Full text of FedViews : May 11, 2017

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Twelfth Federal Reserve District

FedViews
May 11, 2017

Economic Research Department
Federal Reserve Bank of San Francisco
101 Market Street
San Francisco, CA 94105
Also available upon release at
http://www.frbsf.org/economic-research/publications/fedviews/

Rhys Bidder, economist at the Federal Reserve Bank of San Francisco, stated his views on the current
economy and the outlook as of May 11, 2017.


Real GDP grew at an annualized rate of 0.7% in the first quarter, down significantly from the 2.1%
pace of the previous quarter. Much of this weakness reflected transitory factors such as declines in
inventories and reductions in spending on utilities owing to unseasonably warm weather. We expect
a substantial bounceback in the coming quarters, with growth averaging around 1¾% in 2017 and
2018.



The April labor market report featured strong employment growth, as non-farm payrolls expanded
by 211,000 jobs, making the six-month moving average 176,000. This growth is substantially above
the rate that the economy needs to create in the longer run in order to absorb new entrants into the
labor force, which we estimate to be somewhere between 50,000 and 100,000.



The unemployment rate fell in April to 4.4%, somewhat below our estimate of the natural rate of
unemployment of between 4.8% and 5.0%, reflecting continued strong, though gradually slowing,
payroll growth. We expect unemployment to fall further, reaching 4.2% towards the end of the year,
before rising towards its natural rate in the coming two to three years.



Inflation data for March were somewhat soft. The 12-month percentage change in the personal
consumption expenditure (PCE) price index was 1.8%, down from 2.1% in the prior month.
Excluding volatile food and energy components, the core PCE price index increased by 1.6%,
below the February pace of 1.8%. While these data imply a pause in the upward path in price
inflation over the last two years, we expect inflation to resume gradually converging to the Fed’s
2% target.



Long-term interest rates have subsided somewhat since the increases observed following the U.S.
presidential election last November. With the Federal Reserve maintaining its target rate between
¾% and 1% at its meeting in May, futures data imply that financial markets expect a further rate
increase in June and again later in the year.



While the unemployment rate (formally referred to as U3) is traditionally taken to be the most
reliable indicator of labor underutilization, it is useful to consider alternative measures. The U3

The views expressed are those of the author, with input from the forecasting staff of the Federal Reserve Bank of San Francisco.
They are not intended to represent the views of others within the Bank or within the Federal Reserve System. FedViews generally
appears around the middle of the month. The next FedViews is scheduled to be released on or before June 16, 2017.

measure only takes into account people who are unemployed if they have looked for a job in the
past month.


The U5 measure of labor underutilization augments U3 by considering people who may not have
looked for a job recently, but are regarded as still marginally attached to the labor force, having
looked for a job in the past year. The U6 measure in turn augments U5 by also including those
working part-time, but who would prefer to work full-time.



During the great recession, all three unemployment measures increased dramatically, though U5
and especially U6 increased by relatively large amounts—indicating a greater degree of slack than
captured by U3. All of these measures have since declined during the recovery, with U5 as well U3
now at their pre-recession levels, suggesting that labor market slack has been eliminated.



U6, however, has not quite returned to its pre-recession level, implying perhaps that some slack still
remains. While this is possible, research suggests that structural changes in the labor market over
the past decade can account for much of the remaining gap between the current and pre-recession
levels of U6. These changes include a shift towards sectors where part-time work is more prevalent,
and a reduction in the share of young people in the work force who might voluntarily chose to work
part-time.



The definition of unemployment can be extended further by taking into account other categories of
labor-force non-participants, such as students or retirees who may still enter the labor force, though
with low probability. A “Non-Employment Index” that weights different categories of nonparticipants by their probability of transitioning into the labor force indicates that this measure of
labor market slack also has returned to its pre-crisis level, thus conveying essentially the same
message about labor market conditions as U3.



Quit rates among employed workers have recovered to pre-recession levels, indicating that workers
are more confident in their ability to leave a job and find another. This accords with data indicating
that firms are experiencing increasing difficulty in filling open positions.



