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april 2007 R e s e r v e B a n k o f S a i n t L o u i s The F e d e r a l A Quarterly Review of Business and Economic Conditions Home Prices Booms, Busts and Something in Between banking Deregulation Helps Small-Business Owners oil Growth in China and India Spurs Price Increases COMMUNITY PROFILE Murray, Ky., Bucks Trends in Manufacturing www.stlouisfed.org Table of Contents The Regional Economist is published quarterly by the Research and Public Affairs departments of the Federal Reserve Bank of St. Louis. It addresses the national, international and regional economic issues of the day, particularly as they apply to states in the Eighth Federal Reserve District. The Eighth District includes the state of Arkansas and parts of Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee. Views expressed are not necessarily those of the St. Louis Fed or the Federal Reserve System. Articles may be reproduced if the source is credited. Please send a copy of the reprinted materials to the editor. We appreciate hearing from readers about this publication. Please direct your comments to either co-editor: Michael R. Pakko at 314-444-8564 or by e-mail at michael.r.pakko@stls.frb.org, or to Howard J. Wall at 314-444-8533 or by e-mail at wall@stls.frb.org. You can also write to either one at the address below. Submission of a letter to the editor gives us the right to post it to our web site and/or publish it in The Regional Economist unless the writer states otherwise. We reserve the right to choose which letters to use and to edit them for clarity and length. Robert H. Rasche Director of Research 3 Fewer Boomers and Teens in the Labor Force Affects Us All 4 By David C. Wheelock Home prices have fallen in some markets, and the inventory of residences for sale has risen. But just because there was a boom in the housing market doesn’t mean there will be a bust. If prices do fall across the country, however, the overall economy could suffer on multiple levels. 10 By Yuliya Demyanyk, Charlotte Ostergaard and Bent Sorensen Before deregulation, banks were often tied in so closely with the local economy that they were unable to help out small businesses during tough times. But once banking markets were opened up to geographic diversity and competition, more banks were in a better position to lend money—even in tough times. 12 Single-copy subscriptions to The Regional Economist are free of charge. To subscribe, call 314-444-8809; e-mail debbie. j.dawe@stls.frb.org; or write to The Regional Economist, Public Affairs Office, Federal Reserve Bank of St. Louis, Post Office Box 442, St. Louis, MO 63166. You can also subscribe via our web site at www.stlouisfed.org/ publications/subscribe.html. oil Growth in China and India Spurs Price Increases By Justin P. Hauke and Christopher J. Neely The rapid economic growth in Asia’s two most populous countries is spurring an increase in demand for oil. As demand goes up, oil prices go up. After adjusting for inflation, a barrel of oil today costs about what it did during the 1979 oil shock. 14 COMMUNITY PROFILE Murray, Ky., Bucks Trends in Manufacturing By Susan C. Thomson While the nation’s manufacturing muscle has been wasting, this town in western Kentucky and its surrounding county have been bulking up, adding 300 factory jobs in five years. Credit is given to everything from the quality of labor to inexpensive electricity to the presence of a business-friendly state university. 16, 17 DISTRICT OVERVIEWS Revised Data Show Larger Job Gains in Metro Areas Last year was a better one than first thought when it comes to employment across the 18 metropolitan areas in the Eighth District. The initial estimates, released in January of this year, said those metro areas gained 34,900 jobs in 2006. But a revision of the data, released in March, showed an increase of 60,700 jobs. Joni Williams Art Director Mark Kunzelmann Becca Marshall Contributing Artists banking Deregulation Helps Small-Business Owners Randall C. Sumner Director of Public Affairs Al Stamborski Managing Editor home prices Slump Could Lean Heavily on Economy Cletus C. Coughlin Deputy Director of Research Michael R. Pakko Howard J. Wall Co-Editors PRESIDENT’S MESSAGE 18 NATIONAL OVERVIEW Will the Economy Find Its Groove This Year? By Kevin L. Kliesen GDP has been growing slightly below its trend, and core inflation has been running slightly above what policymakers would desire. But there’s still a good chance that the economy will get back to its earlier track by the end of the year. 19 MEASURING THE ECONOMY National Data Selected major macroeconomic and farm sector indicators. [2] The Regional Economist April 2007 n www.stlouisfed.org President’s Message “Because the slowdown in labor force growth is still quite new, there is much uncertainty about what’s actually happening.” William Poole President and CEO, Federal Reserve Bank of St. Louis Decline in Labor Force Participation Could Lower Standard of Living T he United States is at a turning point in labor force participation. For more than 50 years after World War II, the percentage of the working-age population (16 and older) in the labor force rose each year. Since 2000, this number has teetered up and down, but the trend is most certainly downward. The explanations for this reversal are both obvious and, perhaps, surprising. The consequences are much less clear. As one might guess, a major portion of the decline in labor force participation is due to the baby boomers, who have finally started to retire