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Class III FOMC - Internal (FR)

Part 2

September 10, 2008

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

Class III FOMC - Internal (FR)

September 10, 2008

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
Economic activity appears to have decelerated considerably this quarter. The labor
market deteriorated further in July and August, as private payrolls declined and the
unemployment rate moved sharply higher. In addition, industrial output likely fell
steeply in August, in part because of large cutbacks in motor vehicle assemblies and in
energy output. On the spending side, consumer spending appears to be weakening under
the ongoing pressures from declining household wealth, sluggish real wages, tight credit
conditions, and dismal sentiment. Meanwhile, residential investment has continued to
move down at a pace similar to that seen in recent months. In contrast, business
investment in equipment (other than motor vehicles) and structures appears to have held
up early this quarter. Consumer price inflation has moved up significantly in recent
months. However, some of the pressures driving up inflation seem to be easing.
Labor Market Developments
The labor market has continued to deteriorate. According to the August employment
report, private payroll employment fell 101,000 last month, a slightly larger decline than
the average pace seen from January to July of this year. Most major industry groups shed
jobs last month; manufacturing posted a particularly noticeable loss of 61,000.
Employment also fell by 37,000 in the related temporary help services industry. In
contrast, job losses in the construction industry diminished over the past two months
despite the ongoing contraction in residential investment. Nonbusiness services, which
include the education and health industries, and natural resources and mining showed
increases in line with those of recent months. With the average workweek of production
and nonsupervisory workers holding steady, aggregate hours have edged lower, and in
August they stood 1.5 percent at an annual rate below the second-quarter average.
In the household survey, the unemployment rate jumped 0.4 percentage point, to
6.1 percent, last month. Both adult men and adult women experienced large increases in
their unemployment rates, while the unemployment rate of teens retraced only a small
portion of its steep increase between April and July. We think that part of the rise in the
overall unemployment rate in August was due to the emergency unemployment benefits
that went into effect in July.1 However, the remainder seems indicative of a further
increase in labor market slack. Another measure of slack, the fraction of workers who

The extended benefits program increases unemployment for two reasons. First, the program draws
some individuals who were out of the labor force into unemployment because a person must be looking for
work to collect benefits. Second, the program reduces the incentive for benefit recipients to actively seek
and accept employment offers.

II-1

II-2
Changes in Employment
(Thousands of employees; seasonally adjusted)
2007
Measure and sector

2007

2008

June

Average monthly change
Nonfarm payroll employment
(establishment survey)
Private
Natural resources and mining
Manufacturing
Ex. motor vehicles
Construction
Residential
Nonresidential
Wholesale trade
Retail trade
Financial activities
Professional and business services
Temporary help services
Nonbusiness services1
Total government
Total employment (household survey)
Memo:
Aggregate hours of private production
workers (percent change)2
Average workweek (hours)3
Manufacturing (hours)

July

Aug.

Monthly change

91
71
3
-22
-15
-19
-20
1
9
6
-9
26
-7
76
21
22

80
45
4
-17
-8
-41
-39
-2
6
0
-14
44
4
71
35
-16

-82
-97
4
-43
-31
-41
-30
-11
-6
-29
-7
-39
-24
66
15
-81

-71
-100
6
-39
-31
-49
-30
-19
-7
-26
-6
-29
-30
63
29
-26

-100
-110
8
-44
-38
-50
-28
-22
-4
-8
-13
-55
-36
69
10
-155

-60
-66
10
-38
-38
-20
-16
-4
-16
-18
-3
-17
-24
50
6
-72

-84
-101
12
-61
-22
-8
-19
10
-11
-20
-3
-53
-37
50
17
-342

1.3
33.8
41.2

1.0
33.8
41.2

-1.1
33.7
41.1

-.9
33.7
41.0

-.1
33.7
41.0

-.1
33.7
40.9

1. Nonbusiness services comprises education and health, leisure and hospitality, and "other."
2. Establishment survey. Annual data are percent changes from Q4 to Q4. Quarterly data are percent changes from preceding
quarter at an annual rate. Monthly data are percent changes from preceding month.
3. Establishment survey.

Changes in Private
Payroll Employment

Aggregate Hours and Workweek of
Production and Nonsupervisory Workers
Thousands

400

35.0

Hours

2002 = 100

110

3-month moving average
300

300

200

100

-100

34.5

106

Aug.
34.0

-100

-200

-300

2000

2002

2004

2006

2008

-400

104
102
100

Aug.

-400

108

Aggregate
hours
(right scale)

Workweek
(left scale)

33.5

98
96

33.0

2000

2002

2004

2006

2008

II-3
Selected Unemployment and Labor Force Participation Rates
(Percent; seasonally adjusted)
2007
Rate and group

2008

2007

June

July

Aug.

Civilian unemployment rate
Total
Teenagers
20-24 years old
Men, 25 years and older
Women, 25 years and older

4.6
15.7
8.2
3.6
3.6

4.8
16.4
8.6
3.7
3.8

4.9
16.8
9.0
3.8
3.9

5.3
17.4
9.8
4.2
4.1

5.5
18.1
10.1
4.3
4.2

5.7
20.3
10.2
4.6
4.2

6.1
18.9
10.5
5.0
4.8

Labor force participation rate
Total
Teenagers
20-24 years old
Men, 25 years and older
Women, 25 years and older

66.0
41.3
74.4
75.6
59.7

66.0
41.0
74.0
75.5
59.7

66.0
40.3
73.9
75.5
59.9

66.1
41.4
74.6
75.2
60.0

66.1
40.5
74.8
75.3
60.1

66.1
40.8
74.9
75.6
59.9

66.1
40.2
74.9
75.6
60.1

Percent

Labor Force Participation Rate
and Unemployment Rate

Persons Working Part Time
for Economic Reasons

Percent

67.6

6.5

4.0

Percent of household employment

6.0

67.2
Unemployment rate
(right scale)

67.0
66.8

4.0

Aug.

67.4
3.6

3.6

3.2

2.8

2.4

5.5
5.0

66.6
Aug.

66.4
66.2
66.0
65.8
65.6

4.5
4.0

Participation
rate (left scale)

3.5

2000 2001 2002 2003 2004 2005 2006 2007 2008

3.0

2.0

Job Losers Unemployed
Less Than 5 Weeks

Unemployed Due to Job Loss
4.0

2000 2001 2002 2003 2004 2005 2006 2007 2008

Percent of labor force

4.0

1.4

Percent of household employment

1.4

3-month moving average (thick line)
3.5

3.5
Aug.

1.2

3.0

2.5

2.0

1.5

1.0

2000 2001 2002 2003 2004 2005 2006 2007 2008

1.0

Aug.

1.2

1.0

0.8

0.6

2000 2001 2002 2003 2004 2005 2006 2007 2008

0.6

II-4
Labor Market Indicators

Unemployment Insurance
4.0

Layoffs and Job Cuts

Millions

Thousands
Insured unemployment
(left scale)

3.5

Aug. 23

550
500

300

Percent of private employment

Thousands

250

July
3.0

450

200

2.5

400

150

350

100

300

250

1.8

Layoffs and discharges
(right scale)
1.6

1.4

1.2

Initial claims
(right scale)

2.0

Aug.

1.5
1.0

Aug. 30
2000

2002

2004

2006

2008

1.0

Announced job cuts
(left scale)
2000

2002

2004

2006

2008

Note. 4-week moving averages.

Note. Both series are seasonally adjusted by FRB staff.
Source. For layoffs and discharges, Job Openings and
Labor Turnover Survey; for job cuts, Challenger, Gray,
and Christmas, Inc.

Job Openings and Hires

Job Availability and Hard-to-Fill Positions

Percent of private employment

4.5

4.0

Hires
4.0
3.5

3.5

Percent

Index

July

2.5

110

2.0

1.5

120

2004

2006

2008

Source. Job Openings and Labor Turnover Survey.

Expected Labor Market Conditions

70
50

Hard-to-fill**
(left scale, 3-month moving average)

2000
2002
2004
2006
2008
*Proportion of households believing jobs are plentiful, minus
the proportion believing jobs are hard to get, plus 100.
**Percent of small businesses surveyed with at least one
"hard-to-fill" job opening. Seasonally adjusted by FRB staff.
Source. For job availability, Conference Board; for hardto-fill, National Federation of Independent Business.

Net Hiring Plans
Index

120

Aug.

Job openings
2.0

2002

3.0
2.5

2000

150
130

Job availability*
(right scale)

30
3.0

0.8

Conference Board

Percent

Manpower, Inc.

105
90

105

Aug.
75
Reuters/Michigan

Aug.
45
30

2000

2002

2004

2006

2008

Note. The proportion of households expecting labor
market conditions to improve, minus the proportion expecting
conditions to worsen, plus 100.

Q4
45

National Federation of
Independent Business*
(3-month moving average)
2000

2002

Aug.
2004

2006

2008

Note. Percent planning an increase in employment
minus percent planning a reduction.
*Seasonally adjusted by FRB staff.

5
0

II-5

are working part time for economic reasons, also continued to rise in August.
Meanwhile, the labor force participation rate held steady at 66.1 percent.
Initial claims for unemployment insurance under regular state programs have moved
considerably higher since the July/August Greenbook. We think that the level of these
claims has also been boosted by the emergency unemployment compensation program, as
it was the last time such a program was in place, in 2002, because some individuals who
apply for extended benefits turn out to be eligible for regular benefits (for which they
must file a claim). However, claims have remained elevated for longer this time than in
2002, an indication that the labor market may have weakened further over the past month.
Most other labor market indicators also suggest a further weakening of the labor market.
With regard to separations, the short-term job losers rate has changed little on balance in
recent months, but the layoffs and discharges rate, as measured by the Job Openings and
Labor Turnover Survey (JOLTS), edged up further in July. In addition, announcements
of downsizing plans compiled by Challenger, Gray, and Christmas, Inc., remained at a
high level in August.
With regard to hiring, both the JOLTS hiring rate and the JOLTS job openings rate have
continued their downward trajectories. Perceptions of job availability in the Conference
Board survey edged down further in August, while the National Federation of
Independent Business (NFIB) measure of hard-to-fill positions remained at a very low
level last month. The outlook for hiring remains gloomy. According to the Manpower
survey, firms have lowered their fourth-quarter net hiring plans appreciably. And while
hiring plans in the NFIB survey ticked up in August, the three-month moving average
stands close to its nadir in the last recession.
According to both the Reuters/University of Michigan and Conference Board surveys,
household expectations of future labor market conditions have improved a bit from their
very low mid-summer levels. Even so, these expectations remain at lower levels than at
any time since the early 1990s.
With real GDP reported to have posted a sizable increase even as hours were declining,
the staff estimates that productivity in the nonfarm business sector rose at an annual rate
of 4½ percent last quarter after having increased at a rate of 2½ percent in the first
quarter.2 Over the four quarters ending in the second quarter of this year, productivity
2

According to the productivity and cost data based on the preliminary national income and product
accounts release, productivity in the nonfarm business sector increased at an annual rate of 4.3 percent last

II-6

rose 3½ percent. In the nonfinancial corporate sector, the gain in productivity over the
past year was somewhat smaller, at 2¼ percent.
Output per Hour
(Percent change from preceding period at an annual rate;
seasonally adjusted)

Sector
Nonfarm business
All persons
All employees2
Nonfinancial corporations3

2006:Q2 2007:Q2
to
to
2007:Q2 2008:Q2
.5
.6
1.0

3.41
2.91
2.31

2007

2008

5.8
4.9
1.8

.8
-.7
1.9

Q1
2.6
2.5
-.2

Q2
4.51
5.01
5.61

1. Staff estimates.
2. Assumes that the growth rate of hours of non-employees equals the growth rate of hours of employees.
3. All corporations doing business in the United States except banks, stock and commodity brokers,
and finance and insurance companies. The sector accounts for about two-thirds of business employment.
Nonfinancial corporate output is calculated as an income-side measure.

Industrial Production
Industrial production (IP) is on track to post another decline in the third quarter after
having fallen at an annual rate of more than 3 percent in the second quarter. Output in
July edged up 0.2 percent, but the production indicators for August suggest that IP fell
sharply last month. In particular, aggregate hours of production workers in
manufacturing declined 1.1 percent, and the available weekly production data, which
cover about one-quarter of IP, point to a plunge in motor vehicle assemblies and declines
in the output of refined petroleum products and electricity generation. The factory
operating rate in July, at 77.7 percent, was 2 percentage points below its 1972–2007
average and 2½ percentage points below its recent peak in July 2007; most major
industry groups are operating at below-average rates.3
Motor vehicle assemblies fell more than 1½ million units in August to an annual rate of
8.2 million units. The drop in production reflects a decision by the automakers to scale
back their production plans following the plunge in July vehicle sales. At a 9 million unit
pace, third-quarter schedules are now 1¾ million units below the level of assemblies in

quarter. The staff estimate is based on source data that became available after the GDP release and on
revisions to the June employment data.
3
Major industry groups with above-average operating rates in July included aerospace products and
parts, which has been supported by the continued rollout of the more fuel-efficient Boeing 787 Dreamliner;
energy-related industries, such as petroleum refining and oil and gas extraction; computers and
communications equipment; food; and primary metals.

II-7

Selected Components of Industrial Production
(Percent change from preceding comparable period)

Component

Proportion
2007
(percent)

2008

20071
Q1

2008
Q2

May

Annual rate
Total
Previous

June

July

Monthly rate

100.0
100.0

2.1
2.1

.4
.5

-3.2
-3.1

-.2
-.2

.4
.5

.2
...

Manufacturing
Ex. motor veh. and parts
Ex. high-tech industries

78.7
73.6
69.3

2.3
2.6
1.3

-1.0
.0
-1.1

-3.9
-2.1
-3.3

.0
.0
.0

.1
-.2
-.2

.4
.2
.2

Mining
Utilities

11.6
9.7

.2
3.1

3.5
8.0

2.4
-4.1

.1
-2.2

.9
2.3

.9
-1.9

Selected industries
Energy

24.7

2.3

7.0

-1.0

-.8

High technology
Computers
Communications equipment
Semiconductors2

4.3
1.0
1.3
2.0

22.3
16.7
20.6
25.9

17.6
25.0
6.4
21.8

16.9
8.4
15.7
21.9

-.2
.3
-.2
-.5

.5
.7
.0
.8

.3
.6
-.2
.4

Motor vehicles and parts

5.1

-2.2

-14.4

-28.9

4.8

3.6

65.9
19.9
3.6
16.3

1.1
.3
-2.4
.9

-2.0
-1.7
-11.7
.6

-3.3
-1.4
-5.1
-.6

.0
.0
-.1
.0

-.1
.0
-.5
.2

.0
-.2
-.3
-.2

Business equipment
Defense and space equipment

7.3
1.7

2.8
4.2

2.6
1.3

-6.6
-3.3

.2
-.5

.0
.8

.5
.6

Construction supplies
Business supplies

4.2
7.4

-1.9
-.1

-7.6
-3.5

-5.1
-5.3

.4
-.1

-.2
-.9

.3
-.4

25.4
13.6
11.7

1.8
2.9
.6

-2.5
-.4
-4.9

-2.9
-3.0
-2.8

.0
-.5
.6

.0
.3
-.4

.1
.2
-.1

Total ex. selected industries
Consumer goods
Durables
Nondurables

Materials
Durables
Nondurables

1. From fourth quarter of preceding year to fourth quarter of year shown.
2. Includes related electronic components.
... Not applicable.

Capacity Utilization
(Percent of capacity)
19722007
average

199495
high

200102
low

2007
Q4

June

July

Total industry

81.0

85.1

73.6

81.0

80.6

79.7

79.8

79.9

Manufacturing
Ex. motor veh. and parts
Mining
Utilities

79.7
79.9
87.5
86.8

84.6
84.3
88.7
93.9

71.5
71.2
84.8
84.6

79.3
79.8
90.2
85.9

78.7
79.4
90.4
86.7

77.6
78.6
90.9
85.7

77.5
78.4
91.4
86.2

77.7
78.4
92.1
84.4

Stage-of-process groups
Crude
Primary and semifinished
Finished

86.6
82.2
77.7

89.5
88.2
80.4

81.9
74.6
69.9

89.3
81.3
77.6

89.5
80.8
77.2

89.4
79.8
75.9

89.4
79.8
76.1

90.1
79.5
76.4

Sector

2008

II-8
Production of Domestic Light Vehicles
(Millions of units at an annual rate except as noted)
2008
Item

June

July

Aug.

Sept.

U.S. production1
Autos
Light trucks

9.7
3.9
5.7

8.5
3.6
4.9

8.7
4.4
4.3

8.6
4.2
4.5

9.0
3.7
5.3

9.6
4.7
4.9

8.0
4.1
3.8

8.7
4.4
4.3

Days’ supply2
Autos
Light trucks

66
52
77

72
48
94

n.a.
n.a.
n.a.

75
49
99

88
59
115

71
61
80

n.a.
n.a.
n.a.

Inventories3
Autos
Light trucks

2.48
.86
1.63

2.41
.78
1.63

n.a.
n.a.
n.a.

2.41
.78
1.63

2.58
.85
1.73

2.42
.89
1.54

n.a.
n.a.
n.a.

9.9

8.8

9.0

8.9

9.2

9.8

8.2

8.9

Memo: U.S. production,
total motor vehicles4

Note. FRB seasonals. Components may not sum to totals because of rounding.
1. Production rates for September and the fourth quarter reflect the latest industry schedules.
2. Quarterly values are calculated with end-of-period stocks and average reported sales.
3. End-of-period stocks.
4. Includes medium and heavy trucks.
n.a. Not available.

Inventories of Light Vehicles
Millions of units
3.6
3.4
3.2
3.0
2.8
2.6
Aug.
1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2.4
2.2

2008

Days’ Supply of Light Vehicles
Days
90
Using sales in current month
Using 3-month moving average of sales

80
Aug.

70
60
50
40

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

II-9

2007 and only a little above the second-quarter pace, when strikes severely curtailed
production at General Motors. Preliminary schedules for the fourth quarter are for
production to remain at about this low level.
Although the number of new vehicles in inventory has not been particularly elevated by
historical standards, days’ supply reached an uncomfortably high level of 88 days at the
end of July, due to the plunge in sales that month. However, the cut in assemblies,
combined with a recovery in the pace of sales, caused days’ supply to drop back to
71 days in August, a level much closer to the automakers’ target of 65 days. The excess
stocks that remain are concentrated in light trucks, where days’ supply had jumped to an
extremely bloated 115 days in July before dropping back to 80 days in August; days’
supply of autos stood at a relatively lean 61 days last month.
Elsewhere in transportation, the production of aircraft and parts has jumped during the
past few months. As of August, Boeing had about 3,700 unfilled orders and was
producing about 40 planes per month; Boeing’s backlog, all else being equal, would
support production for quite some time. However, Boeing’s machinists went on strike
last week, which idled most domestic capacity for commercial aircraft assembly.
Prospects for resolution of the strike are uncertain, but if the strike were to last one
month, we estimate that it would take down manufacturing IP by roughly ½ percentage
point in September and a small effect on October as well—similar to the experience with
the previous strike in 2005.
Following a sizable gain in the second half of last year, the output of high-tech equipment
decelerated to a modest annual growth rate of about 17 percent in both the first and
second quarters of this year. Computer production decelerated noticeably in the second
quarter after having been boosted by strong server sales in the first quarter. Reports from
computer manufacturers are mixed, but, on balance, they indicate that foreign demand
has been robust and domestic demand has been soft. Looking ahead, International Data
Corporation’s projection for computer sales suggests that production is likely to increase
moderately in the third quarter; however, the mixed tone of recent statements from
manufacturers suggests a fair bit of uncertainty. Production of communications
equipment stepped up in the second quarter, consistent with a strong increase in revenue
at Cisco. However, capital spending guidance for telecommunications service providers
(TSPs) suggests little impetus to third-quarter production.4

TSPs are estimated to account for roughly one-third of private communications equipment investment
and production.

