Full text of FedViews : September 13, 2018

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Twelfth Federal Reserve District

FedViews

Economic Research Department
Federal Reserve Bank of San Francisco
101 Market Street
San Francisco, CA 94105

September 13, 2018

Also available upon release at
https://www.frbsf.org/economic-research/publications/fedviews/

Òscar Jordà, vice president at the Federal Reserve Bank of San Francisco, stated his views on the current
economy and the outlook as of September 13, 2018.



The second estimate of real GDP growth in the second quarter of 2018 came in at 4.2%, up 0.1
percentage point from the first estimate. Consequently, we have left our forecast for the remainder of
2018 unchanged at just under 3%. This is well above our estimate of the economy’s long-run
sustainable growth rate. As the effects from the federal fiscal stimulus fade and financial conditions
gradually tighten, we project that growth will slow down to just under 2% by 2020.



The Bureau of Labor Statistics reported that total nonfarm employment in August increased by
201,000 jobs, although data for June and July were revised downward by a combined 50,000 jobs.
That leaves the average for the past six months at under 200,000 jobs per month. Even so, this pace
of monthly job growth remains well above the breakeven level needed to keep pace with the growth
of the labor force. As a result, although the unemployment rate remained at 3.9% in August, we
expect that it will continue to decline further below our 4.6% estimate of the natural rate of
unemployment.



Core PCE inflation in July came in at 2%, the Federal Open Market Committee’s (FOMC) target.
With the economy expected to continue to grow above potential and the unemployment rate
declining further from our estimate of the natural rate, we expect upward pressure on inflation in the
medium term. We project that four-quarter inflation will slightly overshoot the 2% target in the next
year or two.



Following the conclusion of its latest meeting on August 1, the FOMC announced its decision to
maintain the target range for the federal funds rate at 1¾ to 2%. The Committee noted that recent
economic activity has been strong and that risks to the economic outlook appear roughly balanced.
The Committee expects further gradual increases in the target range for the federal funds rate.



Interest rates have continued to edge up with the gradual removal of monetary accommodation.
However, the current level of the federal funds rate stands about 75 basis points below our estimate
of its long-run equilibrium level.



A buildup of financial stress during good times is always a concern for the outlook. The more
leveraged the financial system, the more exposed it is. Since World War II, and especially in the past
20 to 30 years, modern finance has given greater credit access to households, primarily in the form of
mortgage borrowing.

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 October 15, 2018.



As credit has expanded relative to the size of the economy, banks have increasingly had to rely on
wholesale funding relative to their deposit base. This is a source of fragility. Wholesale funding is
highly runnable, meaning that large pools of funds can vanish overnight thereby leaving banks in
search of liquidity, and making the financial system more vulnerable.



Higher capital buffers allow banks to absorb and process losses more easily. This is particularly
noticeable in a financial crisis: analysis of financial crises in advanced economies over the past one
hundred fifty years shows that recoveries are visibly sped up when banks have more capital.