in droves. So many are kicking off their wing tips in favor of Birkenstocks that even the large influx of immigrants can’t make up the difference. Contributing unexpectedly to this decline in labor force participation is the American teenager. Fewer are working because—hold on to your hats—they apparently are listening to their elders and staying in school. What all this means is that fewer workers are producing income and output relative to the total number of U.S. residents. Because the output of each worker must sustain the consumption of a larger number of individuals, maintaining the per capita standard of living in this country will become increasingly difficult. Making matters worse, tax revenue will grow more slowly as labor force growth slows. Not only will Social Security and Medicare finances become strained, but all growth in total discretionary government spending, including that for the military, may have to be cut back. The possible solutions to these problems are many. The government could cut spending and/or increase taxes. Baby boomers could be persuaded to stay on the job a bit longer. (Some already are, and for a variety of reasons—they need health insurance, they lost their pension, they fear cuts in Social Security or, simply, they feel too young to end their careers.) Boosting productivity could also compensate for the loss of workers. A better educated workforce would go a long way toward obtaining more output per hour of labor input. (Think of those teens who are staying in school.) An increase in research would help, too. One study says that half of the economy’s growth in the second half of the 20th century can be linked to rising research activity. To transform research results into production, entrepreneurs need the right conditions (less regulation, adequate financial rewards). Finally, increased saving by both individuals and the government could help pro[3] vide sufficient capital for offices, factories and equipment—all of which are needed to boost production. Because the slowdown in labor force growth is still quite new, there is much uncertainty about what’s actually happening. For example, job growth has been falling over the past 10 years, from about 250,000 jobs a month to maybe half of that today. Such changes concern those of us in charge of monetary policy because we believe full employment goes hand in hand with price stability. The creation of only 70,000 jobs a month would have triggered fears of a recession in the past—and would have set off appropriate actions by monetary policymakers. But next year, 70,000 new jobs a month might be enough to constitute full employment—if there truly are far fewer people in the workforce. So as not to needlessly stimulate or rein in the economy, policymakers will have to hunt hard for better scraps of information to supplement the standard labor force statistics released every month. Housing Slump Could Lean Heavily on Economy By David C. Wheelock [4] The Regional Economist April 2007 n www.stlouisfed.org During the recent housing boom, U.S. house prices seemed to shoot up faster than crabgrass. Homeowners enjoyed an average increase of 54.4 percent in the value of their houses between 2001 and 2005, as measured by a house price index produced by the Office of Federal Housing Enterprise Oversight (OFHEO).1 However, as Tip O’Neil, the former speaker of the U.S. House of Representatives, used to say about politics, all housing markets are local. [5] The extent to which a given homeowner saw an increase in the value of her house during the boom was largely determined by its location. Between 2001 and 2005, houses in the Port St. Lucie-Fort Pierce, Fla., area rose in price by an average of 144 percent—the largest increase of any U.S. metropolitan area. By contrast, house prices in Lafayette, Ind., rose by a mere 11 percent on FIG. 1 Ratio of House Prices to Income Varies Dramatically Across States 2.00 1.80 1999=1.0 1.60 U.S. Calif. Fla. Mo. Texas 1.40 1.20 1.00 0.80 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 The figure shows the ratio of the OFHEO house price index to median household income (index divided by income) for selected states and the country. The ratio increased by about 50 percent between 1999 and 2005 for the United States as a whole. It rose by nearly 90 percent in Florida, by over 100 percent in California, by 38 percent in Missouri and by just 22 percent in Texas. average—the smallest increase among U.S. metropolitan areas. The 10 metropolitan areas with the largest increases in house prices were all located in either Florida or California, whereas four of the markets with the smallest rises were located in Indiana. Historically, differences in income and population growth largely explain why house prices rise at different rates in different markets. In June 2005, the U.S. Census Bureau announced that Port St. Lucie was the fastest-growing city in the United States; so, the rapid rise in that city’s house prices is not surprising. Many other cities that had large increases in house prices during the boom also had rapidly growing populations. However, the phenomenal rise in house prices in some markets during the past five years has left many analysts questioning whether such fundamentals as population and income growth alone can explain the recent boom. Controlling for differences in median household income, we still find tremen[6] dous variation in house price growth rates across markets. Figure 1 shows the average level of house prices, as measured by the OFHEO index, relative