II-10
Indicators of High-Tech Manufacturing Activity

Rate of Change in Semiconductor
Industrial Production

High-Tech Inventory-Sales Ratios
1995 = 100

Percent
14
3-month moving average

140

12
120

Semiconductor inventory

MPUs

100

4
2
July

Contract electronics & wholesale chip companies
60
Downstream final goods companies

Non-MPUs
-2
2002
2003
2004
2005
2006
Note. MPU is a microprocessor unit.

2007

2008

-4

2002
2003
2004
2005
2006
2007
2008
Note. Company inventories aggregated by company chip
consumption weights.

Circuit Board Orders and Shipments

U.S. Personal Computer and Server Absorption
Billions of dollars

Millions of units, ratio scale
180

Orders

0.70

Millions of units, ratio scale
19.0
Q2
18.0
Q3
17.0

0.65

16.0

0.80
0.75

160
140
July

Servers (left scale)

15.0

0.60
0.55

PCs (right scale)

14.0

120
0.50
100

0.45

Shipments
2002
2003
2004
2005
2006
2007
2008
Note. U.S. and Canadian shipments of bare and loaded circuit
boards.
Source. Institute for Printed Circuits.

Cisco Revenue and U.S. Sales of High-End
Data Networking Equipment

0.40

2002
2003
2004
2005
2006
2007
2008
Note. FRB seasonals. PCs include desktops, notebooks, and
ultra portables. Q3 PC units are an IDC forecast.
Source. International Data Corporation.

13.0
12.5
12.0
11.5
11.0
10.5

Capital Expenditures by Selected
Telecommunications Service Providers
Billions of dollars, ratio scale

2006 = 100
Q2
Q1

75
70
65

140
Annual average
120

60
55

100

U.S. sales
80

45
40

Cisco
2001 2002 2003 2004 2005 2006 2007 2008
Note. FRB seasonals.
Source. Synergy Research Group and Cisco Systems.

35
2008 guidance

2001 2002 2003 2004 2005 2006 2007 2008
Note. FRB seasonals. Includes AT&T, Verizon, Sprint Nextel,
and companies related by merger, acquisition, or spinoff.
Source. SEC filings. Guidance from Dell’Oro.

II-11
Indicators of Industrial Activity

Motor Vehicle Assemblies
Millions of units

Utilities Output
2002 = 100

Millions of units

0.6

120

13.5
Autos and light trucks (right scale)

115
12.5

0.5

Electricity
Aug.

11.5
0.4

110

105

July

100

10.5
95

0.3

0.2
0.1

Medium and heavy trucks
(left scale)

+ Sept.
+

9.5
Natural gas

8.5
80

2002
2003
2004
2005
2006
2007
2008
2009
Note. September values are based on latest industry schedules.

7.5

Weekly Production Index excluding Motor
Vehicles and Electricity Generation

2002
2003
2004
2005
2006
2007
2008
2009
Note. The August value for electricity generation is based on
weekly generation data.

Foreign Industrial Production
2002 = 100

Index
10.2
Monthly aggregate of weekly index
Weekly index

112

10.1

110

10.0

108

9.9
9.8
June

9.7

106

9.6

104

9.5

102

9.4
100

9.3
9.2
Feb. May Aug. Nov. Feb. May Aug. Nov. Feb. May Aug.
2006
2007
2008
Note. One index point equals 1 percent of 2002 total industrial
output.

IP Diffusion Index and
Real Adjusted Durable Goods Orders
Percent

2002
2003
2004
2005
2006
2007
2008
Note. Foreign IP index is a weighted average of Canadian,
Mexican, Japanese, German, French, Italian, and British IP
indexes. The weights are U.S. manufacturing export shares.

ISM Diffusion Index and Average of
Regional New Orders Diffusion Indexes
Diffusion index

Index

70
IP diffusion (right scale)

ISM

60
1

55
60

July
0

RADGO (left scale)

-3

-1
-2

40
35

30
2002
2003
2004
2005
2006
2007
2008
Note. IP diffusion index is calculated on the basis of 3-month changes.
The measure for real adjusted durable goods orders (RADGO) is a
3-month moving average.

Aug.
Regional average

50
45

40
2002
2003
2004
2005
2006
2007
2008
Note. Regional average consists of new orders indexes from the
Chicago, Dallas, Kansas City, New York, Philadelphia, and Richmond
surveys.

II-12

The weaker demand from computer and communications equipment manufacturers
contributed to a deceleration in semiconductor production in the first half of this year,
after a considerable increase in the second half of last year. For the third quarter,
production gains will likely remain relatively subdued; for example, a major
manufacturer reported that it is not seeing the usual seasonal boost to orders in advance
of the holiday season. In addition, although inventory-sales ratios for semiconductors do
not appear excessive, they seem to be creeping up at contract electronics companies and
at wholesale chip companies, and some recent reports have cited excess inventories of
DRAM (dynamic random-access memory) and flash memories.
Elevated energy prices continue to spur drilling for oil and natural gas. Output in this
industry increased at an annual rate of 5½ percent so far this year. Hurricane Gustav,
which passed through the center of the Gulf of Mexico at the end of August, led to the
evacuation of most oil and natural gas extraction platforms and rigs in the region as well
as to the precautionary closure of some oil refineries. These actions appear to have
reduced the August change in IP by less than 0.1 percentage point but will have a more
noticeable effect in September as the production stoppages extended well into the month.5
Output excluding the production of energy, motor vehicles and parts, and high-tech
equipment was little changed for a third month in July. The output of consumer goods
slipped further, continuing a trend that started in the fourth quarter of 2007. The
production of business equipment rose about ½ percent in July after having edged up, on
net, over the previous two months, but much of the increase is attributable to a rebound in
the volatile farm machinery category. Elsewhere, the production of construction supplies
has changed little, on net, over the past several months, as increases in the output of
supplies more likely to be associated with nonresidential construction have provided
some offset to further sharp declines in the production of supplies typically tied to
residential construction. The output of business supplies has continued to trend down,
with notable negative contributions from printing and publishing. Lastly, the output of
materials to be further processed in the industrial sector was little changed in July.
Near-term indicators of production suggest that the industrial sector is likely to remain
soft over the next few months, though output growth will undoubtedly be boosted at
some point by a strike-related rebound in production at Boeing and the return to
production of energy facilities in the Gulf of Mexico. The new orders diffusion indexes
5

As of September 9, nearly 80 percent of crude oil production and about 65 percent of natural gas
production in the Gulf of Mexico remained offline; in addition, one petroleum refinery remained entirely
shut down. These numbers are likely to increase reflecting the effects of Hurricane Ike.

II-13

from the Institute for Supply Management (ISM) and the various regional surveys have
generally remained below 50. While the three-month moving average of real orders for
durable goods (adjusted to exclude industries for which reported orders have little
information content for predicting shipments) has edged up a bit in recent months, it
remains consistent with weak IP. In addition, foreign demand, which has helped support
IP for much of the past year, shows signs of slowing. For example, a trade-weighted
average of the industrial production indexes for some of the United States’ major trading
partners has been falling since late last year.
Motor Vehicle Sales
Demand for light vehicles improved last month but remained at a relatively low level.
After having plunged to an annual rate of just 12.5 million units in July, light vehicle
sales rebounded to 13.7 million units in August, about the same pace as in June.
. The August
increase in light vehicle sales likely reflected, in part, an expansion of customer incentive
programs by the automakers. In particular, sales at General Motors surged more than
800,000 units (annual rate), and the company cited a strong response to its “EmployeeDiscount-For-Everyone” program.6 More generally, the availability of cash rebates and
cut-rate financing has risen sharply in the past few weeks. In addition, while concerns
over gasoline prices remain high, they appear to have subsided a little as prices have
eased; the percentage of respondents to the Reuters/Michigan survey who cited high
gasoline prices or gasoline shortages as reasons for their negative view of car-buying
conditions moved down somewhat in August, and demand shifted back towards trucks
and away from autos last month.
Besides high gasoline prices and weak macroeconomic fundamentals, a number of other
forces appear to be weighing on the demand for light vehicles. In particular, lower tradein values for light trucks have reduced the cash that many consumers expected to have on
hand to apply toward the purchase of new vehicles. The lower trade-in values have also
prompted several automakers to pull back from leasing, which typically has accounted
for about 20 percent of sales, because their lending arms are accruing large losses when
consumers return leased vehicles that have fallen out of favor, such as large SUVs.7
Finally, consumers also face tighter credit conditions for more traditional financing—
both from captive auto finance companies, such as GMAC, and from banks.
6

Although General Motors’ employee pricing program was originally scheduled to expire on
September 2, the company extended it until the end of September.
7
Chrysler has decided to exit the leasing business altogether, and Ford and General Motors have
announced plans to scale back vehicle leasing.

II-14
Sales of Light Vehicles
(Millions of units at an annual rate; FRB seasonals)
2007
Category

2007

Total

2008
Q1

June

July

Aug.

16.1

16.0

15.2

14.1

13.6

12.5

13.7

7.6
8.5

7.7
8.2

7.4
7.8

7.6
6.5

7.5
6.1

6.9
5.6

6.8
6.9

North American1
Autos
Light trucks

12.3
5.2
7.1

12.2
5.4
6.8

11.5
5.1
6.5

10.4
5.0
5.3

9.9
4.9
5.1

9.1
4.4
4.6

10.4
4.5
5.9

Foreign-produced
Autos
Light trucks

3.8
2.4
1.4

3.7
2.4
1.3

3.7
2.6
1.1

3.7
2.7
1.0

3.5
2.5
1.0

3.3
2.3
1.0

51.3

50.5

50.2

45.9

45.3

42.4

45.9

Autos
Light trucks

Memo:
Detroit Three domestic
market share (percent)2

Note. Components may not sum to totals because of rounding.
1. Excludes some vehicles produced in Canada that are classified as imports by the industry.
2. Domestic market share excludes sales of foreign brands affiliated with the Detroit Three.

Content redacted.

Car-Buying Attitudes

Market Share of Light Vehicles by Segment
Index

Percent
76

Percent
180

0.42

Appraisal of car-buying conditions (right scale)
160

0.38

Large and
midsize cars

0.34

140

120

Pickup/van/SUV

40
28
16

0.30
0.26

Bad time to buy:
Gas prices and shortages
(left scale)

Aug.

100

Aug.

-8

2002

2003

2004

2005

2006

2007

2008

Source. Reuters/University of Michigan Survey.

2009

Small cars

0.22
0.18

Cross utility

2006

2007

2008

Note. Data through May. FRB seasonals.

0.14
2009

0.10

II-15

Consumer Spending
Consumer spending has weakened noticeably in recent months against the backdrop of a
deteriorating labor market, higher food and energy prices, lower equity and housing
wealth, and depressed sentiment. Moreover, the temporary boost to spending growth
from the tax rebates seems to be waning. Real personal consumption expenditures (PCE)
declined 0.4 percent in July after having edged lower in June, as a result of a precipitous
drop in motor vehicle outlays and a substantial decline in spending on other goods in
those two months. The recent weakness in consumer spending on goods excluding motor
vehicles contrasts sharply with surprisingly solid growth in the spring. Meanwhile,
outlays for services (excluding the volatile energy components) were reported to have
increased modestly in June and July.8
The weakness in real consumer spending reflects the challenging conditions that
households currently face. In the second quarter, lower equity prices and the ongoing
declines in house prices pushed the ratio of wealth to income down for a third
consecutive quarter to about its level in early 2004. Subdued gains in wages and salaries,
combined with sharply higher food and energy prices, have also restrained the purchasing
power of households. Excluding the temporary boost of roughly $90 billion (current
dollars not at an annual rate) in tax rebates disbursed from May through July, real
disposable income fell at an annual rate of ¾ percent last quarter and continued to move
lower in July. Consumer sentiment remains depressed, although readings from both the
Reuters/Michigan and Conference Board surveys improved modestly in July and August.
In spite of an apparent tightening of lending standards, credit card balances continued to
increase at a solid pace in July as households likely borrowed to support their spending.
Housing
Residential construction activity continued to decline steeply through mid-year. In July,
single-family housing starts fell to an annual rate of 641,000 units, while adjusted permit
issuance—a useful month-ahead indicator of starts—slid to an annual rate of 593,000
units. At an annual rate of decline of 22 percent, the contraction in single-family starts
over the three months ending in July was similar to the rate of decline earlier in the year.
In the multifamily sector, starts fell to 324,000 units in July, mostly reversing the
previous month’s outsized gain. June’s spike in multifamily starts can be traced to more-

As always, recent quarters’ estimates of real services spending—comprising over 60 percent of total
PCE—may not be offering a timely view of the overall spending trajectory, because spending on several
categories of services are based on judgmental trends for the period more recent than the 2006 Service
Annual Survey.

II-16
Real Personal Consumption Expenditures
(Percent change from preceding comparable period)
Category

2007

2008
Q1
Q2
Annual rate

May

2008
June
July
Monthly rate

Total real PCE

2.8

1.8

-.1

-.4

Motor vehicles
Goods ex. motor vehicles
Ex. energy
Services
Ex. energy
Memo:
Nominal retail control1

2.0
3.2
3.5
2.6
2.6

-10.7
-.3
.5
2.4
2.2

-19.3
5.1
6.2
1.3
1.1

-.8
.5
.7
.3
.1

-2.4
-.4
-.6
.2
.2

-4.0
-.8
-.6
.0
.2

5.2

4.6

10.3

1.1

1.0

1. Total sales less outlays at building material and supply stores and automobile and other motor
vehicle dealers.

Change in Real PCE Goods
Percent

1.0

Percent

2.0

0.8

1.6

0.6

1.2

2.0
1.6
1.2

6-month

0.4

0.8

0.2

0.4

-0.0

-0.2

-0.4

-0.8

-0.6

-1.2

-0.2

July

6-month moving average

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

0.8

-0.4

1-month
July
2006

2007

2008

-0.8
-1.2

Note. Shaded bars indicate periods of business recession as defined by the
National Bureau of Economic Research.

Change in Real PCE Services
Percent

0.5

Percent

1.0
0.8

0.4

0.3

1.0
0.8

6-month
0.6

0.6

0.4

0.2

0.2
July

0.2

-0.0

-0.2

6-month moving average
0.1

0.1
July

0.0

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

Note. Shaded bars indicate periods of business recession as defined by the
National Bureau of Economic Research.

-0.4

1-month

-0.6
0.0

-0.8

-0.6
2006

2007

2008

-0.8

II-17
Fundamentals of Household Spending

Change in Real DPI

Personal Saving Rate

12-month percent change

Percent

2
July

0
-2
-4

1998
2000
2002
2004
2006
2008
Note. Values for December 2004 and December 2005
exclude the effect on income of the one-time Microsoft
dividend in December 2004.

2
July

-2

-4

-4
1998
2000
2002
2004
2006
2008
Note. The value for December 2004 excludes the effect on income
of the one-time Microsoft dividend in that month.

Target Federal Funds Rate
and 10-Year Treasury Yield

Household Net Worth and Wilshire 5000
16200

Index

Ratio

7.0

Percent

7
6

14200

Wilshire 5000
(left scale)

Treasury
yield

Sept. 9
6.0

Ratio of household
net worth to DPI*
(right scale)

4200

1998

2000

2002

2004

2006

Federal
funds
rate

5.5

6200

10200
8200

3
Sept. 9

7
6

6.5

12200

5.0
1

2008

4.5

1
1998

2000

2002

2004

2006

2008

2010

*The value for 2004:Q4 excludes the effect on income
of the one-time Microsoft dividend in December 2004.

Consumer Confidence
160

1985 = 100

1966 = 100
Reuters/
Michigan
(right scale)

140

110
100

120

90
80

100

80
Aug.

Conference Board
(left scale)

60
40

120

1990

1991

1992

1993

1994

1995

1996

Aug.

1997

1998

1999

2000

2001

2002

2003

2004

2005

Note. Shaded bars indicate periods of business recession as defined by the National Bureau of Economic Research.

2006

2007

2008

2009

60
50
40

II-18

Private Housing Activity
(Millions of units, seasonally adjusted; annual rate except as noted)
2008
Sector
All units
Starts
Permits
Single-family units
Starts
Permits
Adjusted permits1
Permit backlog2
New homes
Sales
Months’ supply3
Existing homes
Sales
Months’ supply3
Multifamily units
Starts
Permits
Permit backlog2
Mobile homes
Shipments
Condos and co-ops
Existing home sales

2007

May

June

July

1.36
1.40

1.05
.99

1.02
1.03

.98
.98

1.08
1.14

.97
.94

1.05
.98
.99
.109

.73
.65
.67
.096

.67
.63
.65
.089

.68
.64
.65
.094

.66
.62
.64
.089

.64
.58
.59
.093

.78
8.40

.56
10.24

.52
10.45

.51
10.62

.50
10.47

.52
9.69

4.94
8.67

4.39
10.24

4.34
10.31

4.41
10.02

4.26
10.39

4.39
10.03

.309
.419
.075

.325
.341
.067

.349
.400
.071

.300
.343
.065

.424
.522
.071

.324
.353
.067

.096

.092

.088

.087

.084

.085

.713

.560

.573

.580

.590

.610

1. Adjusted permits equal permit issuance plus total starts outside of permit-issuing areas.
2. Number outstanding at end of period. Excludes permits that have expired or have been canceled,
abandoned, or revoked. Not at an annual rate.
3. At current sales rate; expressed as the ratio of seasonally adjusted inventories to seasonally adjusted
sales. Quarterly and annual figures are averages of monthly figures.

Private Housing Starts and Permits
(Seasonally adjusted annual rate)
Millions of units

Millions of units

2.0

1.0

1.8

Single-family starts (right scale)
1.6

.8
1.4
.7

1.2
Single-family adjusted permits (right scale)
1.0

.5
July

.4
.4
July

Multifamily starts (left scale)
.2

1999

2000

2001

2002

2003

2004

2005

2006

Note. Adjusted permits equal permit issuance plus total starts outside of permit-issuing areas.