For most of the recovery period, wage increases have been limited, averaging around 2% annually.
Some wage measures, such as average hourly earnings and employment costs, have been picking up
recently, perhaps reflecting the fact that the economy has reached and perhaps moved beyond full
employment. For example, earnings rose 2.5% in the year through April. Nevertheless, wage
pressures still are not surging, likely reflecting limited productivity growth and the generally low
inflation environment of recent times that may have dampened wage demands. However, a more
forward-looking indicator, such as the fraction of small businesses planning wage increases, has
been rising for some time. This is consistent with the view that sustained labor market tightness will
result in increased wage pressures.

Employment growth slowing but healthy

Growth continues at a moderate pace
Real GDP

%

Percent change from 4 quarters earlier

Nonfarm payroll employment

FRBSF
Forecast

Thousands
400

Monthly change; seasonally adjusted

4

Monthly
350

3

300

2
Apr.
211,000

1

Q1

250

0

200

6-month
moving
average

-1
-2

150
100

-3

50

-4
-5
2009

2010

2011

2012

2013

2014

2015

2016

2017

2014

2018

2015

2016

0

2017

Source: Bureau of Labor Statistics

Source: Bureau of Economic Analysis and FRBSF staff

Unemployment slightly below natural rate
Unemployment rate and forecast

Inflation close to target
%

Seasonally adjusted monthly observations, forecast is quarterly average

12

PCE price inflation

%

Percent change from 4 quarters earlier

5
4

10
8

Overall PCE
price index

Target rate

3

FRBSF
forecasts

2

FRBSF
forecast

6
4

Apr.
4.4

2009

2010

2011

2012

2013

2014

2015

2016

2017

1

Q1

Core PCE
price index

0

2

2018

Source: Bureau of Labor Statistics and FRBSF staff

0

-1

2009

2010

2011

2012

2013

2014

2015

2016

2017

-2

2018

Source: Bureau of Economic Analysis and FRBSF staff

Long-term rates remain low

Underutilization measures near normal

Interest rates

%

Weekly average

8

Rates of labor underutilization

%

Monthly; seasonally adjusted

18

U3 + discouraged +
marginally attached +
part-time for economic
reasons (U6)

7
6

30-year mortgage

U3 + discouraged +
marginally attached (U5)

5

16
14
12
10

4

8

05/05

3
Federal
funds
rate

Ten-year Treasury
Two-year Treasury

6

Unemployed (U3)

2

4

1

2

Q4 2006

0
2009

2010

Source: FAME

2011

2012

2013

2014

2015

2016

2017

0
03

04

05

06

07

08

09

Source: Bureau of Labor Statistics

10

11

12

13

14

15

16

17

Healthy job prospects reflected in quits

Broader measures sending similar signal
Non-employment index and unemployment rate
Monthly; seasonally adjusted

%

%

12

2.5

Non-employment

Quits and job openings
Monthly; seasonally adjusted

Net Percentage
of Firms

35

Quits (left)
10

30
2.0
25

8

1.5

20

6

Unemployment (U3)

4

1.0

2

0.5

15
10

Firms with unfilled
openings (right)

5

Q4 2006
0
03

04

05

06

07

08

09

10

11

12

13

14

15

16

0.0

17

Tightness possibly causing wage pressure
%

AHE and ECI: monthly, seasonally adjusted; Planning wage increases: quarterly

6

20

5
Firms planning wage
increases (left)

15

4

10

3
Employment costs
(right)

5

2
Avg. hourly earnings
(right)

0

1

-5

0
03

04

05

06

07

Source: NFIB and BLS

08

09

10

11

12

13

04

05

06

07

08

Source: NFIB Survey and BLS

% Compensation growth
25

0
03

Source: BLS and FRBSF; Hornstein, Kudlyak, and Lange 2014

14

15

16

17

09

10

11

12

13

14

15

16

17