to median household income for various states and for the United States as a whole between 1995 and 2005. The values of the ratio are set equal to 1 in 1999 to more readily compare the change in house prices relative to income across states during the boom. Whereas the ratio of house prices to income increased by about 50 percent between 1999 and 2005 for the United States as a whole, the ratio increased by nearly 90 percent in Florida and by over 100 percent in California. On the other hand, the ratio rose just 22 percent in Texas and 38 percent in Missouri. Differences in the cost and availability of land for new construction might explain some of the differences in the growth of house prices relative to median income across states. However, many commentators argue that “speculative bubbles” drove house prices in many markets that had the most rapid increases in average house prices. The economist Robert Shiller defines a speculative bubble as “a situation in which temporarily high prices are sustained largely by investors’ enthusiasm rather than by consistent estimation of real value.”2 Indirect evidence of speculative bubbles in housing markets includes high rates of buying second or third homes by investors and others who hope to resell them for a quick profit. Although many commentators have argued that speculative bubbles arose in housing markets throughout the United States, in the sober world of economic analysis, conclusive evidence of bubbles has been hard to come by. Mortgage interest rates fell to unusually low levels during the early 2000s, which reduced the cost of buying and owning a home. Further, a limited quantity of land available for new construction kept the supply of housing from increasing as rapidly as demand in many markets, especially on the East and West coasts.3 Still, in the words of former Federal Reserve Chairman Alan Greenspan, many U.S. housing markets showed signs of considerable “froth.”4 The End of the Boom The growth in U.S. house prices peaked in the third quarter of 2005— the same quarter, perhaps coincidentally, that hurricanes Katrina and Rita struck the Gulf Coast and analysts began to warn of slowing in the U.S. economy. Mortgage interest rates also began to rise in that quarter. Since then, the growth of home prices has slowed dramatically, The Regional Economist April 2007 n declines in house price appreciation rates, include California and Florida, as well as the District of Columbia. It should be noted, however, that despite large declines in their growth rates, Arizona, California, the District of Columbia and Florida continued to have comparatively high rates of house price appreciation through the third quarter of 2006. Most states in the Midwest and South had far smaller increases in house prices during the boom, but also saw relatively little subsequent slowing in their house price appreciation rates. These states continue to have comparatively slow appreciation rates, however, and a few states that experienced little appreciation FIG. 2 States’ House Price Appreciation Rates during the Boom and After 2 Difference in Appreciation Rate: 2006:Q3 vs. 2005:Q3 (in percentage points) from an average annual growth rate of 11.2 percent in the third quarter of 2005 to a mere 1.5 percent in the third quarter of 2006, as measured by the seasonally adjusted OFHEO house price index based only on purchase transactions. Some analysts believe that the anemic rate of price growth shown by the OFHEO index may actually overstate the true rate of increase in U.S. house prices in the current environment. One reason is that the OFHEO index is based only on recent sales, and houses that sell in a down market are likely to be relatively more appealing than average and perhaps hold their values better than other houses do. The index also excludes sales involving mortgages over $417,000, which is the upper limit for loan purchases by Fannie Mae and Freddie Mac, the two largest players in the secondary mortgage market. Sales involving larger mortgages, which are especially common in the areas of the country that saw the most house price appreciation during the boom, do not influence the OFHEO index. By contrast, the median sales price of existing homes calculated by the National Association of Realtors is based on a random sampling of all existing home transactions from throughout the country, including those involving large mortgages or even no mortgage at all.5 The median sales price of existing single-family houses peaked at over $230,000 in July 2006. Although prices usually decline in fall and winter months, the decline in 2006 was somewhat larger than usual. In November 2006, the median sales price was $217,000, which was $8,000 below the median in November 2005. All states have experienced a slowing in the growth of house prices since the third quarter of 2005. However, as shown in Figure 2, the slowing has been the most pronounced in states that experienced the largest gains in house prices during the boom. The figure plots state-level observations on the change in the house price appreciation rate, as measured by the OFHEO index, between the third quarter of 2005 and the third quarter of 2006 against the cumulative increase in house prices during the four-year period ending in the third quarter of 2005. For example, during the boom, house prices in Arizona rose by an average of nearly 70 percent. However, the growth of house prices in Arizona slowed dramatically after the boom. During the third quarter of 2006, Arizona house prices rose at an