2007

2008

II-19

stringent building codes that took effect in New York City on July 1, which apparently
led developers to pull forward the start date of some planned apartment projects.
Home sales have moved sideways in recent months at very weak levels. The Census
Bureau’s measure of sales agreements for new homes—at 515,000 units in July—has
changed little in recent months, but is down 35 percent from a year ago. Sales of existing
single-family homes have been relatively flat since the end of last year, and recent
readings of the pending home sales index suggest that sales will remain at a low level in
the near term.9
Recent cutbacks in new residential construction have further reduced the level of newhome inventories, and the flat pace of sales in recent months has allowed these inventory
reductions to finally start to bring down the months’ supply of new homes for sale. Even
so, the months’ supply of new homes for sale remains extremely elevated at more than
double the level that prevailed prior to the downturn in the housing market.
Tight conditions in mortgage credit markets over the summer continued to restrain
housing demand. The deterioration has been especially acute for mortgages that cannot
be purchased by government-sponsored enterprises (GSEs); securitization of such loans
has virtually halted, and lending spreads remain very wide. Conforming mortgage
markets had also tightened over the summer. As of last week, the average rate for a
standard 30-year fixed-rate conforming mortgage had risen about 30 basis points since
May to 6.4 percent; however, rates at some lenders have reportedly retraced most of this
increase in the past few days in response to the conservatorship of Fannie Mae and
Freddie Mac. Non-price lending terms also tightened considerably over the summer as
the GSEs’ tighter lending standards made conforming mortgages more difficult to obtain.
Moreover, down-payment requirements have become more binding for many potential
borrowers (notwithstanding the first-time homebuyer tax credit described in the footnote
above) because primary mortgage insurers have tightened standards and are charging
higher fees, and because fewer lenders are willing to extend second mortgages that would
allow borrowers to sidestep these requirements.
House prices remain on a downward trajectory. For existing homes, the monthly version
of the purchase-only repeat-sales price index calculated by the Office of Federal Housing
9

A provision of the Housing and Economic Recovery Act of 2008, passed at the end of July, offers
first-time home buyers a tax credit of up to $7,500 on homes purchased between April 9, 2008, and
June 30, 2009; the homebuyer must pay back this credit (without interest) in the succeeding 15 years (or
sooner if the house is resold). The tax credit is not expected to have any effect on published home sales
statistics until August or September.

II-20

Indicators of Single-Family Housing

New Single-Family Home Sales

Index (2001 =1 00)

140

Millions of units
_ (annual rate)
15

130

1.3

6.0
120
5.5

Content partially redacted.

Existing Single-Family Home Sales
Millions of units
_ (annual rate)
65

1.1

110

0.9
100

5.0

90
4.5
80

0.7
0.5

Note.

Source. National Association of Realtors.

Source.
for sales agreements, Census Bureau.

Inventories of New Homes
and Months' Supply
600

Thousands of units

Mortgage Rates
Months

July

550

Percent

500

450

7
July

400

350

4
300

250

200~~~~~~~~~~~Ut,~~~~~uu

Note. Months' supply is calculated using the 3-month moving
average of sales.
Source. Census Bureau.

Note. The September reading is a monthly average of data
available through Sept. 3, 2008.
Source. Federal Home Loan Mortgage Corporation.

Prices of Existing Homes

Price of New Homes

Percent change from year ea~ier
Monthly OFHEO purchase-only index
S&P/Case-Shiller national price index

