.a.

...

...

...

Unemployment rate
Consumer prices3
Trade balance

4

Current account5

1. Annual rate. Annual figures are Q4/Q4.
2. Percent, n.s.a. Data are released for May and October only. Figures for Q4 reflect data
for October.
3. Percent change from year-earlier period, except annual figures, which are Dec./Dec.
4. Billions of U.S. dollars, annual rate.
5. Billions of U.S. dollars, n.s.a., annual rate.
n.a. Not available. ... Not applicable.

IV-33

In Venezuela, real GDP fell 29 percent on a four-quarter basis in the first
quarter, reflecting a 47 percent decrease in oil output and a 21 percent decline in
non-oil output. The decline implies a drop of 52 percent (s.a.a.r.) from the
previous quarter, according to staff estimates. The first quarter result follows a
similarly large drop in real GDP in the fourth quarter of 2002. Plummeting
economic activity in recent months has been associated with political turmoil
that led to a general strike from December to February. Activity has also been
weakened by the imposition of capital controls last January, which have virtually
halted non-oil related imports and disrupted production in sectors that rely on
imported intermediate goods. Monthly consumer price inflation rose in April
and May, despite the pegging of the currency to the dollar last February; the rise
has been attributed to shortage-induced increases in domestic prices of imported
goods. Oil production and exports remain below pre-strike levels.
Venezuelan Economic Indicators
(Percent change from previous period, s.a., except as noted)
2002
Indicator

2001

2003

2002
Q4

Real GDP1

Mar.

Apr.

May

.9

Unemployment rate

2

Consumer prices3
Non-oil trade balance4
Trade balance

Q1

4

Current account5

-16.7

-41.5

-52.4

...

...

...

13.3

15.5

n.a.

n.a.

n.a.

n.a.

n.a.

12.3

31.2

30.6

35.5

34.1

33.5

35.0

-12.2

-7.4

-5.5

-2.5

n.a.

n.a.

n.a.

9.3

13.9

14.8

12.8

n.a.

n.a.

n.a.

3.9

7.7

8.6

7.8

...

...

...

1. Annual rate. Annual figures are Q4/Q4.
2. Percent, n.s.a. For 2002, Q2 is latest reported.
3. Percent change from year-earlier period, except annual figures, which are Dec./Dec.
4. Billions of U.S. dollars, annual rate.
5. Billions of U.S. dollars, n.s.a., annual rate.
n.a. Not available. ... Not applicable.

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
DIVISION OF RESEARCH AND STATISTICS

Date:

June 24, 2003

To:

Members of the FOMC

From:

Division of Research and Statistics

Subject:

Corrected Greenbook Chart

The attached chart shows a corrected version of the long-term unemployment series
that was presented in the lower-right panel of page II-3 from the June Greenbook.

SELECTED UNEMPLOYMENT AND LABOR FORCE PARTICIPATION RATES

(Percent; based on seasonally adjusted data)
2002

2002
Civilian unemployment rate
(16 years and older)

Q3

2003

Q4

Ql

2003

Mar.

Apr.

May

5.8

5.8

5.9

5.8

5.8

6.0

6.1

Teenagers
20-24 years old
Men, 25 years and older
Women, 25 years and older

16.5
9.7
4.7
4.6

16.7
9.6
4.7
4.6

16.1
9.9
4.9
4.6

17.2
9.2
4.9
4.4

17.7
8.9
4.9
4.6

18.0
10.1
5.1
4.7

18.5
10.5
5.2
4.6

Labor force participation rate

66.6

66.6

66.5

66.3

66.2

66.4

66.4

47.4
76.4
75.9
59.4

47.6
76.6
76.0
59.3

46.8
75.8
75.6
59.4

45.2
75.5
75.3
59.6

44.1
74.8
75.3
59.6

45.0
75.5
75.6
59.8

45.1
76.0
75.5
59.7

Teenagers
20-24 years old
Men, 25 years and older
Women, 25 years and older

Labor Force Participation Rate
and Unemployment Rate

Percent
67.4

Percent
S7.0

67.2

-6.5

67.0

-6.0

66.8

-5.5

66.6

-5.0

66.4

-4.5

66.2

4.0

66.0

S3.5

Short-term Unemployed
(Less than 5 weeks)
(Percentage of labor force)

Long-term Unemployed
(Over 26 weeks)
(Percentage of labor force)

Percent
-1.6
-1.4
ay

-1.2
- 1.0
-0.8
-0.6

- 0.4
0.2
L

0.0