average rate that was nearly seven percentage points below the rate experienced during the third quarter of 2005. Other states that had large increases in house prices during the boom, then large www.stlouisfed.org Miss. Tenn. 1 0 Mo. Ind. Ill. –1 –2 Ark. Mass. Ky. Calif. –3 –4 –5 D.C. –6 Fla. –7 Ariz. –8 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Cumulative appreciation of OFHEO house price index between 2001:Q3 and 2005:Q3 States that had large increases in home prices during the boom had large drops in price appreciation rates once the boom ended. Arizona, for example, saw housing prices jump 70 percent between 2001 and 2005; in the following year, the increase in house prices dropped seven percentage points. On the other hand, states that experienced small gains during the boom had smaller drops afterward. All the states in the Eighth Federal Reserve District (orange dots) fell into this latter group. during the boom, such as Michigan, have also seen large declines in house price growth since the third quarter of 2005. What about a Bust? Analysts have been predicting a collapse of house prices for several years. In the past, some house price booms were followed by large price declines. However, other booms simply fizzled out into extended periods of flat or slowly rising house prices. In the 1980s [7] and 1990s, there were 20 state-level housing booms, defined as three or more quarters of annualized growth in excess of 7 percent in the ratio of house prices to state per capita income.6 Of these booms, 10 were followed by declines in nominal house prices of at least 5 percent and nine were followed by declines of more than 10 percent over a period of four or more quarters. The other 10 booms were followed by extended periods of either flat or slowly rising prices, indicating that the adage “what goes up, must come down” does not always apply to housing markets.7 By the same token, several instances of large declines in house prices were not preceded by a boom. Several Midwestern farm and manufacturing states experienced price declines of 10 percent FIG. 3 Months’ Supply of Single-Family Houses for Sale 8 7 6 Months 5 4 3 2 1 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 or more during the early 1980s, as did a number of energy-producing states in the mid-1980s. All of the declines occurred when falling commodity prices or declining profits in older manufacturing industries caused large declines in state personal incomes. Later in the 1980s and into the 1990s, house price busts occurred in New England, California and Hawaii. All of these states had experienced housing booms, marked by large increases in the ratio of house prices to income, before prices collapsed. Most markets did not experience a significant decline in house prices during 2006. However, nationwide the construction of new homes plunged. From a seasonally adjusted peak of 2.3 million units in January 2006, the number of new, privately owned housing units of all types that were started fell to an annual rate of just 1.5 million units in October, its lowest level since July 2000, before increasing to 1.6 million units in November. [8] Starts of single-family houses followed a similar pattern. Sales of new and existing homes also plunged, leaving the inventory of unsold homes on the market at unusually high levels. For example, throughout most of 2006, the inventory of new one-family houses for sale exceeded a seasonally adjusted six-months’ supply at current sales rates. As Figure 3 shows, this level of inventory had not been seen since 1996. During the boom, the inventory of new houses on the market was frequently less than a four-months’ supply. During 2006, the slowdown in housing sales and construction mainly affected persons whose livelihoods were directly tied to the housing industry, such as construction workers, real estate agents and mortgage brokers. Analysts estimate the slump reduced U.S. GDP growth by approximately one percentage point during the second half of 2006. If the slump worsens, and especially if house prices fall sharply, the consequences for the national economy could become even more serious. The large increase in average U.S. home prices between 2001 and 2005 contributed to an enormous increase in household wealth, which helped to fuel growth in consumer spending. Analysts fear that by destroying wealth, a decline in house prices would reduce consumer spending and possibly drag the economy into a recession. Further, falling house prices would erode the value of collateral behind the $9.5 trillion residential mortgage debt market and, thereby, increase the losses that lenders experience on loan defaults. Analysts have debated the extent to which consumers spent the capital gains they enjoyed on their houses during the boom and, therefore, the extent to which consumer spending would fall as a result of a decline in house prices. Standard economic theories of consumption argue that an increase in wealth will lead to an increase in spending, but that higher spending will be spread out over a person’s lifetime and have relatively little impact in any one year. Economists estimate that for every dollar increase in wealth, current spending will rise on the order of 2.5-5 cents. Some economists argue, however, that increases in housing wealth have a larger impact on spending than increases in other forms of wealth, such as stocks and bonds. One reason for this differential impact is that housing typically comprises a larger share of the assets of lower-income persons, who may