Percent change from year ea~ier

6
15

5
June

-5

-15

-3
-6
-9
~~~~LU~~~~~~~~~~~~LU-12

Source. Census Bureau.

II-21

Enterprise Oversight (OFHEO) decreased 4.8 percent over the 12 months ending in June.
By comparison, the national S&P/Case-Shiller repeat-sales price index—which, unlike
the OFHEO index, includes houses financed by nonconforming loans—fell about
15 percent over the past year. As for new homes, the constant-quality price index—
which attempts to control for changes in the quality and geographic composition of new
homes sold—was down 3½ percent in the second quarter relative to its level a year
earlier. Although these lower prices may be starting to bolster sales, survey evidence and
anecdotal reports suggest that expectations of further house price declines remain quite
prevalent, a consideration that may make potential buyers reluctant to purchase homes
until prices show signs of stabilizing.
Equipment and Software
We estimate that investment in equipment and software (E&S) fell at an annual rate of
3½ percent in the second quarter, largely because of a sharp drop in business spending on
motor vehicles. In contrast, growth of real outlays for nontransportation E&S held up
reasonably well last quarter. More recently, nominal orders and shipments of nondefense
capital goods excluding aircraft rose substantially in July, although some of the gain in
nominal shipments reflected unusually large price increases. Moreover, as in previous
months, July orders and shipments may have reflected increased foreign demand. Thus,
the nominal shipments data likely overstates the true strength of domestic investment
demand.
Along those lines, the fundamental determinants of E&S investment appear consistent
with weak domestic demand. Although business output growth has not decelerated
substantially over recent quarters, other determinants of business spending suggest
gloomier prospects. The user cost of capital has been rising, as corporate bond yields
have edged up this year, despite declining Treasury yields, and capital goods prices have
accelerated. In addition, corporate profits have weakened, and cash flow moved down
again last quarter. And although monthly readings of business conditions—both national
and regional—have edged up over the past few months, they remain downbeat for the
most part.
Business outlays on transportation equipment fell sharply in the second quarter as
business purchases of light trucks tanked. Spending on light motor vehicles appears to
have declined again this quarter, a result of automakers aggressively scaling back
deliveries to daily rental companies in August; demand from other businesses remained
sluggish as well. Moreover, sales of medium and heavy trucks fell back a good bit in
July from the already-subdued rate observed in recent months. The pace of new orders

II-22
Orders and Shipments of Nondefense Capital Goods
(Percent change; seasonally adjusted current dollars)
2008
Category

May

Annual rate

June

July

Monthly rate

Shipments
Excluding aircraft
Computers and peripherals
Communications equipment
All other categories

-.1
-.4
-5.8
2.6
-.1

3.4
5.9
-19.0
5.8
8.8

-.2
.2
2.9
4.9
-.5

.7
.6
-2.4
5.7
.4

2.5
1.6
-2.6
.8
2.0

Orders
Excluding aircraft
Computers and peripherals
Communications equipment
All other categories

-5.6
4.7
-1.7
.6
5.7

-6.8
10.2
-5.3
.2
12.9

.0
-.3
9.3
1.6
-1.3

-2.3
1.6
.3
-4.1
2.3

6.3
2.5
-11.0
18.4
2.5

Memo:
Shipments of complete aircraft1

43.4

43.1

45.9

41.8

40.9

1. From Census Bureau, Current Industrial Reports; billions of dollars, annual rate.
Source. Census Bureau.

Communications Equipment
20
17
14

Non-High-Tech,
Nontransportation Equipment

Billions of chained (2000) dollars, ratio scale
Shipments
Orders

20
17
14

Billions of chained (2000) dollars, ratio scale

47
July

July
5

Orders

Shipments

2000
2002
2004
2006
2008
Note. Shipments and orders are deflated by a price index
that is derived from the BEA’s quality-adjusted price indexes
and uses the PPI for communications equipment for
monthly interpolation.

2000
2002
2004
2006
2008
Note. Shipments and orders are deflated by the staff
price indexes for the individual equipment types included
in this category. Indexes are derived from the BEA’s
quality-adjusted price indexes.

Computers and Peripherals
240
210
190
170

2000 = 100

Medium and Heavy Trucks

Billions of chained (2000) dollars
July
Industrial production
(left scale)

150

1240

21
19

1060
940
820

17
15

130
110

Thousands of units, ratio scale

1240
1060
940
820

Net new orders
of class 5-8 trucks

700

580

460

13
Real M3
shipments
(right scale)

11
9

340

July

340

Sales of class 4-8 trucks
70

2000
2002
2004
2006
2008
Note. Ratio scales. Shipments are deflated by the staff
price index for computers and peripheral equipment, which
is derived from the BEA’s quality-adjusted price indexes.

220

2000

2002

2004

2006

2008

220

Note. Annual rate, FRB seasonals.
Source. For sales, Ward’s Communications; for orders, ACT Research.

II-23
Fundamentals of Equipment and Software Investment

Real Business Output
4-quarter percent change

4
Q2

-2

-4

1990
1990 1991
1991 1992
1992 1993
1993 1994
1994 1995
1995 1996
1996 1997
1997 1998
1998 1999
1999 2000
2000 2001
2001 2002
2002 2003
2003 2004
2004 2005
2005 2006
2006 2007
2007 2008
2008
Source. Bureau of Economic Analysis.

User Cost of Capital

Corporate Bond Yields
4-quarter percent change

-4

Percent

13.5

12.5

11.5

Non-high-tech

-3
-6
-9

-15

High-tech
1990
1995
2005
1990 1992 1994
1996 1998 2000
2000 2002 2004
2006 2008

-3

-9

6.5

-12

5.5

-15

4.5

Sept. 9

7.5
6.5

10-year BBB

5.5
2000 2001
2001 2002
2002 2003
2003 2004
2004 2005
2005 2006
2006 2007
2007 2008
2008
2000

4.5

Note. Daily averages based on Merrill Lynch bond data.

Surveys of Business Conditions
Ratio

Billions of chained (2000) dollars

1.4
1300

Q2
Real cash flow
(left scale)

Diffusion index

70
ISM
Philadelphia Fed

1.5

1500

1.3

60
50

1.1
Ratio of cash flow
to fixed investment
(right scale)

500

Aug.

700

1.2

900

300

8.5

7.5

Corporate Cash Flow

1100

9.5

8.5

Source. Staff calculation.

1700

10.5
10-year high-yield

9.5

-6

-12

10.5

13.5

1.0
0.9

40
40
30

0.8
19901991

1995
1995

2000
1999

20032005

0.7
2007

Note. Cash flow and fixed investment for the corporate business
sector.
Source. Bureau of Economic Analysis; FRB flow of funds accounts.

2000
2002
2004
2006
2008
2000 2001 2002 2003 2004 2005 2006 2007 2008
Source. Manufacturing ISM Report on Business;
Philadelphia Fed Business Outlook Survey.

II-24

Nonresidential Construction and Indicators
(All spending series are seasonally adjusted at an annual rate; nominal CPIP deflated by
BEA prices through Q1 and by staff projection thereafter)

Total Structures

Office, Commercial, and Other
Billions of chained (2000) dollars

290

Billions of chained (2000) dollars

July
270

270

250

230

210

July

80
70
60

190
170

2000

2002

2004

2006

2008

80
70

Other
July

60
50

Commercial

July

Office

190

170

30
2000

2002

2004

2006

2008

Note. Other consists of structures for religious organizations,
education, lodging, amusement and recreation, transportation,
and health care.

Architectural Billings and
Nonresidential Construction Employment

Manufacturing
and Power & Communication
Billions of chained (2000) dollars

70
60

Power & communication

70
60

3.0

Manufacturing

2000

2002

2004

Billings (right scale)

2006

2008

1.5

1.0
0.5
0.0

20
10

Diffusion index

2.5
2.0

July

Percent

Change in
employment (left scale)

-0.5
-1.0

2000

2002

2004

2006

July

Aug.

2008

Note. Both series are 3-month moving averages. Employment
consists of industrial, commercial, and specialty trade construction.
Source. For billings, American Institute of Architects;
for employment, Bureau of Labor Statistics.

Vacancy Rates

Drilling and Mining Indicators
Percent

18
15

Office
Industrial

Number

Millions of feet

2200
July
2000
Sept.
1800

1600

20
Q2

9
15

Retail
6

2000

2002

2004

2006

2008

Note. Industrial space includes both manufacturing
structures and warehouses.
Source. Torto Wheaton Research.

2400

Drilling rigs
(right scale)

Footage drilled
(left scale)

1400
1200
1000

800
600
2000

2002

2004

2006

2008

Note. The September readings for drilling rigs are based on
data through September 5, 2008. Both series are seasonally
adjusted by FRB staff.
Source. DOE/Baker Hughes.

400

II-25

for these trucks also slumped in July, an indication that sales are unlikely to improve in
the near term. Domestic aircraft investment stepped up in the second quarter, but the
Boeing machinists’ strike, as mentioned above, seems likely to cause a drop in deliveries
this quarter.
Spending on high-tech E&S posted a moderate gain in the second quarter, as robust gains
in investment in communications equipment were balanced by tepid growth of spending
on computers. In the current quarter, the lukewarm 2008 guidance from TSPs (as noted
earlier), along with the decline of computer orders and shipments in July, suggests
weaker spending may be in store.
Nominal orders and shipments of equipment other than high-tech and transportation
jumped in July. Although July’s data partly reflected a large rise in prices and perhaps
another increase in foreign demand, these factors are probably not large enough to
explain the entire nominal increase.10 Furthermore, orders outpaced shipments by a
considerable margin in June and July. July’s increase in orders was relatively broad
based, with particular strength seen in orders for measuring and controlling devices,
heating and ventilation equipment, industrial machinery, and construction machinery.
Nonresidential Construction
Real nonresidential investment (other than drilling and mining) increased at a robust rate
in the second quarter. However, nominal expenditures declined in July, and market
fundamentals and forward-looking indicators remain downbeat. Vacancy rates in the
office and industrial sectors moved higher in the first half of the year after several years
of declines, and vacancy rates for retail space continued on an upward trajectory. In the
resale market, sales of existing commercial properties have plunged so far this year from
2007’s record pace, and prices seem to be softening. On the financing side, issuance of
commercial mortgage-backed securities has fallen dramatically this year, corporate bond
spreads remain wide, and the Senior Loan Officer Opinion Survey on Bank Lending
Practices reported a dramatic tightening of standards for commercial real estate loans
over the first half of this year. Meanwhile, construction costs are also surging: The
producer price index for materials and components of construction rose at an annual rate
of 23 percent over the three months ending in July, and anecdotes from general
contractors suggest that price increases for key construction inputs (like asphalt, steel,
and plastic materials) are squeezing profit margins. These developments appear to be
depressing plans for new projects. Indeed, the three-month average of the architectural
10

The producer price index for these capital goods rose 0.8 percent in July, which accounted for a
sizable portion of the 2 percent increase in July nominal shipments.

II-26
Nonfarm Inventory Investment
(Billions of dollars; seasonally adjusted annual rate)
2007
Measure and sector

2008

May

June

July

-20.6
-21.3
.7

-17.9
-15.3
-2.6

-52.9
-10.2
-42.7

n.a.
n.a.
n.a.

Manufacturing and trade ex. wholesale
and retail motor vehicles and parts
Manufacturing
Wholesale trade ex. motor vehicles & parts
Retail trade ex. motor vehicles & parts

6.1
2.9
-3.3
6.5

5.6
13.7
.0
-8.2

-23.7
-24.5
4.9
-4.0

-37.3
-23.5
2.2
-16.0

-14.6 e
-7.5e
4.1 e
-11.2

n.a.
n.a.
n.a.
n.a.

Book-value inventory investment
(current dollars)
Manufacturing and trade ex. wholesale
and retail motor vehicles and parts
Manufacturing
Wholesale trade ex. motor vehicles & parts
Retail trade ex. motor vehicles & parts

70.4
34.7
23.0
12.7

95.8
60.5
39.0
-3.7

95.3
39.3
48.5
7.5

78.1
38.3
45.9
-6.1

129.8
81.6
42.8
5.4

n.a.
31.0
62.1
n.a.

Real inventory investment
(chained 2000 dollars)
Total nonfarm business
Motor vehicles
Nonfarm ex. motor vehicles

n.a. Not available.
e Staff estimate of real inventory investment based on revised book-value data.
Source. For real inventory investment, BEA; for book-value data, Census Bureau.

ISM Customers’ Inventories:
Manufacturing

Inventory Ratios ex. Motor Vehicles
Months

1.9
1.8

1.9

Index

1.8

Staff flow-of-goods system

55
1.7

July

1.6

1.5

1.4

1.3

1.2

1.2
Census book-value data

1.1

Aug.

1.7

1.6

2000
2000

2002
2002

2004
2004

June
2006
2006

2008
2008

Note. Flow-of-goods system covers total industry ex.
motor vehicles and parts, and inventories are relative
to consumption. Census data cover manufacturing and
trade ex. motor vehicles and parts, and inventories are
relative to sales.

1.1

2000
2000

2002
2002

2004
2004

2006
2006

2008
2008

Note. A number above 50 indicates inventories are "too high."
Source. Manufacturing ISM Report on Business.

II-27

billings index has registered a string of weak readings that are suggestive of outright
declines in nonresidential building outlays in the second half of this year.
Supported by rising energy prices, investment in drilling and mining structures increased
at an annual rate of nearly 25 percent in the first half of the year. Recent readings for
footage drilled and the number of drilling rigs in operation suggest that investment
continued its upward climb in July and August.
Business Inventories
Firms drew down their inventories at a rapid pace in the second quarter, and book-value
data for the manufacturing and wholesale trade sectors suggest that inventories declined
further in July. The indicators we track are not sending a clear signal regarding whether
firms are holding excess inventories. The ratio of book-value inventories to sales
(excluding motor vehicles) continued to trend down through June. However, information
from the staff’s flow-of-goods inventory system suggests that months’ supply excluding
motor vehicles and parts remains elevated, particularly in areas such as construction
supplies, business equipment, and, to a lesser degree, consumer goods. Anecdotal reports
of inventory imbalances have been limited to light trucks and some categories of
semiconductors. Meanwhile, purchasing managers reported that their customers’
inventories were high in August, as the ISM’s customers’ inventories index came back up
to about the elevated value it had attained in June.
Federal Government Sector
The deficit in the unified federal budget continued to widen in July as outlays surged, the
last major wave of stimulus rebates was sent out, and tax receipts were about flat.11
Adjusted for payment-timing shifts and financial transactions, the unified budget deficit
in July was $33 billion larger than the adjusted deficit in July of last year, with the
stimulus rebates accounting for almost half the erosion.12 The Congressional Budget
Office, in its updated budget outlook released on September 9, anticipates an unadjusted

The Economic Stimulus Act of 2008 authorized an expected total of $112 billion in stimulus rebates,
with $94 billion already sent out by the end of August, another $5 billion to be disbursed over the
remainder of calendar year 2008, and nearly $13 billion to be distributed during the 2009 tax-filing season.
12
The deficit in July on an unadjusted basis that includes financial transactions was even wider, as the
Federal Deposit Insurance Corporation spent $14 billion to cover insured deposits at failed financial
institutions. Moreover, the Daily Treasury Statements show that another $4 billion in outlays for deposit
insurance were made in August and September. These outlays are expected to be recovered over time as
the assets of the failed institutions are sold and the premium payments made by financial institutions to
cover deposit insurance are raised.

II-28
Federal Government Budget
(Unified basis; adjusted for payment-timing shifts and financial
transactions; data from Monthly Treasury Statement)

Surplus or Deficit (-)

Billions of dollars

300

300
12-month moving sum

200

100

-100

-200

-300

-300
July

-400
-500

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Outlays and Receipts

2006

2007

2008

-400
-500

2009

Percent change from year earlier

20
Receipts

12-month moving sum
15

Outlays

July

-5

-10

-15

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

-15

2009

Recent Federal Outlays and Receipts
(Billions of dollars except as noted)

July

12 months ending in July

2007

2008

Percent
change

2007

2008

Percent
change

Outlays
Net interest
National defense
Major transfers1
Other

226.3
24.0
46.8
122.2
33.3

249.0
24.1
55.1
136.0
33.8

10.0
.1
17.8
11.3
1.5

2,743.5
236.4
556.5
1,510.1
440.6

2,927.4
245.6
611.9
1,623.8
446.1

6.7
3.9
10.0
7.5
1.3

Receipts
Individual income and payroll taxes
Corporate income taxes
Other

170.4
142.3
9.6
18.5

160.5
131.0
10.3
19.2

-5.8
-7.9
6.6
3.9

2,559.0
1,966.8
381.9
210.3

2,546.3
1,991.5
327.9
227.0

-.5
1.3
-14.1
7.9

Surplus or deficit (-)
Memo:
Unadjusted surplus or deficit (-)

-55.9

-88.5

...

-184.6

-381.1

...

-36.4

-102.8

...

-166.0

-375.6

...

Function or source

1. Includes Social Security, Medicare, Medicaid, and income security programs.
... Not applicable.

II-29

deficit for fiscal year 2008 of $407 billion and projects the deficit to widen to
$438 billion in fiscal 2009, both about 3 percent of nominal GDP.
Federal outlays in July, adjusted for payment-timing shifts and financial transactions,
were 10 percent above last July’s level. Nominal defense spending increased almost
18 percent from its year-earlier level and is consistent with a robust increase in real
defense purchases this quarter as measured in the national income and product accounts.
Transfer payments in July moved up briskly relative to a year earlier; they were boosted
by outsized increases in outlays for Medicare and Medicaid and also by the portion of the
stimulus rebates sent to households with little or no tax liability (such rebates are counted
as transfer payments in the budget).13
Excluding the effects of the stimulus rebates, tax receipts in July were about unchanged
from their year-earlier level and increased only 2 percent in the 12 months ending in July
relative to the comparable period a year earlier. The slowdown in the inflow of federal
tax receipts has been most pronounced in corporate taxes, probably because of the decline
in corporate profits over the past year. Net corporate receipts over the 12 months ending
in July were 14 percent below their level in the year-earlier period. Individual income
and payroll taxes, excluding the stimulus rebates, posted a gain of only 4 percent, an
increase likely consistent with the slowing pace of personal income.
The Congress has been slow to work on the annual appropriations bills necessary to fund
discretionary federal spending programs in fiscal 2009, which begins on October 1. So
far, the House has passed only one of the 12 appropriations bills, and the Senate has
passed none. A continuing resolution will be needed to fund agencies covered by
appropriations bills that have not been enacted by the start of the new fiscal year.
The placing of the GSEs Fannie Mae and Freddie Mac into conservatorship will likely
lead to additional budgetary costs through purchases by the Treasury of the equity or
mortgage-backed securities of the GSEs, which would be counted as outlays in the
unified budget. The Treasury reports that it will begin purchasing new GSE mortgagebacked securities in September. The Treasury also has agreements with Fannie Mae and
Freddie Mac to purchase up to $100 billion in senior preferred stock from each GSE in
order to help keep each enterprise's assets greater than its liabilities. At this time,
however, the magnitude of these costs is highly uncertain.

The Congressional Budget Office estimates that the temporary emergency unemployment insurance
program will increase benefits by $12 billion until the program expires at the end of March 2009.

II-30

State and Local Indicators

Real Spending on Consumption & Investment

Net Change in Employment

Percent change, annual rate

Thousands of jobs, monthly average

12
Spending
4-quarter moving average

-2

-4

1998

2000

2002

2004

2006

2008

-4

30
20

-10

Source. BEA, national income and product accounts.

1998

2000

2002

2004

2006

2008

Net Saving
Percent of nominal GDP

Billions of chained (2000) dollars

200

190

July

1.0

0.5

0.0

190

180

170

160

150

-0.5

140

1998

2000

2002

2004

2006

2008

140

-0.5
Q2

-1.0

Note. Nominal CPIP deflated by BEA prices through
Q2 and by a staff projection thereafter.
Source. Census Bureau, Construction Spending.

1988

1993

Individual and
corporate income
taxes
Total
revenues

2008

-1.0

Percent change from year earlier

4-quarter moving average

2003

Local Revenues

Percent change from year earlier

1998

Source. BEA, national income and product accounts.

State Revenues
20

-10

Source. BLS, Employment Situation.

Real Construction
Annual rate

30
Year to date

4-quarter moving average

12
10
Property taxes

8
6
Q1

-5

-10

-15

1998

2000

2002

2004

2006

2008

Source. Census Bureau, Quarterly Summary of State and
Local Government Tax Revenue.

4
2

Total revenues
1998

2000

2002

2004

2006

2008

Source. Census Bureau, Quarterly Summary of State and
Local Government Tax Revenue.

II-31

State and Local Government Sector
The incoming indicators point to a modest rate of increase in real state and local spending
in recent months after taking account of both the latest data and the substantial revisions
to earlier figures for employment (downward) and construction (upward). According to
the latest labor market report, state and local employment rose 18,000 in August, the
same as the average gain recorded so far this year.14 Meanwhile, real construction
expenditures now seem to have rebounded sharply in the second quarter after a steep drop
earlier in the year. In July, nominal construction spending rose to a level 1¾ percent (not
at an annual rate) above its second-quarter average; this gain reflected sizable increases in
all major categories but highways and set the stage for a further rise in real construction
spending in the third quarter.
On the whole, state and local revenue flows have been reasonably subdued of late,
although the available data point to a noticeable—though likely transitory—pickup in
receipts growth in the second quarter. Drawing on information from 45 states, the
Rockefeller Institute of Government estimates that state tax revenues increased 5 percent
on a year-over-year basis in the second quarter after having posted increases in the
neighborhood of just 2 percent in the preceding two quarters.15 Personal income taxes
rose 8 percent—an increase that appears to have been boosted by a solid rise in final
payments of previous-year tax liabilities and thus is unlikely to be repeated in coming
quarters. As for the other major categories, collections of sales and corporate taxes both
declined over the year ending in the second quarter, while other revenues rose sharply,
especially in energy-producing states like Texas and Alaska.
Prices
Headline consumer prices rose rapidly for a third consecutive month in July. Driven by