have a higher marginal propensity to consume, than it does of high-income persons. Moreover, many households have little collateral for loans other than their house; so, an increase in The Regional Economist April 2007 n the value of their houses can ease constraints on their borrowing and spending. A key aspect of the debate about the impact of the recent housing boom on consumer spending has centered on the use of funds obtained from the refinancing of mortgages and home-equity lines of credit. During the boom, homeowners extracted over $1 trillion of equity from their homes through cash-out refinancing and home-equity loans. Unfortunately, the data do not exist to tell us definitively how these dollars (both residential and commercial), especially in light of the increased use of nontraditional mortgage loan products.11 These products, which include interest-only loans and adjustable-rate loans that permit negative amortization, expose borrowers and lenders to greater house-price and interest-rate risk than traditional mortgage loans do. Hence, either a decline in house prices or an increase in interest rates could increase mortgage delinquencies and reduce lender profits. Consequently, banking supervisors are keeping an eye on Compared with the condition of banks around 1990, U.S. banks today are on the whole much better capitalized and, thereby, better www.stlouisfed.org ENDNOTES 1 This calculation is the percentage increase in the seasonally adjusted OFHEO repeat-sales house price index for purchase transactions only between the fourth quarters of 2000 and 2005. See www.ofheo.gov/HPI.asp. 2 Shiller Himmelberg, Mayer and Sinai (2005) and Smith and Smith (2006) are two recent studies that conclude that economic fundamentals can explain the rapid growth in house prices in most U.S. housing markets. 4 “The Economic Outlook.” Testimony of Chairman Alan Greenspan before the Joint Economic Committee, U.S. Congress, June 9, 2005. 5 See www.realtor.org/research.nsf/ pages/ehspage. 6 able to withstand a modest increase in real estate loan defaults. were used. Some analysts estimate that as much as 60 percent of extracted equity was used for consumption which, if true, would suggest that a decline in housing wealth could seriously erode consumer spending. Other studies conclude that much of the wealth pulled out of houses was invested or used to pay down other household debt, and relatively little was consumed. These estimates suggest that a modest fall in house prices would not lead to a sharp pullback in spending.8 A Squeeze on Lenders In addition to having a potentially large impact on consumer spending through a reduction in wealth, a serious decline in house prices could also reverberate through the economy by eroding the capital of banks and other lenders that experience increased defaults on real estate loans. In the 1980s and early 1990s, losses from real estate loan defaults chewed up lender capital and contributed to a rise in bank and thrift (e.g., savings and loan) failures.9 The banks’ weak capital positions not only constrained their ability to lend but also slowed the pace of the economic recovery from the recession of 1990-91, then-Federal Reserve Chairman Greenspan argued at the time.10 Compared with the condition of banks around 1990, U.S. banks today are on the whole much better capitalized and, thereby, better able to withstand a modest increase in real estate loan defaults. Nevertheless, as a share of bank assets, residential real estate loans and securities rose sharply during the recent housing boom. Although a considerable amount of these loans and securities is guaranteed by third parties, banking regulators have expressed concern recently about the increased exposure of banks to real estate the exposure of banks to real estate, as well as their overall safety and soundness, to try to minimize the damage that would result from any collapse in real estate prices. Summing Up (2005), p. xviii. 3 For comparison, between 2001 and 2005, 17 states experienced increases in the ratio of house prices to per capita income of at least 7 percent for three or more consecutive quarters, and this ratio rose at an average 5.4 percent annual rate during 2001:Q1-2005:Q1 for the United States as a whole. 7 See Wheelock (2006). 8 See McCarthy and Steindel (2006) for more information and estimates of the influence of changes in housing wealth on consumer spending. 9 See The recent housing boom produced some dramatic increases in house prices in many parts of the United States. Prices soared in hot markets where rapid population and income growth drove up the demand for housing faster than supply. Some of these markets showed signs of speculative bubbles, including high rates of investor purchases, but the existence of bubbles is difficult to prove. Unfortunately, the difficulty of determining the extent to which prices rise in excess of fundamental value makes it difficult to forecast whether prices are going to fall. Looking back at regional housing booms in the United States during the 1980s and 1990s, we find that while some periods of rapidly rising house prices were followed by large price declines, others were followed by periods of flat or slowly rising prices. Moreover, in some states, large declines in house prices were not preceded by a boom. Hence, the presence of a boom does not necessarily portend a bust. If house prices do fall in many markets, we will probably see an increase in mortgage loan defaults, as well as continued distress for persons engaged in housing construction and in other real estate-related employment. The extent to which a decline in house prices would affect consumer spending is uncertain, however. Hence, policymakers will continue to watch closely for signs that a housing slump is having a broader impact on the economy. David C. Wheelock is an economist at the Federal Reserve Bank of St. Louis. [9] Federal Deposit Insurance Corp. (1997). 10 “Risk and Uncertainty in Monetary Policy.” Remarks by Chairman Alan Greenspan at the Meetings of the American Economic Association, San Diego, Calif., Jan. 3, 2004. 11 For example, see “A Supervisor’s Perspective on Mortgage Markets and Mortgage Lending Practices.” Remarks by Gov. Susan Schmidt Bies at the Mortgage Bankers Association Presidents Conference, Half Moon Bay, Calif., June 14, 2006. REFERENCES Federal Deposit Insurance Corp. History of the Eighties—Lessons for the Future, Volume 1: “An Examination of the Banking Crises of the 1980s and early 1990s.” Washington, D.C., 1997. Himmelberg, Charles; Mayer, Christopher; and Sinai, Todd. “Assessing High House Prices: Bubbles, Fundamentals and Misperceptions.” Journal of Economic Perspectives, Vol. 19, No. 4, Fall 2005, pp. 67-92. McCarthy, Jonathan; and Steindel, Charles. “Housing Activity and Consumer Spending.” Macroeconomic and Monetary Studies Function, Federal Reserve Bank of New York, working paper, 2006. Shiller, Robert J. Irrational Exuberance. Second Edition. Princeton, N.J.: Princeton University Press, 2005. Smith, Margaret Hwang; and Smith, Gary. “Bubble, Bubble, Where’s the Housing Bubble?” Paper prepared for the Brookings Panel on Economic Activity, March 30-31, 2006. Wheelock, David C. “What Happens to Banks When House Prices Fall? U.S. Regional Housing Busts of the 1980s and 1990s.” Federal Reserve Bank of St. Louis Review, Vol. 88, No. 5, September/October 2006, pp. 413-30. Banking Deregulation Helps Small-Business Owners Stabilize Their Income By Yuliya Demyanyk, Charlotte Ostergaard and Bent Sorensen u ntil recently, U.S. bank retail markets were subject to severe restrictions. In many states, banks’ ability to branch and operate holding companies within and across state borders was limited. The removal of these restrictions has helped small-business owners stabilize their personal income. Deregulation of State-Level Banking and Branching Banking restrictions were imposed by state legislators, who, with the McFadden Act of 1927 and the Bank Holding Company Act of 1956, were given the power to regulate branching and acquisitions of in-state banks by out-of-state banks. Restrictions were lifted gradually by the individual states in the 1980s and 1990s in a process that culminated with the Riegle-Neal Act of 1994, which permitted national branching. Restrictions on banks’ ability to branch within a state were widespread. In 1985, full statewide branching was outlawed in 22 states. Even in 2001, four states still prohibited the establishment of new branches in the same state where the main office was located. Other restrictions were directed at banks’ abilities to branch through mergers and acquisitions, preventing a bank holding company from acquiring another bank and converting it into a branch. Deregulation, which started in the late 1970s, took several forms:1 Intrastate deregulation allowed for: • statewide branching by mergers and acquisitions, and • statewide branching by establishment of new (de novo) branches. And interstate banking deregulation allowed for: • entry by out-of-state banks from selected (neighboring) states on a reciprocal basis, and • free formation of multistate bank holding companies in any U.S. state.2 Income Stabilization When production of goods and services in a state rises or falls, so does the income of its residents. However, fluctuations in production are usually associated with smaller fluctuations in income—this is referred to as income stabilization. In the academic literature, the term “risk-sharing” is commonly used to describe this phenomenon. We have developed a statistical measure of income stabilization. For example, income stabilization equals 60 percent if production in a state falls by 10 percentage points and income falls by only four percentage points (i.e., income is stabilized by 60 percent because only 40 percent of the fall in production is reflected in income). Likewise, when production growth is high, income grows but, again, at a lower rate. Income of business owners can be stabilized in several ways. Directly, income is stabilized when the ownership is diversified. For example, an oil firm in Texas may be partly owned by stockholders in Missouri. If there are unfavorable local economic conditions in Missouri that lead to lower production of goods and services and, therefore, lower income, dividends from Texas help prevent Missouri residents’ income from falling as much as it would otherwise. Indirectly, banks and other financial institutions help to stabilize income by lending to business [10] owners. For example, when a business is entirely owned by a sole proprietor, earnings from business production directly become income of the proprietor. In bad times, low business production leads to low income. On the other hand, if the business is partly financed by a bank, income does not decline as much as earnings for several reasons. First, a loan may free up wealth that the owner may invest in other assets that are not associated with his or her business. When the business owner receives income from such assets, his or her total income becomes partly independent of the