further large increases in food and energy prices, overall PCE prices rose 0.6 percent in
July, thereby bringing the 12-month change to 4.5 percent, 2¼ percentage points higher
than the year-earlier increase. After some surprisingly low increases in the spring, core
PCE prices saw larger increases in June and July, which likely reflected, in part, further
cost pressures and higher import prices. Indeed, prices for goods at intermediate stages
of production continued to rise rapidly through July. Nevertheless, some cost pressures

State and local employment is now estimated to have risen just 6,000 in June and 2,000 in July
compared with the previous estimates of 41,000 in June and 28,000 in July. The downward revision was
concentrated in local education employment, which is often revised substantially over the summer months.
15
The missing states are New Jersey, New Mexico, North Carolina, Rhode Island, and Virginia.
Taken together, these states accounted for 9 percent of state tax revenues in fiscal 2007.

II-32

Price Measures
(Percent change)
12-month change

3-month change

1-month change

Annual rate

Monthly rate

July
2007

July
2008

Apr.
2008

July
2008

June
2008

July
2008

CPI
Total
Food
Energy
Ex. food and energy
Core goods
Core services
Shelter
Other services
Chained CPI (n.s.a.) 1
Ex. food and energy 1

2.4
4.2
1.0
2.2
-.6
3.3
3.7
2.9
1.9
1.8

5.6
6.0
29.3
2.5
.6
3.3
2.5
4.4
4.8
2.2

2.3
6.3
5.6
1.2
-.7
1.9
.8
3.2
...
...

10.6
8.4
79.4
3.5
1.7
4.1
2.9
6.0
...
...

1.1
.8
6.6
.3
.1
.4
.3
.5
...
...

.8
.9
4.0
.3
.5
.3
.2
.4
...
...

PCE prices
Total
Food and beverages
Energy
Ex. food and energy
Core goods
Core services
Housing services
Other services
Core market-based
Core non-market-based

2.2
3.9
.8
2.0
-.7
3.2
3.5
3.0
1.7
3.6

4.5
5.7
30.0
2.4
.2
3.3
2.7
3.5
2.1
3.8

2.8
6.4
5.3
1.9
-.4
2.9
1.6
3.4
1.5
3.8

7.5
7.6
79.6
2.8
.5
3.7
2.6
4.1
2.5
3.9

.7
.6
6.8
.3
.1
.3
.3
.3
.3
.3

.6
1.0
4.0
.3
.2
.3
.2
.3
.2
.5

PPI
Total finished goods
Food
Energy
Ex. food and energy
Core consumer goods
Capital equipment
Intermediate materials
Ex. food and energy
Crude materials
Ex. food and energy

4.2
6.4
7.1
2.5
2.6
2.3
4.2
2.4
12.9
9.5

9.8
8.7
28.0
3.5
3.8
3.0
16.6
10.2
51.2
36.3

6.4
2.5
14.1
4.7
5.0
4.0
17.1
11.9
80.5
79.5

18.9
10.9
72.6
4.7
5.1
4.8
36.0
23.2
76.5
37.9

1.8
1.5
6.0
.2
.3
.3
2.1
1.3
3.7
-.2

1.2
.3
3.1
.7
.6
.8
2.7
2.0
4.2
3.4

Measures

1. Higher-frequency figures are not applicable for data that are not seasonally adjusted.
... Not applicable.

II-33

Consumer Prices
(12-month change except as noted)

PCE Prices

CPI and PCE ex. Food and Energy
Percent

4
July

Total PCE
3

Percent

CPI

July

Core PCE

2000

2002

2004

2006

2008

PCE excluding Food and Energy

2
PCE
CPI
chained

2000

2002

2004

2006

2008

PCE Goods and Services
Percent

Percent

July
3

July
2

Services ex. energy

1
July

0
1

Market-based components

-1
-2

2000

2002

2004

2006

2008

-3

PCE excluding Food and Energy

-1
Goods ex.
food and energy

2000

2002

-2
2004

2006

2008

-3

CPI excluding Food and Energy
Percent

Percent

-1

3-month change, annual rate
4
3

July

-1

2000

2002

2004

2006

2008

3-month change, annual rate

2000

2002

2004

2006

2008

-1

II-34

Energy and Food Price Indicators
(Data from Energy Information Administration except as noted)

Total Gasoline Margin
180

Gasoline Price Decomposition
Cents per gallon

Retail price less average spot crude price*

160

180
160

Cents per gallon

450
400

400

350
140

140

120

300

450

350
Rack price

Retail price*

Sept. 8

300

250

200

Sept. 8
100

100

60
2009

150

2005
2006
2007
2008
* Regular grade seasonally adjusted by FRB staff,
less average spot crude price: 60% WTI, 40% Maya
heavy crude. Includes gasoline taxes.

100
50

Gasoline Inventories
Millions of barrels
Excluding ethanol
Adjusted for ethanol use*

245
235

225

215

205

195
185

Sept. 5

195

185
2009

2005
2006
2007
2008
Note. Shaded region is average historical range as
calculated by DOE. Monthly data through June 2008,
weekly data thereafter.
* Adjustment for approximate amount of fuel ethanol to be
blended with RBOB component of inventories; estimated by
FRB staff.

Cents per gallon

450

Near-futures price, daily
Monthly futures, Sept. 9

500
450

400

350

300

250

200

150

100

2005
2006
2007
Source. Chicago Board of Trade.

100
2009

2008

Spot Agricultural Commodity Prices
12-month percent change

6
5

9
8
7

50
2009

2005
2006
2007
2008
* Regular grade seasonally adjusted by FRB staff.
** 60% WTI, 40% Maya heavy crude.

500

PCE Food Prices
6

100

Ethanol Prices

245
235

150
Average spot crude price**

Food and beverages

July

Dollars per bushel

Corn (left scale)
Soybeans (right scale)
Wheat (right scale)

14
12

5
3

Sept. 9

4
2

2
Ex. food and energy

1
0

2005
2006
2007
Source. Bureau of Economic Analysis.

2008

0
2009

3
2

2005
2006
2007
Source. Commodity Research Bureau.

2008

0
2009

II-35

may be weakening: The dollar has strengthened, and spot commodity prices for crude
oil, natural gas, and other industrial raw materials have declined recently.
Consumer energy prices rose another 4 percent (not at an annual rate) in July after
similarly large gains in May and June. This recent string of increases in energy prices
pushed up the 12-month change through July to 30 percent. Recent declines in crude oil
prices have eased the pressure on gasoline margins, which had been abnormally tight for
some time, and are now leading to lower prices at the pump. Indeed, survey data suggest
that retail gasoline prices decreased considerably in August and early September. Spot
prices for natural gas have also moved down recently as inventories (seasonally adjusted)
have remained ample.
Consumer food prices rose 1 percent in July, an even larger increase than the already
elevated readings seen in recent months. The 12-month change through July now stands
at 5.7 percent, much higher than the 3.9 percent increase recorded over the preceding
12 months. Although prices for almost all food commodities are substantially above their
levels from a year ago, these prices have stepped down, on balance, since the July/August
Greenbook (cattle is one notable exception). However, prices for food away from home
have accelerated in the past few months; these prices tend to reflect broader inflationary
pressures and tend to be relatively persistent.
Core PCE prices increased 0.3 percent for a second month in July. These increases
pushed up the three-month change through July to an annual rate of 2.8 percent, up from
a pace of only 1.9 percent during the three months ending in April.16 The 12-month
change in core PCE prices, at 2.4 percent, is up nearly ½ percentage point from the yearearlier increase. This acceleration was widespread across prices for goods and most
services; one important exception is housing services, for which prices have decelerated
over the last 12 months, a slowdown consistent with the general weakness in this sector.
The cost pressures affecting finished goods prices are showing through even more clearly
to prices of intermediate materials. The producer price index for core intermediate
materials rose 2 percent in July, which brought the three-month change to an annual rate
of 23 percent. These price increases have been widespread but are especially noticeable
for metals and for energy-intensive categories such as chemicals, plastics, and paints.
The string of recent advances pushed the 12-month change through July to 10 percent,
16

In addition to the larger increases in overall core PCE prices in June and July, data on the nonmarket component of these prices were revised up earlier in the year as part of the annual revisions to the
NIPA.

II-36

Broad Measures of Inflation
(Percent change, Q2 to Q2)
Measure

2005

2006

2007

2008

Product prices
GDP price index
Less food and energy

2.9
3.1

3.5
3.4

2.8
2.5

2.0
1.9

Nonfarm business chain price index

3.1

3.6

2.1

1.5

Expenditure prices
Gross domestic purchases price index
Less food and energy

3.3
3.0

3.9
3.2

2.6
2.4

3.5
2.2

PCE price index
Less food and energy

2.5
2.1

3.3
2.3

2.4
2.1

3.7
2.2

PCE price index, market-based components
Less food and energy

2.2
1.7

3.1
1.9

2.2
1.8

3.6
1.9

CPI
Less food and energy

2.9
2.2

3.9
2.5

2.6
2.3

4.3
2.3

Chained CPI
Less food and energy

2.6
1.9

3.6
2.2

2.4
1.9

3.8
2.0

Median CPI
Trimmed mean CPI

2.4
2.4

2.9
2.6

3.1
2.7

3.1
3.0

Trimmed mean PCE

2.3

2.7

2.6

Surveys of Inflation Expectations
(Percent)
Reuters/Michigan Survey

Period

Actual
CPI
inflation 1

1 year 2

Professional
forecasters
(10 years) 4

5 to 10 years 3

Mean

Median

Mean

Median

CPI

PCE

2006:Q4

1.9

3.5

3.0

3.5

3.0

2.5

...

2007:Q1
Q2
Q3
Q4

2.4
2.7
2.4
4.0

3.6
4.2
4.1
4.1

3.0
3.3
3.2
3.3

3.4
3.5
3.5
3.3

2.9
3.0
3.0
2.9

2.4
2.4
2.4
2.4

2.0
2.0
2.1
2.1

2008:Q1
Q2
Q3

4.1
4.4
n.a.

4.2
6.4
n.a.

3.8
5.0
n.a.

3.3
3.8
n.a.

3.0
3.3
n.a.

2.5
2.5
2.5

2.2
2.2
2.2

2008:Apr.
May
June
July
Aug.

3.9
4.2
5.0
5.6
n.a.

5.7
7.0
6.5
6.3
5.3

4.8
5.2
5.1
5.1
4.8

3.5
4.0
4.0
3.5
3.9

3.2
3.4
3.4
3.2
3.2

...
2.5
...
...
2.5

...
2.2
...
...
2.2

1. Percent change from the same period in the preceding year.
2. Responses to the question, By about what percent do you expect prices to go up, on
average, during the next 12 months?
3. Responses to the question, By about what percent per year do you expect prices to go up,
on average, during the next 5 to 10 years?
4. Median CPI and PCE price projections compiled by the Federal Reserve Bank of Philadelphia.
... Not applicable.
n.a. Not available.

II-37

Measures of Expected Inflation
Survey Measures (Reuters/Michigan)
12

Percent

Quarterly

Percent
12

Monthly

5
Aug.

Median, next 5 to 10 years
6
4
Q2
Median, next 12 months

2
0

1972 1975
1976

1980
1980

1985 198819901992 1995
1984
1996

2000
2000

2005 2008
2004

Inputs to Models of Inflation
12

2005

Percent

Quarterly

Distributed lag of
core PCE inflation**

Percent

Percent
5

Quarterly

5 to 10 years ahead

Weekly
Sept. 9

4
3

3
Q2

0
0
0
1980
1985 198819901992 1995
2000
2005 20082010
2005 2006 2007
2008
1972 1975
1976
1980
1984
1996
2000
2004
*For 2007 forward, the median projection for PCE inflation over the next 10 years from the Survey of Professional Forecasters (SPF);
for 1991 to 2006, the equivalent SPF projection for the CPI; for 1981 to 1991, a related survey for the CPI conducted by Richard Hoey;
and for the period preceding 1981, a model-based estimate constructed by Board staff. The survey data before 2007 are adjusted down
0.5 percentage point to put the CPI projections approximately on a PCE basis.
**Derived from one of the reduced-form Phillips curves used by Board staff.

Inflation Compensation from TIPS

Quarterly

2008

8
FRB/US long-run expectations measure
for PCE inflation*

2007

Percent

2006

Next 5 years

0
0
2001
2002
2003
2004
2005
2006
2007
2008
2005
2006
2007
2008
Note. Based on a comparison of an estimated TIPS yield curve with an estimated nominal off-the-run Treasury yield curve, with an
adjustment for the indexation-lag effect.

II-38

Commodity Price Indexes
Journal of Commerce

Ratio scale, 2006 = 100
180
140
Sept. 9

100

100
Industrials
60

Metals
1991 1992
1992 1993 1994
1994 1995 1996
1996 1997 1998
1998 1999 2000
2000 2001 2002
2002 2003 2004
2004 2005 2006
2006 2007 2008
2008 2009

Note. The Journal of Commerce (JOC) industrial price index is based almost entirely on industrial commodities, with a small
weight given to energy commodities. Copyright for Journal of Commerce data is held by CIBCR, 1994.

Commodity Research Bureau
Ratio scale, 1967 = 100

500

650
600
550
500

400

600
Sept. 9

450
Spot industrials
350
300

300
250

200

Futures

200

1991 1992
1992 1993 1994
1994 1995 1996
1996 1997 1998
1998 1999 2000
2000 2001 2002
2002 2003 2004
2004 2005 2006
2006 2007 2008
2008 2009
Note. The Commodity Research Bureau (CRB) spot industrials index consists entirely of industrial commodities, excluding
energy. The CRB futures index gives about a 60 percent weight to food commodities and splits the remaining weight roughly
equally among energy commodities, industrial commodities, and precious metals.

Selected Commodity Price Indexes
(Percent change)

Index
JOC industrials
JOC metals
CRB spot industrials
CRB spot foodstuffs
CRB futures

2007 1

12/18/07
to
7/29/08 2

7.6
2.1
8.2
25.5
18.2

15.7
20.4
3.6
23.4
16.1

7/29/08 2
to
9/9/08

52-week
change to
9/9/08

-10.5
-17.9
-6.1
-7.5
-12.5

1. From the last week of the preceding year to the last week of the year indicated.
2. July 29, 2008, is the Tuesday preceding publication of the July Greenbook.

3.7
-5.3
-3.8
19.7
11.6

150

II-39

nearly 8 percentage points higher than the change over the preceding 12 months.
Nevertheless, as with energy and many food commodities, prices of industrial
commodities have moved lower in recent weeks. Both the Commodity Research Bureau
spot industrials index and the Journal of Commerce industrial commodities index have
moved down since the July/August Greenbook, declining 6 percent and 10½ percent
respectively.
Measures of inflation expectations are flat or down a little since the last Greenbook. In
the Reuters/University of Michigan survey, median expectations for year-ahead inflation
moved down to 4.8 percent in August but still remain 1½ percentage points higher than
they were late last year. The Reuters/Michigan measure of median inflation expectations
over the next 5 to 10 years held steady at 3.2 percent last month, down from its recent
high of 3.4 percent but still above its January reading of 3.0 percent. As measured by the
Survey of Professional Economists, expectations for PCE price inflation over the next 10
years held steady at 2.2 percent in the third quarter. Finally, inflation compensation
derived from yields on nominal and inflation-protected Treasury securities has moved
down since the last Greenbook, and the 5-year forward measure is now close to its level
around the turn of the year.
Labor Costs
Hourly compensation has continued to increase moderately with no sign of acceleration.
Compensation per hour in the nonfarm business sector was revised down in the first half
of the year on the basis of earnings data from unemployment insurance records through
the first quarter. We now estimate that compensation per hour rose at an annual pace of
3¾ percent in the first half—about the same as the increase over 2007. More recently,
average hourly earnings increased 0.4 percent in August and thus brought the 12-month
change to 3.6 percent, down from 4.0 percent over the preceding 12 months.

II-40

Hourly Compensation and Unit Labor Costs
(Percent change from preceding period at compound annual rate; based on seasonally adjusted data)
2006:Q2 2007:Q2
to
to
2007:Q2 2008:Q2e

Category

2007

2008

Q2 e

Compensation per hour
Nonfarm business

4.2

4.0

3.3

5.3

3.8

3.7

Unit labor costs
Nonfarm business

3.7

-2.4

4.5

1.2

-.7

e Staff estimate.

Compensation per Hour

Unit Labor Costs

(Percent change from year-earlier period)

(Percent change from year-earlier period)
Percent

8
7

Productivity and costs*

6
5

5
Q2

4
3

ECI

Percent

1
0

-1

-2

-3

1996

1998

2000

2002

2004

2006

2008

* Value for 2008:Q2 is a staff estimate.

1996

1998

2000

2002

2004

2006

2008

-3

Note. Value for 2008:Q2 is a staff estimate.

Average Hourly Earnings

Markup, Nonfarm Business

(Percent change from year-earlier period)
Percent

4.5
4.0

Aug.

3.5

4.5

1.66

4.0

1.64

Ratio
Q2

1.66
1.64

3.5

1.62

3.0

1.60

2.5

1.58

2.0

1.56

1.5

1.54

1.0

1.52

1.0

1996

1998

2000

2002

2004

2006

2008

Average,
1968-present

1.56
1.54

1996

1998

2000

2002

2004

2006

2008

Note. The markup is the ratio of output price to unit
labor costs. Value for 2008:Q2 is a staff estimate.

Last Page of Domestic Nonfinancial Developments

1.52

Domestic Financial
Developments

III-T-1

Selected Financial Market Quotations
(One-day quotes in percent except as noted)
2007

Change to Sept. 9 from
selected dates (percentage points)

2008

Instrument
Aug. 6

June 24

Aug. 4

Sept. 9

2007
Aug. 6

2008
June 24

2008
Aug. 4

5.25

2.00

-3.25

.00

4.74
4.72

1.80
2.20

1.72
1.93

1.63
1.85

-3.11
-2.87

-.17
-.35

-.09
-.08

Commercial paper (A1/P1 rates)2
1-month
3-month

5.26
5.29

2.36
2.78

2.41
2.72

2.44
2.78

-2.82
-2.51

.08
.00

.03
.06

Large negotiable CDs1
3-month
6-month

5.34
5.27

2.80
3.17

2.80
3.10

2.80
3.11

-2.54
-2.16

.00
-.06

.00
.01

Eurodollar deposits3
1-month
3-month

5.33
5.35

2.70
3.00

2.60
3.00

2.65
3.00

-2.68
-2.35

-.05
.00

.05
.00

Bank prime rate

8.25

5.00

-3.25

.00

Intermediate- and long-term
U.S. Treasury4
2-year
5-year
10-year

4.49
4.52
4.82

2.80
3.55
4.29

2.49
3.25
4.15

2.22
2.88
3.80

-2.27
-1.64
-1.02

-.58
-.67
-.49

-.27
-.37
-.35

U.S. Treasury indexed notes5
5-year
10-year

2.43
2.48

1.10
1.76

1.15
1.71

1.25
1.67

-1.18
-.81

.15
-.09

.10
-.04

Municipal general obligations (Bond Buyer)6

4.51

4.76

4.74

4.62

.11

-.14

-.12

Private instruments
10-year swap
10-year FNMA7
10-year AA8
10-year BBB8
10-year high yield8

5.44
5.34
6.12
6.57
9.21

4.84
4.98
6.54
7.00
10.13

4.66
4.82
6.62
7.17
10.57

4.22
4.31
6.40
7.01
10.57

-1.22
-1.03
.28
.44
1.36

-.62
-.67
-.14
.01
.44

-.44
-.51
-.22
-.16
.00

Home mortgages (FHLMC survey rate)9
30-year fixed
1-year adjustable

6.59
5.65

6.45
5.27

6.52
5.22

6.35
5.15

-.24
-.50

-.10
-.12

-.17
-.07

Short-term
FOMC intended federal funds rate
Treasury bills1
3-month
6-month

Record high

Change to Sept. 9
from selected dates (percent)

2008

Stock exchange index
Dow Jones Industrial
S&P 500 Composite
Nasdaq
Russell 2000
Wilshire 5000

Level

Date

June 24

Aug. 4

Sept. 9

Record
high

2008
June 24

2008
Aug. 4

14,165
1,565
5,049
856
15,807

10-9-07
10-9-07
3-10-00
7-13-07
10-9-07

11,807
1,314
2,368
708
13,421

11,284
1,249
2,286
704
12,738

11,231
1,225
2,210
707
12,477

-20.71
-21.76
-56.23
-17.35
-21.07

-4.88
-6.83
-6.69
-.09
-7.04

-.47
-1.96
-3.31
.45
-2.06

1. Secondary market.
2. Financial commercial paper.
3. Bid rates for Eurodollar deposits collected around 9:30 a.m. eastern time.
4. Derived from a smoothed Treasury yield curve estimated using off-the-run securities.
5. Derived from a smoothed Treasury yield curve estimated using all outstanding securities and adjusted for the carry effect.
6. Most recent Thursday quote.
7. Constant-maturity yields estimated from Fannie Mae domestic noncallable coupon securities.
8. Derived from smoothed corporate yield curves estimated using Merrill Lynch bond data.
9. Home mortgage rates for September 9, 2008, are for the week ending September 4, 2008.
_______________________________________________________________________
NOTES:
August 6, 2007, is the day before the August 2007 FOMC meeting.
June 24, 2008, is the day before the June 2008 FOMC monetary policy announcement.
August 4, 2008, is the day before the most recent FOMC monetary policy announcement.
_______________________________________________________________________

III-C-1

Financial Institutions
GSE Preferred Stock Prices

GSE Common Stock Prices
Dollars

Daily

Aug. FOMC

Fannie Mae
Freddie Mac

Dollars
35
Daily
30

Aug. FOMC

Fannie Mae
Freddie Mac

50
45
40

30
25

Sept.
9

15
10

Sept.
9

-5
Feb.

Apr.

June

-5

Aug.

Feb.

Apr.

2008

June

Aug.

2008

Source. Bloomberg.

CDS Senior Debt Spreads for GSEs

CDS Subordinated Debt Spreads for GSEs
Basis points

Daily

Aug. FOMC

Fannie Mae
Freddie Mac

Basis Points
120

Daily

Aug. FOMC

Fannie Mae
Freddie Mac

400
350

100
300
80

250

Sept.
5

200
150

40
100
Feb.

Apr.

June

Aug.

Feb.

Apr.

2008

June

Aug.

2008

Note. Trading essentially halted after FHFA placed Fannie Mae
and Freddie Mac in conservatorship.
Source. Markit.

CDS Spreads for Investment Banks

CDS Spreads for U.S. Commercial Banks
Basis points

Daily

Basis points
300

Aug. FOMC

Daily

Regional bank index
Large bank index

250

200

Aug. FOMC

Sept.
9

200
Sept.
9
150

150

100

100
50
50
Jan.

Apr.

July
2007

Oct.

Jan.

Apr.
July
2008

Note. Median spread for 10 investment banks.
Source. Markit.

Oct.

Jan.

Apr.

July
2007

Oct.

Jan.

Apr.

July
2008

Oct.

Note. Median spreads for 7 regional and 5 large commercial banks.
Source. Markit.

Domestic Financial Developments
Overview
Over much of the intermeeting period, financial markets were strained by concerns about
Fannie Mae and Freddie Mac and about the prospect of continued write-downs and credit
losses at financial institutions more broadly. Some uncertainty was resolved on
September 7, when the Treasury Department and the Federal Housing Finance Agency
announced that Fannie Mae and Freddie Mac had been placed into conservatorship and
that Treasury would establish a backstop lending facility for Fannie and Freddie and
initiate a program to purchase mortgage-backed securities (MBS). In the two days
following the announcement, spreads on Fannie Mae and Freddie Mac debt and on
agency MBS decreased significantly, while share prices for their common and preferred
stock plunged.
On net over the intermeeting period, investors pushed back their expectation for the onset
of monetary policy tightening to the third quarter of next year and marked down their
expected level of the federal funds rate at the end of 2010 about 60 basis points. Yields
on both intermediate- and long-term nominal Treasury securities decreased over the
intermeeting period, and inflation compensation derived from yields on Treasury
inflation-indexed securities fell in the near- and far-term. Broad equity indexes moved a
bit lower, on net, while risk spreads on corporate bonds increased somewhat. Indicators
of business and household credit quality pointed to a further deterioration, and the pace of
borrowing generally continued to slow.
Financial Institutions and Market Functioning
Fannie Mae’s and Freddie Mac’s lower-than-expected second-quarter earnings results
intensified concerns about the ability of the two housing government-sponsored
enterprises (GSEs) to raise fresh capital to offset mounting losses on their mortgage
exposures. Before the conservatorship announcement, prices for the GSEs’ preferred and
common stock had declined on balance since the August meeting of the Federal Open
Market Committee (FOMC), while credit default swap (CDS) spreads on the GSEs’
senior debt narrowed further, as market participants speculated that a possible
government intervention regarding the GSEs could significantly dilute the existing shares
but protect payments on senior debt. In response to the announcement, risk spreads on
the GSEs’ debt and MBS dropped further, while the value of their common and preferred
stock plunged. Fannie Mae’s auction of $1 billion of 3- and 6-month bills on
September 9 was reportedly well-received by the market.

III-1

III-2

Short-Term Funding and Interbank Markets
Spread between Libor and OIS Rates

Spreads on 30-Day Commercial Paper

Basis points
Aug. FOMC

Daily

Basis points
120

Daily

Aug. FOMC

100
3-month

200

80
Sept.
10

150

Sept.
9

1-month

250

100

A2/P2

50
20
ABCP

July

Oct.
2007

Jan.

Apr.
July
2008

July

Oct.
2007

0
Jan.

Apr.
July
2008

Note. Libor quotes are taken at 6:00 a.m., and OIS quotes
are observed at the close of business of the previous trading day.
Source. British Banker’s Association.

Note. The ABCP spread is the AA ABCP rate minus the AA
nonfinancial rate. The A2/P2 spread is the A2/P2 nonfinancial