fortunes of the business. Second, banks may value a relationship with a business owner and, therefore, extend credit in bad times or allow postponement of interest and/or principal payments, thereby helping the owner avoid a large fall in income. In either case, income is stabilized relative to business earnings. Banking Deregulation Helps Small Businesses Intrastate branching restrictions, together with restrictions on the formation of multistate bank holding companies, severely limited banks’ ability to diversify their portfolios geographically. Banks in regulated states were tied in more closely with the local economy, resulting in limited ability to either withstand local economic shocks or to help local businesses bear risk. The Regional Economist April 2007 n Home office protection laws prohibited outside banks from opening new branches in small towns or rural areas where another bank was already located. Such regulations gave small community banks home turf, shielding them from competitive pressures by preventing entry by more-efficient banks. By opening up previously isolated banking markets for geographic diversification and competition, the quality of banking improved. An emerging literature documents that deregulation provided strong benefits to the economy.3 Small businesses depend on bank finance much more than large businesses that can issue bonds or stocks. Improvements in banking, therefore, are more important for smaller businesses. Because of their dependence on banks, smallbusiness owners had a lower ability to stabilize their incomes when the banking industry was highly regulated. As can be seen in the accompanying figure, states with relatively more small businesses had on average a lower degree of income stabilization before deregulation than the states with fewer small businesses. Income Stabilization after Deregulation The banking industry became more integrated, more competitive and more geographically diversified after deregulation. While we have shown this helped stabilize small-business income, the exact channels through which this works are not known for certain. There are two possible ways. First, the level of bank lending to businesses may have increased as moreefficient banks were better able to screen business projects. Second, banks could improve the existing relationships with business borrowers; an important benefit of this would be a higher willingness of banks to extend credit in bad times. Income stabilization Interstate deregulations, on the other hand, affect consolidation of bank corporations across state borders and will have less of an impact on local markets. The ability to operate multistate bank holding companies is likely to have a positive impact on banking efficiency and risk-sharing, but such improvements will benefit not just small-business owners. Therefore, it is of interest to explore the effects of both intrastate and interstate deregulation, and these cases will be considered in turn. Consider states with relatively more small businesses.4 As shown in the figure, there is a clear increase in income stabilization from both types of deregulation. But the effect of moving from a fully regulated environment to an environment with no intrastate restrictions is larger than the effect of moving from no intrastate restrictions to full (intraand interstate) deregulation. States with fewer small businesses also exhibit a noticeable increase in income stabilization following deregulation. However, for these states, the removal of intrastate restrictions has a relatively small effect; the effects from interstate deregulation are larger because they are picking up other channels of income stabilization not related to small businesses. Taken together, the results suggest there is a strong link between a wellfunctioning, competitive banking sector and the ability of small businesses to diversify economic risk. Yuliya Demyanyk is an economist at the Federal Reserve Bank of St. Louis, Bent E. Sorensen is the Lay Professor of Economics at the University of Houston and a fellow of the Centre of Economic Policy Research, and Charlotte Ostergaard is an associate professor at the Norwegian School of Management and a research affiliate in Norges Bank. states with more small businesses Income stabilization, % ENDNOTES 1 The dates of deregulation for each state are at www.stlouisfed.org/publications/ re/2007/b/pdf/dereg.pdf. 2 Branching restrictions took two forms. The first was directed at banks’ ability to branch through mergers and acquisitions, preventing a bank or a bank holding company from acquiring another bank and converting it into a branch. The second form of regulations imposed limits on the opening of new branches, protecting banks from entry by outside banks. Differences in states’ willingness to allow branch networks led to the development of very differently structured bank systems across states. Where some states allowed only unit banking (a bank with no branches), other states permitted statewide branching. Branching restrictions often took the form of home office protection laws, prohibiting a bank from establishing a branch in an area in which the principal (home) office of another bank was located without the written consent of that bank. Areas with home office protection were typically small towns or rural areas with a population below a certain number. Effectively, such laws gave many small community banks home turf, shielding them from competitive pressures. Entry by bank holding companies chartered in other states was only gradually permitted by individual states during the 1980s. Typically, acquisitions by out-of-state bank holding companies were limited to banks from sameregion states and subject to reciprocity, that is, entry was only permitted if the acquiring bank’s home state allowed entry by banks from the target state, although some states were open to nationwide entry. Considerable consolidation, predominantly through mergers and acquisitions, followed states’ deregulation. Many bank holding companies used the opportunity to convert their organization into a branching network, and the number of small banks dropped as they were attractive buy-out targets. 