rate minus the AA nonfinancial rate.
Source. Depository Trust & Clearing Corporation.

Commercial Paper Spread for Financial Firms

Repo Rates on Treasury General Collateral

Basis points
Aug. FOMC

Daily

Sept.
9

Percent
80

Daily

Aug. FOMC

6
5

Overnight

4
40

1-month
Sept.
9

3
2

-20
July

Oct.
2007

Jan.

Apr.
July
2008

0
July

Note. 30-day AA financial rate minus 30-day AA nonfinancial rate.
Source. Markit.

Primary Credit Outstanding

Oct.
2007

Jan.

Source. Bloomberg.

Primary Dealer Credit Facility
Billions of dollars

Weekly average (Wed.)

Apr.
July
2008

Billions of dollars
20

Aug. FOMC
Sept.
3

Weekly average (Wed.)

Aug. FOMC

Sept.
3

0
July

Oct.
2007

Source. Federal Reserve.

Jan.

Apr.
July
2008

July

Oct.
2007

Source. Federal Reserve.

Jan.

Apr.
July
2008

50
45
40
35
30
25
20
15
10
5
0

III-3

CDS spreads for U.S. investment banks widened over the intermeeting period, but
generally remained well below their March peaks. Lehman Brothers was the focus of
much market commentary, as investors anticipated significant writedowns in the third
quarter and speculated about the firm’s ability to raise capital. Lehman’s stock price
plunged in recent days and its CDS spread jumped. CDS spreads for commercial banks
increased somewhat, on balance, with spreads for regional banks remaining substantially
above spreads for large banks, likely reflecting greater concern about asset quality at the
former and the implications for their funding.
Conditions in short-term funding markets remained strained over the intermeeting period.
Spreads of the London interbank offered rate (Libor) over comparable-maturity overnight
index swap (OIS) rates edged higher from their already elevated levels. In the
commercial paper market, spreads on A2/P2 nonfinancial and asset-backed commercial
paper fluctuated in a high range, as did spreads on financial commercial paper. The repo
market for Treasury collateral continued to function reasonably well over the
intermeeting period, and there were indications that conditions in the repo market for
agency debt and agency MBS may have improved a little after Fannie Mae and Freddie
Mac were placed in conservatorship. However, over the intermeeting period as whole,
median “haircuts” on agency MBS and private-label subprime and alt-A MBS repo
transactions increased slightly.
With regard to the Federal Reserve’s liquidity facilities, the 28-day Term Auction
Facility (TAF) auctions conducted over the intermeeting period were again
oversubscribed, and stop-out rates were well above the primary credit rate and just below
one-month Libor rates. The Federal Reserve conducted two auctions of 84-day TAF
credit, both of which were oversubscribed. Primary credit borrowing has climbed further
since the August meeting of the Federal Open Market Committee (FOMC), likely
because of the facility’s relatively favorable terms. However, no credit was extended
through the Primary Dealer Credit Facility over the intermeeting period. Demand was
strong for the three Term Security Lending Facility (TSLF) auctions against Schedule 1
collateral held over the period, while, as in previous auctions, the TSLF auctions against
Schedule 2 collateral were undersubscribed. On August 27, the first auction was held
under the TSLF Options Program (TOP): dealers bid on the option to draw on the TSLF
for a one-week term period bracketing the quarter-end. Demand at the TOP auction was

III-4

Policy Expectations and Treasury Yields

Eurodollar Rates

Percent

FOMC
statement

3.6

Durable goods
orders

CPI

GSE Announcement
(Sept. 7)

June 2009

3.4

PPI/Housing
starts

GDP

Unemployment

3.2

3.0
December 2008
2.8

2.6
Aug. 4

Aug. 7

Aug. 12

Aug. 15

Aug. 20

Aug. 25

Aug. 28

Sept. 3

Sept. 8

Note. 5-minute intervals. 8:00 a.m. to 4:00 p.m. No adjustments for term premiums.
Source. Bloomberg.

Implied Federal Funds Rate

Implied Volatility of Interest Rates
Basis points

Percent
4.50

Daily

4.25
4.00

Basis points

300

250

August

6-month Eurodollar (left scale)* FOMC
10-year Treasury (right scale)

3.75
3.50
3.25
2.75

September 9, 2008

Sept.
9

150

Feb.

2008

June

Oct.

2009

Feb.

June

Oct.

300

200
Oct. Feb. June Oct. Feb. June Oct. Feb. June

2010

2005

2006

2007

2008

Note. Estimated from federal funds and Eurodollar futures, with an
allowance for term premiums and other adjustments.
Source. Chicago Mercantile Exchange; CBOT.

*Width of a 90 percent confidence interval computed from the
term structures for the expected federal funds rate and implied
volatility.

Treasury Yield Curve

Inflation Compensation
Percent

Percent
5.0

August 4, 2008

Daily

August
FOMC

4.5

3.3
3.1

4.0

September 9, 2008

3.5

2.9

5 to 10 years ahead

2.7

3.0

Sept.
9

2.5

1.7
1.5

1.0
5

Years ahead

Note. Smoothed yield curve estimated from off-the-run Treasury
coupon securities. Yields shown are those on notional par Treasury
securities with semiannual coupons.
Source. Federal Reserve Bank of New York.

2.3
1.9

Next 5 years*

1.5
3

2.5
2.1

2.0

600

400

1.50
Oct.

700

500

100

2.00
1.75

1000

800

2.50
2.25

1100

900
200

3.00

August 4, 2008

1200

Jan.

Apr.

July

2007

Oct.

Jan.

Apr.

July

2008

Note. Estimates based on smoothed nominal and inflation-indexed
Treasury yields.
*Adjusted for lagged indexation of TIPS.
Source. Federal Reserve Bank of New York.

III-5

strong, with propositions easily exceeding the $25 billion maximum quantity of TSLF
draws afforded by the options.1
Policy Expectations and Interest Rates
The market’s expected onset of monetary policy tightening was pushed back to the third
quarter of next year amid heightened concerns about the health of financial institutions
and against a backdrop of deteriorating labor market conditions and a further decline in
oil prices, which was seen as tempering inflation pressures. Futures quotes suggest that
market participants expect slightly more than 1 percentage point of policy tightening by
the end of 2010, about 60 basis points less than at the time of the last FOMC meeting.
Uncertainty about the expected path of policy decreased, as the option-implied
distribution of the federal funds rate six months ahead narrowed somewhat and became
less skewed toward higher policy rates. FOMC communications over the intermeeting
period elicited very little market reaction, as the Committee’s decision to leave the
federal funds rate unchanged at the August FOMC meeting, as well as the accompanying
statement and the subsequent release of the minutes, were in line with investor
expectations.
Yields on 2- and 10-year nominal Treasury securities declined about 25 basis points and
35 basis points, respectively. Yields on 2- and 10-year inflation-indexed securities rose
and were little changed, respectively, leaving inflation compensation notably lower
across the term structure. The decrease in inflation compensation was most pronounced
at shorter horizons, reflecting the expected effects of the drop in oil prices.
Stock Prices, Corporate Yields, and Risk Spreads
Broad equity price indexes decreased about 2 percent over the intermeeting period, with
shares of retail firms widely outperforming the market. Financial sector indexes ended
the period down 1½ percent, but were very volatile. The spread between the 12-month
forward trend-earnings-price ratio for S&P 500 firms and a real long-run Treasury
yield—a rough gauge of the equity risk premium—remained at the top of its range over
the past 25 years. Options-implied volatility on the S&P 500 index remained in the
elevated range of the past year.
Over the intermeeting period, yields on investment-grade corporate bonds decreased
slightly, while yields on speculative-grade bonds were little changed. Given the
1

Results from the second TOP auction, scheduled for September 10, were not available in time for the
Greenbook publication.

III-6
Corporate Yields, Risk Spreads, and Stock Prices
Selected Stock Price Indexes

Ratio of Trend Earnings to Price for S&P 500 and
Long-Run Treasury Yield
Percent

Aug. 4, 2008 = 100
Daily
Aug.
FOMC
S&P Financial
S&P Retailers

S&P 500

Mar.

June Sept. Dec.
2007

Sept.
9

Mar.

190
180
170
160
150
140
130
120
110
100
90
80
70

Monthly

(Trend earnings) / P*

8
6

Sept.
9

Long-run real Treasury yield

1988

June Sept.
2008

1992

1996

2000

2004

4
2

2008

* Trend earnings are estimated using analysts’ forecasts of
year-ahead earnings from I/B/E/S.
+ Denotes the latest observation using daily interest rates and
stock prices and latest earnings data from I/B/E/S.
Source. Thomson Financial.

Source. Standard & Poor’s.

Implied Volatility on S&P 500 (VIX)

Corporate Bond Yields
Percent

Percent
50

Weekly Friday*

12.5

Daily

Aug.
FOMC

10.5

10-year high-yield

Sept.
9

8.5

20
6.5
10-year BBB

4.5
2002 2003 2004 2005 2006 2007 2008

2002 2003 2004 2005 2006 2007 2008

* Latest observation is for most recent business day.
Source. Chicago Board of Exchange.

Note. Yields from smoothed yield curves based on Merrill Lynch
bond data.

Corporate Bond Spreads
Basis points

Investment-Grade CDS Indexes
Basis points

Daily
Aug.
FOMC

800

600

Basis points
450

10-year high-yield
(left scale)

225

Daily
Aug.
FOMC

375

175

Sept.
9

400

200

150

Financial

300
Sept.
9

225

125
100
75

200

Nonfinancial

150
10-year BBB
(right scale)

25
75

2002 2003 2004 2005 2006 2007 2008
Note. Corporate yields from smoothed yield curves based on
Merrill Lynch bond data and spreads measured relative to
comparable-maturity Treasury securities.

0
2002 2003 2004 2005 2006 2007 2008
Source. Markit.

III-7
Corporate Earnings and Credit Quality
S&P 500 Earnings Per Share

Revisions to Expected S&P 500 Earnings

Percent
40

Change from 4 quarters earlier

-1
MidAug.

-10
All firms
Nonfinancials

-20

All firms
Nonfinancials

Percent

Monthly

-3

-30
1998

2000

2002

2004

2006

2008

-4
2002

2003

2004

2005

2007

2008

Bond Ratings Changes of Nonfinancial Companies

Financial Ratios for Nonfinancial Corporations
Ratio

Percent of outstandings

Ratio
0.35

Liquid assets over
total assets
(left scale)

Debt over
total assets
(right scale)

2006

Note. Index is a weighted average of the percent change in the
consensus forecasts of current-year and following-year EPS for a
fixed sample.
Source. Thomson Financial.

p Preliminary.
Source. Thomson Financial.

0.12

-2

0.09

Annual rate
Upgrades

20
Q1
Q2
July

10
0

0.30

10
20

0.06

0.25

Downgrades

40
0.03

50
1990 1993

1996 1999

2002

2005 2008

1992 1994 1996 1998 2000 2002 2004 2006 2008

Note. Data are annual through 1999 and quarterly starting in
2000:Q1.
Source. Calculated using Compustat data.

Source. Calculated using data from Moody’s Investors Service.

Selected Default and Delinquency Rates

Expected Year-Ahead Defaults

Percent of outstandings
7

Percent of liabilities
2.0

Monthly

6
1.5

5
C&I loan delinquency rate
(Call Report)

July

1.0

3
Q2

Bond default rate*

0.5

2
1

July

0.0

0
1990

1993

1996

1999

2002

2005

2008

* 6-month moving average, from Moody’s Investors Service.

1993

1996

1999

2002

2005

2008

Note. Firm-level estimates of default weighted by firm liabilities as
a percent of total liabilities, excluding defaulted firms.
Source. Calculated using Moody’s KMV.

III-8

Business Finance
Gross Issuance of Securities by U.S. Corporations
(Billions of dollars; monthly rates, not seasonally adjusted)
2007
Type of security

2005

2006

5.4
1.6
3.8

4.6
1.7
2.8

4.7
1.8
2.9

5.5
1.7
3.9

5.4
1.6
3.8

2.3
.3
2.0

22.4
8.3
8.2
5.9

18.7
8.7
5.2
4.8

29.3
13.1
6.2
10.1

37.6
14.9
11.8
10.9

32.5
20.2
3.3
9.0

1.7

-.2

2.4

1.1

2.4

9.6

11.6

6.9
134.1

5.0
170.4

5.3
180.6

Nonfinancial corporations
Stocks1
Initial public offerings
Seasoned offerings
Bonds2
Investment grade
Speculative grade
Other (sold abroad/unrated)
Memo
Net issuance of commercial paper3
Change in C&I loans at
commercial banks3,4
Financial corporations
Stocks1
Bonds2

2008

2004

July

Aug.

4.6
.9
3.7

4.4
.1
4.4

2.4
.2
2.2

29.5
24.1
1.3
4.1

39.9
25.6
4.9
9.4

18.3
11.9
.7
5.7

13.3
10.9
.4
2.0

-2.0

4.5

-5.5

-.3

27.2

13.9

28.7

16.8

9.8

6.6

-3.1

9.3
200.5

7.9
102.8

13.2
54.9

21.1
77.0

10.3
14.8

1.0
25.7

Note. Components may not sum to totals because of rounding.
1. Excludes private placements and equity-for-equity swaps that occur in restructurings.
2. Data include regular and 144a private placements. Bond totals reflect gross proceeds rather than par value of original discount bonds. Bonds are
categorized according to Moody’s bond ratings or to Standard & Poor’s if unrated by Moody’s.
3. End-of-period basis, seasonally adjusted.
4. Based on adjusted commercial bank credit data through Aug. 2008.
Source. Depository Trust & Clearing Corporation; Thomson Financial; Federal Reserve Board.

Selected Components of Net Debt Financing

Components of Net Equity Issuance

Billions of dollars

70
Monthly rate, nonfinancial firms

50
Monthly rate, nonfinancial firms

Commercial paper*
C&I loans*
Bonds

40
H1

H2
Q1

Total

30
20
10

40
Aug.
July

-10
30

-20
-30

-40
-50

-60
0

-70
Public issuance
Private issuance
Repurchases
Cash mergers

-10
-20

-80
-90
-100

Total

-110

-30
2004

2005

2006

2007

2008

* Seasonally adjusted, period-end basis.
Source. Depository Trust & Clearing Corporation; Thomson
Financial; Federal Reserve Board.

-120
2004

2005

2006

2007

2008

e Staff estimate.
Source. Thomson Financial; Investment Benchmark Report;
Money Tree Report by PricewaterhouseCoopers, National Venture
Capital Association, and Venture Economics.

III-9

relatively large decreases in comparable-maturity Treasury yields, risk spreads on
investment-grade bonds rose to the top of their historical range, and speculative-grade
spreads nearly returned to their March peaks. CDS spreads suggest that compensation for
default risk for investment-grade financial firms rose markedly since the August FOMC
meeting, while that for investment-grade nonfinancial firms was little changed.
Corporate Earnings and Credit Quality
With nearly all second-quarter earnings reports in hand, earnings per share for S&P 500
firms are estimated to have dropped about 25 percent from their year-ago level because of
a plunge in financial sector profits. Earnings per share for nonfinancial firms are
estimated to have increased about 7 percent over the past year, with roughly half the gain
accounted for by the oil and gas industry. An index of analysts’ expectations of earnings
for S&P 500 firms over the coming year showed a sharp downward revision in August,
largely reflecting significant further markdowns for the financial sector.
The credit quality of nonfinancial corporations has deteriorated some in recent months.
The net rate of nonfinancial corporate bond downgrades by Moody’s in July was a little
higher than in the second quarter. The six-month trailing bond default rate and the
delinquency rate on commercial and industrial (C&I) loans at commercial banks have
both risen noticeably since the spring, although they remain at low levels by historical
standards. The aggregate expected default rate over the next year projected by Moody’s
KMV rose in July, reaching its highest level since 2003.
Business Finance
Net debt financing by nonfinancial businesses picked up in August from the weak pace in
July, with the increase accounted for by a jump in nonfinancial commercial paper (CP)
outstanding. Last month, some highly rated firms reportedly tapped the CP market to
finance dividend payments and to fund, at least temporarily, a large acquisition.
Investment-grade bond issuance moderated a bit further in August, while speculativegrade issuance remained very light. Bank lending to business through C&I loans was
about flat during the July–August period, likely reflecting both reduced demand for bankintermediated credit and the tighter terms and standards on these categories of loans that
banks have reported in the past several Senior Loan Officer Opinion Surveys.
Both seasoned and initial equity offerings by nonfinancial corporations remained weak in
August, with almost no issuance outside the energy sector. In the second quarter, equity
retirements from cash-financed mergers fell a bit further, but announcements of new

III-10

Commercial Real Estate
Commercial Mortgage Debt

Sales of Commercial Real Estate

Percent change from year earlier

Billions of dollars
18

Quarterly

140

3-month moving average
Monthly

120

14
100

12
e

4
Aug.

2
0
1998

2000

2002

2004

2006

2008

2002

e Staff Estimate.
Source. Federal Reserve.

2004

2006

2008

Source. Real Capital Analytics.

BBB Commercial Mortgage CDS Index Spreads

Prices
Index, 1996:Q4=100
Quarterly

CMBX.NA
250

Transacted
property

Basis points
2500

Aug.
FOMC

Daily

2000

2006:H2*
2006:H1*
2005:H2*

200

Sept.
8

1500
1000

150
All property

500
100
0

1990

1993

1996

1999

2002

2005

2008

Note. All-property index based on entire NCREIF portfolio.
Transacted-property index based on sales involving NCREIF portfolio.
Source. NCREIF; MIT Center for Real Estate.

Delinquency Rates on Commercial Mortgages

Oct.
2006

Feb.

June
2007

Oct.

Feb.

June
2008

Note. Measured relative to Libor.
*Corresponds to pools of mortgages originated in that period.
Source. JP Morgan.

Delinquency Rates on Commercial Mortgages
at Banks

Percent

Percent
5

Quarterly

Residential
construction

3
At commercial
banks*

CMBS

10
Commercial
construction

2
Existing
properties

At life
insurance
companies

Aug.
Q2

4
2

0
0

1996

1998

2000

2002

2004

*Excluding farmland.
Source. Citigroup; Call Report; ACLI.

2006

2008

Q3
2007

Q2
2008

Note. Data series for residential and commercial construction
begin in 2007:Q1. Existing properties include nonresidential and
multifamily.
Source. Call Report.

III-11

deals continued apace. Retirements from share repurchases are also estimated to have
continued their decline in the second quarter. As a result, on net, nonfinancial firms
retired equity in the second quarter at the slowest pace since 2004.
Commercial Real Estate
The growth of commercial mortgage debt slowed sharply in the second quarter and
appears to have come down further this quarter. In August, the value of commercial real
estate transactions slipped to its lowest level since early 2004, a decline reflecting the
much tighter supply of financing for these transactions and lower prices of commercial
properties. In the second quarter, prices of transacted properties were about 10 percent
below their year-ago peaks. Issuance of commercial mortgage-backed securities (CMBS)
was zero in July and August, and yield spreads for CDS indexes of BBB-rated tranches of
CMBS reached a new high in mid-August before moving down in recent weeks.
Delinquency rates on commercial mortgages held by commercial banks climbed to
4¼ percent in the second quarter, the highest level since 1995, as delinquencies for
construction loans, particularly those associated with residential projects, rose further. In
contrast, the delinquency rate for commercial mortgages held in CMBS remained quite
low in August, and almost no loans held by life insurance companies were delinquent in
the second quarter.
Household Finance
Before the GSE conservatorship announcement was made, interest rates on 30-year fixedrate jumbo mortgages and conforming mortgages had decreased about a quarter
percentage point since the August FOMC meeting. The decline in the conforming
mortgage rate was less than that on comparable-maturity Treasury securities, thereby
leaving the mortgage spread at the top of its range over the past two decades. In part, the
elevated primary market spreads reflected unusually high option-adjusted spreads for
agency MBS amid unsettled conditions in the secondary market. Following the Treasury
announcement, option-adjusted spreads on agency MBS dropped substantially and
reports indicated that some lenders lowered rates on conforming mortgages around
20 basis points.
The very soft housing market has continued to weigh on mortgage credit quality. Two
national indexes, one published by the Office of Federal Housing Enterprise Oversight
and the other by S&P/Case-Shiller, of existing home prices declined further in the second
quarter, albeit not as sharply as in the previous quarter. In June, the delinquency rate on

III-12

Residential Mortgages
Mortgage Interest Rates

Mortgage Rate Spreads
Percent

Weekly

9.0

Aug.
FOMC

30-year fixed-rate
Jumbo rate

Basis points
Aug.
FOMC
300

Weekly

30-year fixed-rate spread
FNMA MBS option-adjusted spread

8.5
Sept.
3

Sept.
3

8.0

200

7.0

175

6.5

150

6.0

125
Sept.
9

5.0
June
2007

Oct.

Feb.

June
2008

Oct.
2006

Feb.

June
2007

Oct.

Feb.

Source. Freddie Mac; Inside Mortgage Finance.

Source. Bloomberg; Freddie Mac.

House Prices

Delinquencies on Mortgages
Percent change

Annual rate, s.a.

OFHEO purchase-only index
S&P/Case-Shiller national index

Q2
Q2

1996

1998

2000

2002

2004

2006

Percent of loans

2008

June
2008

Oct.

Percent of loans

Monthly

3.0
June

2.5

18
Subprime (left scale)

2.0
June

1.5

Prime (right scale)

1.0

8
0.5

6
4

0.0
2002

2004

2006

2008

Source. Office of Federal Housing Enterprise Oversight (OFHEO);
Standard & Poor’s.

Note. Percent of loans 90 or more days past due or in
foreclosure. Prime includes near-prime mortgages.
Source. First American LoanPerformance.

Agency and Non-Agency MBS Issuance

Mortgage Debt

Billions of dollars

Percentage change from previous quarter
300

Monthly rate
GSEs
Ginnie Mae
Non-agency

75
25

Oct.

35
30
25
20
15
10
5
0
-5
-10
-15
-20
-25
-30
-35

100
50

4.5
Feb.

250
225

7.5

5.5

Oct.
2006

275

Annual Rate

250
12
200

150

Q2
Q1
July

100

50
e

2001 2002 2003 2004 2005 2006 2007

2008

Source. For agency issuance, Fannie Mae, Freddie Mac,
and Ginnie Mae. For non-agency issuance, Inside Mortgage
Finance.

0
2001

2003

e Staff estimate.
Source. Federal Reserve.

2005

2007

III-13

prime (and near-prime) residential mortgages edged up 10 basis points, to 1¾ percent,
and the delinquency rate on subprime mortgages increased about 45 basis points, to
18¾ percent. Preliminary data (not shown) indicate that the delinquency rate on
subprime variable-rate mortgages increased further in July.
Issuance of MBS by Ginnie Mae continued to move up in July, while issuance by the
GSEs that month was somewhat below the pace earlier in the year. No private-label
MBS was issued that month. In the second quarter, mortgage debt expanded at an annual
rate below 1 percent, the slowest recorded pace since 1952. The steep decline in total
mortgage borrowing reflects a number of factors, including the tight supply of
nonconforming loans, the rise in mortgage rates since the beginning of the year, the
continuing drop in home prices, and sluggish home sales.
Delinquency rates for revolving and nonrevolving consumer loans at commercial banks
edged up in the second quarter. Delinquencies on auto loans at the domestic captive
finance companies remained elevated in July, and the charge-off rate on prime auto loans
estimated by Moody’s (not shown) rose in June to its highest level since December 2003.
Growth of consumer credit stepped down a little in July. Growth of nonrevolving credit
slowed markedly, even as a large captive finance company launched aggressive auto
financing incentives in July. Since the August FOMC meeting, interest rates on credit
card and auto loans were little changed, generally remaining below the levels seen earlier
this year. Separately, new government-backed funding facilities appear to have largely
assuaged concerns about the availability of student loans for the autumn semester.
The secondary market for consumer loans continues to show signs of strain. Issuance of
asset-backed securities (ABS) collateralized by credit card receivables and by auto loans
was substantially weaker in July and August than earlier this year. Although issuance of
student loan ABS has held up, on net, the August figure reflected a single deal that was
not widely distributed among investors. Spreads on consumer ABS jumped in August
and now stand above their March peaks, suggesting that investors may have grown more
concerned about the likely performance of the underlying loans.
As in July, long-term mutual funds saw sizable outflows last month, which reflected large
withdrawals from equity funds and moderate inflows to bond funds. For the second
consecutive month, money market funds attracted inflows exceeding $40 billion in
August.

III-14

Consumer Credit and Household Wealth
Delinquencies on Consumer Loans

Consumer Credit
Percent

Percent change
6

Credit card loans
at commercial banks
Q2

3-month percent change, annual rate

16
14

Nonrevolving
consumer loans at
commercial banks

12
10

8
6

July
2

Auto loans at captive
finance companies

July

2
1

1998

2000

2002

2004

2006

2008

2000

2002

2004

Source. For auto loans, Federal Reserve; for credit cards and
nonrevolving consumer loans, Call Report.

Source. Federal Reserve.

Gross Issuance of Consumer ABS by Type

AAA ABS Spreads over Swaps

Billions of dollars

2006

2008

Basis points

40
Monthly rate
Student loans
Credit card
Auto

200

Weekly

180
160

3-year FFELP student loan
2-year credit card
2-year auto

140
Sept.
5

H1
H2

100

120
80
60

July

Aug.

20
0

2005

2006

2007

2008

-20
June

Oct. Dec. Feb. Apr. June Aug.
2007
2008
Source. For credit cards and auto, Citigroup Global Markets;
for student loans, Merrill Lynch.

Note. Auto includes car loans, leases, and financing for buyers of
motorcycles, trucks, and other vehicles.
Source. Inside Mortgage Finance; Merrill Lynch.

Aug.

Net Flows into Mutual Funds
(Billions of dollars, monthly rate)
Fund type

Total long-term funds
Equity funds
Domestic
International
Hybrid funds
Bond funds
High-yield
Other taxable
Municipals
Money market funds

2007
H2

2008
Q2

July

Aug.e

Assets
July

31.5
14.3
0.8
13.5
2.6
14.6
0.2
12.0
2.4
26.3

5.8
1.1
-8.5
9.6
1.1
3.5
-0.7
4.8
-0.6
98.8

1.7
-14.9
-13.4
-1.5
0.7
16.0
-1.3
15.2
2.1
126.9

22.6
7.8
3.3
4.4
2.0
12.9
0.9
8.2
3.7
-14.8

-26.0
-26.4
-18.7
-7.7
-1.5
1.8
-0.6
-0.1
2.5
54.4

-11.0
-18.7
-2.7
-16.0
-0.3
8.0
0.1
5.4
2.5
42.7

8,100
5,686
4,243
1,443
664
1,751
147
1,218
386
3,535

Note. Excludes reinvested dividends.
e Staff estimate.
Source. Investment Company Institute.

III-15

Treasury Finance
Foreign Participation in Treasury Auctions

Foreign Custody Holdings

Percent of total issue

Billions of dollars
50

6-month moving average

1600

Aug. FOMC

Weekly average

1400
40

Indirect bids

Sept.
3

Treasury

1200
1000

800

Sept. 2

20
July 31

600
Agency

400

Actual foreign allotment

200
0

2000

2002

2004

2006

2008

0
2003

2004

2005

2006

2007

2008

2009

Note. Indirect bids and actual allotment are a percentage of
the total amount accepted, including the amount tendered to
the Federal Reserve. Moving averages include 2-, 5-, and 10year original auctions and reopenings.

Note. Securities held in custody at the Federal Reserve Bank
of New York on behalf of foreign official institutions.
Source. Federal Reserve Bank of New York.

Treasury On-the-Run Premiums

Average Absolute Nominal Yield Curve
Basis points
Fitting Error

Basis points
40
Monthly average

Daily

14
30

10-year

20
Sept.

8
10

2-year

Sept.
9

-10
2001 2002 2003 2004 2005 2006 2007 2008

2
0

2001 2002 2003 2004 2005 2006 2007 2008

Note. Computed as the spread of the yield read from an estimated
off-the-run yield curve over the on-the-run Treasury yield. September
observation is the month-to-date average.
Source. Federal Reserve Bank of New York.

Note. Calculated from securities with 2 to 10 years until maturity,
excluding on-the-run and first off-the-run securities.

Treasury Bid-Ask Spread

Monthly Average Treasury Market Volume

Cents per
$100 face value
Aug.
FOMC

5-day moving average

Volume (billions)
1.10

300
Monthly average

1.05

250

1.00
Sept.
9

200
0.95
150

2-year on-the-run
Treasury notes

0.90
Sept.

0.85
0.80
Feb. June Oct. Feb. June Oct. Feb. June

2006

2007

2008

Source. BrokerTec Interdealer Market Data.

100
50

2001

2003

2005

2007

Note. September obsevation is average for month to date.
Source. BrokerTec Interdealer Market Data.

III-16

State and Local Government Finance
Gross Offerings of Municipal Securities
(Billions of dollars; monthly rate, not seasonally adjusted)

2007
Type of security
Total
Long-term 1
Refundings 2
New capital
Short-term

2004

2005

2006

34.7
29.8
10.8
19.0
4.9

38.4
34.2
15.6
18.6
4.2

2.0

2.1

Memo: Long-term taxable

2008

July

Aug.

36.1
32.5
10.6
21.9
3.7

41.8
38.5
16.5
22.0
3.4

38.9
32.6
8.7
23.9
6.3

29.5
28.1
11.0
17.0
1.5

52.5
47.0
24.5
22.4
5.5

41.8
36.5
15.6
20.8
5.4

38.9
29.6
13.4
16.3
9.3

2.5

2.2

2.6

1.8

3.1

4.0

1.1

1. Includes issues for public and private purposes.
2. All issues that include any refunding bonds.
Source. Thomson Financial.

Ratings Changes
Number of ratings changes
Annual rate

Upgrades

2400

1800
1200
Q1

600
0
600

Downgrades

1200
1800
2400

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

Source. S&P’s Credit Week Municipal; S&P’s Ratings Direct.

Municipal Bond Yields
General Obligation

Municipal Bond Yield Ratio
Percent

General Obligation over Treasury
8

Weekly

Ratio
1.2

Weekly

7
20-year

1.1

6
Sept.
4

Sept.
4

5
20-year

0.9

3
1-year
Sept.
9

1.0

0.8

1
0
1994 1996 1998 2000 2002 2004 2006 2008
Source. Municipal Market Advisors; Bond Buyer.

0.7
1994 1996 1998 2000 2002 2004 2006 2008
Source. Bond Buyer.

III-17

Treasury Finance
During the intermeeting period, the Treasury conducted auctions of nominal coupon
securities across a range of maturities, and these auctions were generally well received.
Indirect bids, a rough measure of demand from foreign official institutions, stayed near
the bottom of the range seen over the past several years. However, foreign custody
holdings of Treasury securities at the Federal Reserve Bank of New York—another
indicator of foreign demand—increased notably over the intermeeting period, while such
holdings of agency securities declined.
Liquidity in the secondary market for Treasury securities remained somewhat strained
during the period. Spreads between on- and off-the-run Treasury notes generally stayed
elevated, an indication of continued high demand for the most liquid securities. In
addition, fitting errors from the estimated nominal yield curve remained sizable; that is,
there continued to be unusually large differences between yields on Treasury securities
with similar maturities. However, there were some signs of improvement. Average bidasked spreads for on-the-run nominal Treasury notes declined a bit further and now have
nearly returned to levels seen before the onset of the financial turmoil last year, and
trading volumes for on-the-run Treasury securities rebounded in early September from
last month’s low level.
State and Local Government Finance
Issuance of long-term municipal bonds for both advance refundings and new capital
projects was sizable in August. Short-term issuance was also strong last month, a result
of greater-than-typical revenue shortfalls for state and local governments.
Nonetheless, credit quality in the municipal bond sector appears to have remained solid
on the whole, as the number of rating upgrades continued to outpace the number of
downgrades in the second quarter. Yields on long-term municipal bonds decreased
slightly over the intermeeting period, even as those on comparable-maturity Treasury
securities moved down, pushing the ratio of a representative municipal bond yield to a
comparable-maturity Treasury yield to the middle of this year’s elevated range.
Money and Bank Credit
M2 contracted at an annual rate of 1½ percent in August after having expanded 6 percent
in the previous month. Smoothing through the monthly volatility, money growth has
stepped down since the second quarter. The August data showed a considerable
reallocation among the components of M2. Liquid deposits and retail money funds fell at

III-18

M2 Monetary Aggregate
(Based on seasonally adjusted data)
1

Percent change (annual rate)

2006

2007

2008
Q2
July

4.9

5.8

9.5

5.7

Components
Currency
3
Liquid deposits
Small time deposits
Retail money market funds

3.5
.7
18.6
13.0

2.0
4.5
4.3
19.2

-.5
7.0
2.4
38.9

Memo:
Institutional money market funds
Monetary base

15.7
3.1

39.4
2.0

46.8
-.4

Aggregate and components
M2

Level
(billions
of dollars),

Aug.
(e)

6.1

-1.5

7,717

2.3
7.5
-6.2
14.6

8.7
4.8
9.5
5.9

2.2
-8.2
25.3
-5.0

776
4,649
1,234
1,051

33.1
2.0

-.4
8.1

13.2
5.0

2,271
842

1. For years, Q4 to Q4; for quarters and months, calculated from corresponding average levels.
2. Nonbank traveler’s checks are not listed.
3. Sum of demand deposits, other checkable deposits, and savings deposits.
e Estimated.
Source. Federal Reserve.

III-19

annual rates of 8¼ percent and 5 percent, respectively. In stark contrast, small time
deposits surged at a nearly 25 percent pace, as some banks and thrifts apparently
continued to bid aggressively for these deposits to help stabilize their core deposit base.
Last month, growth of currency slowed from the robust pace in July that had reflected
unusual demand from abroad.
In July and August, commercial bank credit expanded at about the same pace as in the
second quarter, as faster growth of securities holdings offset a slower expansion in loans.2
Growth of commercial real estate and C&I loans was tepid, on average, during the JulyAugust period, while residential real estate loans and consumer loans on banks’ books
grew at a pace similar to that in the second quarter.
Data from the Survey of Terms of Business Lending conducted during the week of
August 4 indicated that the average spread on C&I loan originations of less than
$25 million—adjusted for changes in nonprice loan characteristics—was about
unchanged since the May survey.3 The absence of a pronounced widening of yield
spreads on those C&I loans is broadly consistent with the recent NFIB survey, which
showed that concerns among small firms about future credit conditions and current
availability of credit have receded somewhat in recent months. By contrast, terms on
large leveraged syndicated loans have remained very tight.
Commercial bank profitability, as measured by industry return on assets, fell to about
0.4 percent at an annual rate in the second quarter of 2008, the lowest level since the end
of 1990. This year’s decrease has been somewhat more pronounced among the 25 largest
institutions (as measured by assets), a segment of the industry in which a sharp increase
in loan-loss provisions and large write-downs of asset values have weighed heavily on
profits. For the industry as a whole, loan-loss provisions increased to 1.3 percent of total
loans and leases in the second quarter, about three times the year-earlier rate. Despite the
rapid pace of loan-loss provisioning, the ratio of loan-loss reserves to net charge-offs—a
rough gauge of reserve adequacy—fell to a very low level.

Recent fluctuations in bank credit and its components reflect larger-than-usual movements in the
estimated seasonal factors. The seasonal factors for recent months are difficult to estimate—particularly
for commercial real estate loans—because of the timing of changes in the panel of respondent banks.
3

Because there are too few loans over $25 million, and their terms vary so widely, these loans are excluded
from our analysis.

III-20

Commercial Bank Credit
(Percent change, annual rate, except as noted; seasonally adjusted)
Type of credit

Level1
Aug. 2008e

H1
2007

H2
2007

Q1
2008

Q2
2008

July
2008

Aug.
2008e

6.2

11.3

6.0

3.6

1.9

5.3

9,059

Total
Loans2
Total
To businesses
Commercial and industrial
Commercial real estate

7.2

11.5

9.5

4.4

5.1

6,846

6.9
6.2

26.2
10.3

15.5
9.9

13.0
10.2

5.7
-9.2

-.1
4.8

1,511
1,657

To households
Residential real estate
Revolving home equity
Other
Consumer
Originated3
Other4

8.8
3.0
10.7
2.9
3.1
9.6

-1.1
6.5
-3.7
10.8
9.2
19.9

3.4
11.5
.7
8.8
8.2
12.1

3.3
16.1
-1.3
6.0
6.8
-16.3

-5.6
12.1
-12.3
11.0
5.9
14.3

9.1
6.0
10.2
8.5
2.2
3.6

1,856
522
1,334
842
1,251
980

3.3
-5.0
14.5

10.7
-4.3
28.9

-4.2
-11.2
3.0

.9
8.4
-6.6

4.9
15.4
-6.2

5.6
41.1
-32.9

2,213
1,186
1,027

Securities
Total
Treasury and agency
Other5

Note. Yearly annual rates are Q4 to Q4; quarterly and monthly annual rates use corresponding average levels. Data
have been adjusted to remove the effects of mark-to-market accounting rules (FIN 39 and FAS 115), the initial consolidation of
certain variable interest entities (FIN 46), the initial adoption of fair value accounting (FAS 159), and the effects of sizable
thrift-to-bank and bank-to-thrift structure activity in October 2006, March 2007, and October 2007. Data also account for
breaks caused by reclassifications.
1. Billions of dollars. Pro rata averages of weekly (Wednesday) levels.
2. Excludes interbank loans.
3. Includes an estimate of outstanding loans securitized by commercial banks.
4. Includes security loans and loans to farmers, state and local governments, and all others not elsewhere classified.
Also includes lease financing receivables.
5. Includes private mortgage-backed securities; securities of corporations, state and local governments, and foreign
governments; and any trading account assets that are not Treasury or agency securities.
e Estimated.
Source. Federal Reserve.

C&I Loan Rate Spreads

Return on Assets at Commercial Banks
Basis points

Percent

240

Quarterly

220

2.0

Quarterly, s.a.a.r.
25 largest banks
All other banks
1.5

Weighted
average

200
1.0

180
Q2

160

Weighted
average
adjusted*

0.5

140
0.0

1998

2000

2002

2004

2006

2008

Note. Spreads over market interest rate on an instrument of
comparable maturity on loans less than $25 million (2006$).
*Adjusted for changes in nonprice loan characteristics.
Source. Survey of Terms of Business Lending.

1992

1996

2000

Source. Call Report.

Last Page of Domestic Financial Developments

2004

2008

International Developments

International Developments
U.S. International Transactions
Trade in Goods and Services
The U.S. international trade deficit narrowed to $56.8 billion in June, as a large increase
in exports of goods and services more than offset a more moderate increase in imports.

In June, exports rose 4 percent, supported by strength in exports of industrial supplies
(particularly petroleum products), agricultural products, and capital goods. Exports of
automotive products were pushed up by increased shipments of trucks to Canada, while
strong exports of pharmaceutical products boosted consumer goods. Exports of services
also climbed.
The value of exports in the second quarter increased 23¼ percent at an annual rate.
Strong growth was recorded across most major categories; exports of industrial supplies
and agricultural products were particularly robust. In real terms, exports rose 13¼
percent in the second quarter, contributing 1.6 percentage points to U.S. real GDP
growth.

IV-1

IV-2

IV-3

IV-4

The value of imports of goods and services rose 1.8 percent in June, as a strong increase
in imports of oil (both on account of higher volumes as well as an increase in price) more
than offset a sharp decline in non-oil goods. Imports of capital goods fell, as computers
slipped back after surging in May and other capital goods were weak. Imports of
consumer goods declined despite a jump in pharmaceutical products, whereas industrial
supplies and automotive products were flat. Services increased moderately.
The value of imports in the second quarter increased 17½ percent at an annual rate, led by
an increase in oil imports, as an increase in the price of imported oil more than offset a
decline in the volume. In real terms, however, imports contracted 7½ percent, resulting
in a positive contribution to U.S. real GDP growth of 1.4 percentage points.
Prices of Internationally Traded Goods
Non-oil imports. In July, for the second consecutive month, prices of core imports rose
0.9 percent. Compared with the June increase, July’s rise featured a relatively large
contribution from finished goods, mostly reflecting a 0.8 percent increase in the prices for
capital goods excluding computers and semiconductors. Prices for consumer goods also
accelerated, increasing 0.3 percent in July following 0.1 percent in June. As in previous
months most of the increase in the prices of core goods was due to material-intensive
goods; prices for these goods increased 1.8 percent in July following 2.4 percent in June.
Higher prices for chemicals and steel and iron products more than offset falling prices for
nonferrous metals. Higher prices for meat and vegetables also contributed to the
increase.
Oil. The BLS price index for imported oil rose 4 percent in July, amid considerable
volatility in underlying spot prices. The spot price of West Texas intermediate (WTI)
crude oil surged to $145 per barrel in mid July but then reversed course, leaving the
monthly average price for July unchanged from June’s $133 per barrel. Oil prices have
fallen from an average of $117 in August to $103.26 as of September 9. The rapid fall in
oil prices that has occurred since mid-July appears to reflect a continued weakening of
the outlook for global oil demand as well as increases in supply. Part of this increase
stems from Saudi Arabia, which raised crude production for the third consecutive month.

IV-5

IV-6

IV-7

This apparent easing of the global oil balance has more than offset any upward price
pressure stemming from increased geopolitical tensions due to the conflict between
Russia and Georgia, as well as tropical storm activity in the Gulf of Mexico.
Exports. Core export prices rose 1.9 percent in July. Almost all of the increase was due
to higher prices for material-intensive goods. Prices for agricultural products soared
6.7 percent in July, reflecting sharp price increases for corn and soybeans. Prices for
nonagricultural industrial supplies rose 2.6 percent, supported by higher prices for fuels
and chemicals. After increasing 0.1 percent in June, prices for finished goods rose
0.3 percent in July.

IV-8

U.S. International Financial Transactions
Since the July/August Greenbook, we have received data on U.S. international financial
transactions for June and July, along with partial and confidential data on custody
accounts at the Federal Reserve Bank of New York (FRBNY) through early September.
After slowing sharply in the second half of 2007, foreign official flows into the United
States surged during the first half of 2008 (line 1 of the Summary of U.S. International
Financial Transactions table and the chart on Foreign Official Financial Flows). As
market attention increasingly focused on concerns about Fannie Mae and Freddie Mac,
official investors slightly reduced their holdings of agency securities in July. However,
these outflows from agency securities were more than
offset by inflows into Treasury and other short-term
securities. All told, foreign official inflows were on
trend in July, registering $41 billion, with nearly all
coming from China, Russia, and members of the
Organization of Petroleum Exporting Countries.
Data on custody accounts at FRBNY indicate that
official holdings of agency securities continued to
decline through early September, even as holdings of
Treasuries continued to rise (see inset chart). In the
two days following the announcement that Fannie
Mae and Freddie Mac would be placed into
conservatorship, foreign official holdings of agency
securities at FRBNY increased slightly, but it is too
early to tell if this signals a return to previous trends.
Foreign private net purchases of U.S. securities have continued to slow since the financial
turmoil began in mid-2007 and were weak in the first half of 2008, averaging about half
of those recorded in the second half of 2007 (line 4 of the Summary of U.S. International
Financial Transactions table; see also the chart on Private Securities Flows). Foreign
private investors have been selling agency bonds since March, but the pace accelerated in
July to a record $51 billion (line 4b). There were also small outflows from net foreign
private sales of corporate and municipal bonds and corporate stocks (lines 4c and 4d), but
these were mostly offset by net purchases of Treasury securities (line 4a). Overall,
private foreign net sales of U.S. securities in July resulted in a record outflow of $53
billion (line 4).

IV-9

Since early 2007, financial outflows associated with U.S. private investors’ net
acquisitions of foreign securities have been decreasing on average (bottom left panel of
the chart). In July U.S. private investors sold, on net, $30 billion of foreign securities
(line 5), which resulted in an inflow.
The volatile banking sector (line 3) registered an inflow of $21 billion in June, which was
followed by a large outflow of $83 billion in July. Most of the outflow in July was due to
decreased funding from affiliated branches in the Caribbean.
Complete U.S. balance of payments data for the second quarter will not be published
until September 17. However, some partial data have come in, including changes in
quarterly reported custody holdings. These data (which will be included in line 10 of the
table) indicate a further $50 billion in inflows during the second quarter, primarily the
result of a decrease in U.S. residents’ deposits in the Caribbean.

IV-10

IV-11

IV-12

IV-13

Foreign Financial Markets
The dollar has appreciated sharply since the time of the last Greenbook in accordance
with the deterioration of the foreign economic outlook. The major currencies index
increased by 6½ percent, with the dollar gaining over 12 percent against sterling and 10
percent against the euro after the release of weaker-than-expected macroeconomic data
for Europe and the news of downward adjustments to the growth forecasts of the Bank of
England (BoE), the European Central Bank (ECB), and the Organisation for Economic
Co-operation and Development (OECD). The appreciation of the dollar against the yen
has been modest.
Despite gloomier growth expectations, the BoE and the ECB left their policy rates
unchanged over the period, citing concerns about inflation being well above target.
Medium-term policy expectations have declined, however, since the July/August
Greenbook, especially for the Bank of England. The twelve month sterling overnight
index swap (OIS) rate has declined by 44 basis points. The comparable euro rate
declined only 17 basis points amid statements by several ECB Governing Council
Members that some of these expectations are premature due to continued inflationary
pressures. In line with expected easing by central banks, sovereign bond yields have
declined since the end of July, reflecting declines both in real rates and in expected
inflation. Ten-year inflation compensation has declined by roughly 20 basis points in the
euro area and 10 basis points in the United Kingdom. Inflation compensation in Japan
has declined as well, by 15 basis points.
Conditions in money markets deteriorated somewhat since the time of the last
Greenbook. Spreads between three-month sterling Libor and OIS rates increased by 11
basis points, likely driven at least in part by the worsening economic outlook for the
United Kingdom. U.K. housing prices have continued to fall, and Moody’s downgraded
$3.6 billion of nonconforming U.K. residential mortgage-backed securities in August due
to rising delinquencies. The United Kingdom’s financial regulator, the Financial
Services Authority, also fined Credit Suisse for incorrect securities valuations in midAugust and announced that next year it will start probing “a large number” of London
banks for similar problems. Euro Libor to OIS spreads increased only modestly. The
demand for dollar funding in continental Europe still appears to be substantial. The
initial 84-day U.S. dollar auctions of the ECB and the Swiss National Bank (SNB), held
in conjunction with the 84-day Term Auction Facility (TAF) auctions by the Federal
Reserve, were substantially oversubscribed. The ECB and SNB also held three 28-day
auctions during the period, and these drew substantial bids as well. On concern that some

IV-14

European financial institutions might be taking advantage of the ECB’s broad collateral
rules, the ECB announced several changes to its rules. These changes are scheduled to
take effect in February 2009.
Apparently reflecting the same concerns about weakening growth abroad that boosted the
major currencies index of the dollar, the dollar rose nearly 4 percent against the
currencies of our other important trading partners. Currencies throughout the emerging
markets declined, most notably the Brazilian real and the Korean won, which are 13¾
percent and 8¼ percent lower against the dollar, respectively, since the previous
Greenbook. The renminbi, however, depreciated only modestly against the dollar. These
depreciations occurred in spite of the fact that the central banks of Indonesia, Israel,
Korea, Mexico, Philippines, Thailand, and Vietnam tightened policy in an attempt to curb
mounting inflation. A number of countries, including Russia, Korea, and Indonesia, are
believed to have intervened in foreign exchange markets to support their currencies in the
face of downward pressures.
Despite the fact that stock markets rallied after the Treasury Department’s actions
regarding Fannie Mae and Freddie Mac, equity prices around the world have, on net,
declined since the July/August Greenbook. The Dow Jones Eurostoxx index declined by
2½ percent whereas the Nikkei index lost over 7 percent. The Shanghai composite index
fell by as much as 24 percent. Financial stocks in the euro area have risen slightly over
this period. European banks reported second-quarter write-downs totaling around $40
billion, although earnings reports in early August were better than had been expected.

IV-15

IV-16

IV-17

IV-18

IV-19

IV-20

Developments in Advanced Foreign Economies
Economic indicators received since the last Greenbook point to marked deterioration in
the pace of economic activity in the advanced foreign economies. Second-quarter GDP
was flat in Canada and the United Kingdom and fell in both Japan and the euro area. The
weakness in the advanced foreign economies appears to have continued into the third
quarter. Confidence and survey indicators declined considerably in recent months in
most of these economies. In July, employment continued to weaken in Japan, and retail
sales fell in the euro area and decelerated in the United Kingdom. Headline inflation in
the major advanced foreign economies stayed elevated, although it edged down in August
in the euro area. Since the last Greenbook, inflation excluding food and energy was
generally little changed for the major economies. No major central bank changed its
policy rate during the intermeeting period.

IV-21

IV-22

In Japan, real GDP contracted 2.4 percent (a.r.) in the second quarter following a
downward-revised growth rate of 3.2 percent in the first quarter. All major components
of domestic demand except government consumption fell sharply. Private consumption
declined almost 2 percent, and private investment contracted more than 2½ percent. Net
exports also made a small negative contribution to growth.

For the third quarter, trade data suggest a rebound in net exports. After falling sharply
earlier in the year, real exports grew steadily in May, June, and July, while real imports
were up only slightly over the same period. Elsewhere in the economy, recent data point
to continued weakness. Industrial production rose only 0.8 percent over the 12 months
ending in July, well below the 2.2 percent in the previous 12 months. Business and
consumer confidence indicators have deteriorated sharply over the last year and are both
at or near their 2001 lows.
The labor market has continued to weaken. Although the unemployment rate fell back
0.1 percentage point to 4.0 percent in July, the job openings-to-applicants ratio (the
number of officially posted job openings relative to the number of officially registered
job seekers) declined to 0.89, its lowest level since October 2004.

IV-23

Rising energy and food prices have been the primary reason for a 2.3 percent increase in
Japanese consumer prices over the 12 months ending in July. Consumer prices excluding
fresh food (Japan’s official definition of core inflation) rose nearly as much, but prices
excluding food and energy were up only 0.2 percent from last year. The timelier
12-month core CPI inflation for Tokyo slowed from 1.6 percent in July to 1.3 percent in
August.
On August 29, the Japanese government announced a $106 billion stimulus package in
response to the weakening economy. Although details remain sketchy, the bulk of the
stimulus is likely to be allotted to loan guarantees to small and medium-sized enterprises.
However, the stimulus is likely too small to have a substantial impact on Japan's
economy. Japan's Prime Minister Fukuda announced his resignation on September 1 in
an effort to break political deadlock. His party, the Liberal Democratic Party, has called
an election for September 22.

IV-24

IV-25

Euro-area real GDP contracted 0.8 percent (a.r.) in the second quarter, with larger-thanexpected declines in France, Italy, and particularly Germany. A collapse in investment
was the main factor behind the second-quarter weakness. Private consumption also
posted a decline, partially offset by gains in government consumption. The most recent
ECB bank lending survey indicates credit standards in the euro area remained tight in the
second quarter, mainly reflecting deteriorating expectations about the euro-area economic
outlook.

Recent indicators point to continued softness in the third quarter. Euro-area economic
sentiment dropped further in August, reaching its lowest level in over five years.
Purchasing managers’ indexes (PMIs) for both manufacturing and services in August
indicated that these sectors contracted for the third consecutive month. Retail sales
declined 0.4 percent in July. Particularly worrisome is the clear deterioration in the
German economy, which had shown resilience until recently. The German Ifo business
climate index dropped in August for the third consecutive month, the manufacturing PMI
fell below 50, and manufacturing new orders have been decreasing sharply in recent
months.

IV-26

Euro-area 12-month headline inflation, as measured by the harmonized index of
consumer prices (HICP), reached 4 percent in July, a record high. Excluding energy and
unprocessed food, inflation continued to hover around 2½ percent. According to a
preliminary estimate, headline inflation edged down to 3.8 percent in August. The ECB
Council left its policy rate unchanged at 4.25 percent at its August and September
meetings.

IV-27

IV-28

In the United Kingdom, growth of real GDP in the second quarter was revised down to a
meager 0.2 percent (a.r.), held down by flat consumption and plunging housing and
government investment. The fall in domestic demand was offset by positive
contributions from net exports and inventories. Recent data point to further weakness in
the third quarter. In July, retail sales stood below their second-quarter level, the
claim-based measure of the unemployment rate edged up, and industrial production
continued to fall. Confidence indicators have weakened, on balance, since the last
Greenbook to very low levels.

On September 2, the Chancellor of the Exchequer announced a one-year suspension of
taxes on housing transactions of £175,000 or less, a measure that will cost the
government an estimated £600 million. The Chancellor also brought forward £1 billion
in spending to fund a series of measures aimed at accelerating public housing
construction, encouraging first-time buyers, and assisting families facing repossession.
House price indexes fell more than 10 percent in the year to August, and the value of
loans for house purchases in July was only a quarter of its year-earlier level.

IV-29

The 12-month rate of headline inflation climbed to 4.4 percent in July. Food and energy
prices, the largest contributors to the run up in inflation, rose 10 percent and 21 percent,
respectively, over the same period. Although inflation outside of energy and both
processed and unprocessed food crept up in recent months, it remained contained at
1.9 percent. Average earnings, both including and excluding bonuses, stood about
3½ percent higher in July than 12 months earlier.

IV-30

IV-31

In Canada, real GDP rose a tepid 0.3 percent (a.r.) in the second quarter, after a
downward-revised fall of 0.8 percent in the first quarter. Second-quarter GDP was
restrained by a large negative contribution from net exports (2.8 percentage points), as
exports – particularly to the United States – continued to fall sharply. Investment also
fell, partly reflecting a decline in residential construction. In contrast, consumption
growth was strong, at 2.4 percent, although half of its 2007 pace.

Following a loss of 55 thousand jobs in July, employment increased 15 thousand in
August. Since the start of the year, employment has grown 0.5 percent, a much smaller
increase compared to the first eight months of 2007. The unemployment rate remained
unchanged at 6.1 percent.
The 12-month rate of consumer price inflation rose to 3.3 percent in July, up from
1.4 percent in March, reflecting escalating energy prices and an end to the extremely low
rates of food-price inflation over the past year. The Bank of Canada’s preferred measure
of core inflation, which excludes the eight most volatile components of the consumer
price index as well as the effects of indirect taxes, remained muted at 1.5 percent.

IV-32

IV-33

Economic Situation in Other Countries
Data since the July/August Greenbook generally have showed continued slowing in
emerging market economies. Revised data for Mexico indicate that real GDP contracted
in the first quarter and that growth was quite low in the second quarter as well. In Asia,
second-quarter output contracted sharply in Hong Kong and Singapore, and decelerated
significantly in India, Malaysia, and Thailand. However, in a few countries, including
the Philippines, Indonesia, and Venezuela, output rebounded from below-trend rates in
the first quarter. In the current quarter, emerging market economies appear to have
continued to grow at a subdued pace, weighed down by weak external sectors and
varying degrees of weakness in domestic demand.
Headline inflation in the developing world may be beginning to crest. Although inflation
rose in some countries, it fell in several Asian economies including China, Korea,
Singapore, Taiwan, and Thailand. Inflation in Mexico edged just a touch higher in July.
Monetary authorities in several emerging market economies, including Korea and
Mexico, have raised policy rates since the time of the July/August Greenbook.
In China, data thus far in the third quarter have been mixed. In July, industrial
production contracted and bank lending expanded at about its second-quarter pace, which
was the lowest since 2006. On the other hand, the trade balance has jumped higher to
average about $310 billion at an annual rate over July and August, well above the
second-quarter average, as exports rebounded and imports contracted. Exports were
higher to all regions including the United States. In addition, retail sales were up more
than 23 percent from a year earlier.
In August, 12-month consumer price inflation fell to 4.9 percent, down from more than
8 percent early in the year, as food price inflation continued to wane. Excluding food and
energy, inflation has remained subdued at a little over 1 percent. With headline inflation
coming down, authorities have issued statements indicating a shifting of concern away
from inflation and towards slowing growth. Thus far, the authorities have taken limited
actions aimed at aiding the export sector. For example, in early August, China increased
tax rebates for textile and clothing exporters. Monetary authorities have also reportedly
raised banks’ lending quotas 5 percent, with the new funds to be directed toward small
and medium-sized enterprises.

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India’s GDP growth fell in the second quarter to 5½ percent from 9 percent in the first.
The slowdown reflected, in part, the response of domestic demand to three consecutive
interest rate increases by the authorities. Growth also slowed in agriculture and the
export-oriented services sector. Industrial production in the second quarter was flat.
Both consumer and wholesale price inflation increased in July, although the pickup in
wholesale price inflation was small compared with recent months. On August 14, the
government announced a 28 percent increase in employee salaries, which will likely
stimulate consumption but also increase inflation pressures. Imports grew faster than
exports in July, and the trade deficit widened considerably relative to the first and second
quarters.

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In the NIEs1, second-quarter growth slowed in Taiwan and contracted in both Hong
Kong and Singapore. The slowing in Taiwan was broad-based and reflected weaker
domestic and external demand. The same was true in Hong Kong, only to a greater
extent, with output falling 5½ percent. Activity contracted 6 percent in Singapore, due in
part to the volatile biomedical sector, but electronics also slowed, and a decline in
government expenditures weighed on domestic demand. In July, industrial production
edged lower in Korea and showed a sharp contraction in Taiwan. In contrast, production
in Singapore rebounded in July. Trade balances worsened in July except in Singapore,
with Korean and Taiwanese balances moving from a surplus to a deficit.
12-month consumer price inflation remained elevated in Hong Kong, largely reflecting
higher food and energy prices. In Korea, Singapore, and Taiwan, there are some
indications that headline inflation may have peaked. Korean inflation jumped to
5.9 percent in July but moved down to 5.6 percent in August on lower energy prices. On
August 5, the Korean central bank raised its official rate 25 basis points, the first increase
in a year, in order to contain inflation, which remains well above the country’s target.
12-month inflation fell about 1 percentage point in Singapore in July and fell about the
same in Taiwan in August.

Newly industrialized economies: Hong Kong, South Korea, Singapore, and Taiwan

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In the ASEAN-4, real GDP growth in the second quarter slowed markedly in Malaysia
and Thailand, but growth rebounded from slow first quarters in Indonesia and the
Philippines. In July, industrial production in Thailand was flat, and the trade balance
swung from a surplus to a sizable deficit. Indonesia’s trade surplus also narrowed in
July.
Consumer price inflation rose significantly in all of the ASEAN countries in July,
reaching about 12 percent on a 12-month basis in Indonesia and the Philippines. In
August, inflation in Indonesia and the Philippines was little changed but Thailand
recorded a sharp drop, which was primarily due to increased government subsidies on
energy. Similarly, Malaysian authorities cut retail fuel prices a bit in August to quiet
political unrest ignited by a massive fuel price hike in June. To combat high inflation, the
central banks of Indonesia, the Philippines, and Thailand raised interest rates in August.
The political environment in Thailand deteriorated rapidly in late August and early
September. The Thailand Election Committee found that the ruling People’s Power Party
committed election fraud in the December elections. Following increased antigovernment demonstrations, Prime Minister Sundaravej declared a state of emergency,
which allows the military more leeway to contain rioting in the capital.

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In Mexico, real GDP growth in the first quarter was revised sharply lower, from about
2 percent to -½ percent, and output remained anemic in the second quarter, rising only
0.6 percent. Manufacturing, mining, utilities, and the construction sector all contracted in
the second quarter. Retail sales slowed as employment fell and real disposable income
deteriorated owing to the rise in consumer prices. In July, the trade deficit widened as
import growth outweighed the increase in exports. Although overall exports increased in
July, there was a significant contraction in automobile exports.
Headline and core inflation continued to increase in July, with both measures higher than
5 percent on a 12-month basis. With inflation above its 4 percent target, the Bank of
Mexico raised its policy rate ¼ percentage point in mid-August, bringing the rate to
8¼ percent. This increase was the third consecutive one.

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In Brazil, second-quarter real GDP rose 6½ percent following an upward-revised
3.4 percent increase in the first quarter. Consumption was robust, up 4.2 percent, while
gross fixed capital formation soared 23 percent. Net exports posted a neutral contribution
to growth, with both exports and imports rebounding after a weak first quarter when trade
was depressed by a customs strike. Rapid growth in credit and rising incomes from high
commodity prices continued to boost domestic demand. Headline consumer price
inflation declined in August to 6.2 percent on a 12-month basis, driven in part by falling
food prices.

In Argentina, industrial production recovered in the second quarter, and it increased
sharply in July following a resolution to the conflict between farmers and the government
over a proposal to tax exports; the conflict subsided after the Congress rejected the export
tax bill. The trade surplus narrowed in the second quarter, in part reflecting a
strike-related fall in exports, but widened in July. The financial condition of the
government, however, has deteriorated. The government borrowed $1 billion from
Venezuela at a rate 2 percentage points higher than the average of its current outstanding
debt, signaling that the government faces difficulty issuing new bonds at competitive
rates in international markets. In addition, Standard and Poor’s downgraded Argentina’s
sovereign debt rating to B from B+. To restore credibility, the government announced
that it would use some of its international reserves to pay off $6.7 billion of Paris Club
debt, which has been in default since the 2001-02 economic crisis. Headline consumer
price inflation remained around 9 percent in July on a 12-month basis, but the reliability
of the official inflation data remains questionable.

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In Venezuela, second-quarter real GDP rebounded following a large first-quarter decline.
Output rose at an annual rate of 14 percent, despite a contraction in the volatile petroleum
sector of 7 percent. Headline inflation continued to be very high, coming in at more than
33 percent on a 12-month basis in August. The bolivar declined 20 percent against the
dollar in the parallel market over the second half of August. A number of developments
appear to have contributed to the currency drop. These include the government takeover
of Mexican-owned cement company Sidor and the announcement that the government
will acquire Banco de Venezuela, the country’s third largest bank (whose Spanish owners
had been looking for a buyer) Also, in early August, the Chavez-appointed Supreme
Court ruled as constitutional the disqualification of roughly 300 opposition candidates
from the upcoming November local elections.

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Tensions remain high in Russia, after the invasion of Georgia in mid-August. In early
August, Georgia attempted to regain control over the breakaway region of South Ossetia
by force. The Russian response was to send its own troops to this region and to
neighboring Abakhazia, also a separatist province, and then continue into the heart of
Georgia to occupy strategic military locations. The military conflict and political
tensions have exacerbated concerns about the investment climate in Russia and stoked
worries within the EU about the reliability of Russia as a source of energy. Over several
days in August and September, the Russian authorities intervened to support the ruble.
As a result, international reserves fell about $14 billion in August. Despite the
intervention, the ruble has depreciated about 10 percent against the dollar since end-July.
The Russian stock market has been on a downward trend since May. Inflation remains
uncomfortably high, coming in at a 12-month rate of nearly 15 percent in August.
Falling oil prices and rising interest rates could weigh on activity in the future.
In Pakistan, the economic situation is precarious. An overheating of the economy,
together with the sharp rise in world oil and other commodity prices, took 12-month
inflation to nearly 25 percent in July. In its latest monetary policy report, the State Bank
of Pakistan estimates that the government fiscal deficit rose sharply to about 8 percent of
GDP in fiscal year 2007-08 (which runs from July to June), and the current account
deficit rose to about 8½ percent of GDP. Until recently, sufficiently high capital inflows
easily financed the current account deficit, but with intense political uncertainty since late
last year, investor sentiment has turned against the country. The Pakistani rupee has
moved sharply down against the dollar since last October, and there has been a massive
loss of international reserves resulting from efforts to prevent a free-fall of the currency;
reserves are at a critically low level. President Musharraf resigned in mid-August under
pressure from the new ruling coalition, but the coalition broke up soon after his
resignation. In early September, Mr. Zardari (the husband of the assassinated
Ms. Bhutto) was elected President. There does not appear to be a quick end in sight to
political uncertainty, security problems, and severe economic difficulties.

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Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, September 16, 2008 : Greenbook Part 2

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