3 See Jayaratne and Strahan (1996) and Morgan, Rime and Strahan (2004) for evidence and discussion. 4 The states with the largest share of businesses that are small are Alaska, Arizona, Colorado, Florida, Hawaii, Idaho, Iowa, Kansas, Montana, Nebraska, New Mexico, North Dakota, Oklahoma, Oregon, Washington and Wyoming. REFERENCES before and after deregulation 70 60 states with fewer small businesses 50 Demyanyk, Yuliya; Ostergaard, Charlotte; and Sorensen, Bent. “U.S. Banking Deregulation, Small Businesses and Interstate Insurance of Personal Income,” Centre of Economic Policy Research. Discussion Paper No. 5863, 2006, (forthcoming, Journal of Finance). Jayaratne, Jith; and Strahan, Philip. “The Finance-Growth Nexus: Evidence from Bank Branch Deregulation,” Quarterly Journal of Economics, 1996, Vol. 111, No. 3, pp. 639-70. 40 30 20 10 0 www.stlouisfed.org before deregulation after intrastate deregulation after intrastate AND interstate deregulation SOURCE: Authors’ calculations based on data from the Bureau of Economic Analysis, Geospatial and Statistical Data Center, and Demyanyk, Ostergaard and Sorensen (2006). [11] Morgan, Donald P.; Rime, Bertrand; and Strahan Philip E. “Bank Integration and State Business Cycles,” Quarterly Journal of Economics, 2004, Vol. 119, No. 4, pp. 1,555-84. By Justin P. Hauke and Christopher J. Neely Oil might not make the world go round, but it surely greases the wheels of economic activity. As the figure illustrates, oil prices have climbed sharply since 2002 to inflation-adjusted levels that approach those reached during the 1979 oil shock. Supply cuts from Middle Eastern exporters generated the very high prices of the 1970s; this time, demand from Asia’s two most populous countries—China and India—is driving price trends. Market Conditions Oil is a global commodity; its price depends not only on what happens here in the United States, but also on global supply and demand. Several adverse supply factors have recently boosted oil prices. Some such factors had transitory influences on current production, such as oil workers’ strikes in Venezuela (2002) and Norway (2004), and the March 2006 spill that forced British Petroleum to shut down its Prudhoe Bay facilities in Alaska. Other factors have had longer-term consequences, such as political unrest in Nigeria and Iran, and seasonal hurricane damage to U.S. refineries in the Gulf of Mexico. Expectations of future supply and future prices also affect current oil prices. Analysts attribute nearly $10 of the oil price increase since 2001 to a “geopolitical risk premium” that reflects the possibility of terrorist attacks on oil facilities or wars in the Middle East.1 The potential price hikes in the wake of such attacks give suppliers an incentive to hold bigger inventories, which leads to higher prices today. But the recent increase in world energy consumption has had perhaps the greatest impact on current oil prices. Higher consumption has translated directly into price increases because spare productive capacity is much more limited today than it has been over the past 20 years.2 This deficiency is partly due to inadequate investment in many countries and partly due to the inexorable global growth in demand for oil in the recovery from the most recent recession.3 Output Growth and Oil Consumption Worldwide oil consumption increased by a cumulative 11.4 percent from 2001 to 2006 (2.3 percent per annum).4 The United States is the world’s largest petroleum consumer, at 20.6 million barrels per day (mbd). But while U.S. oil consumption has increased by 1 percent annually over the past five years, consumption in other nations, particularly China and India, has grown much faster due to their rapid output growth.5 Over the past 25 years, China’s annual GDP growth—about 9.5 percent—has averaged more than three times that of the United States, while India’s has averaged almost 6 percent, nearly double that of the United States. Chinese Growth China’s market-oriented reforms of its economy, called “Socialism with Chinese Characteristics,” began in 1979. These reforms have generated a truly remarkable period of economic progress. For example, average household incomes have increased by nearly 250 percent since 1994.6 The percentage of Chinese households with amenities such as televisions, automobiles and cell [12] phones has more than doubled over this same period, with even greater increases in urban areas. This economic growth spurred a rising demand for oil, which transformed China from an oil exporter to a major importer. While China was a net petroleum exporter as recently as 1992, its imports reached 33 percent of consumption in 2002. In 2005, China imported about 40 percent of its more-than-seven mbd oil needs, and, in the first five months of 2006, imports were up 18 percent over the same period in the previous year.7 But economic growth alone does not explain China’s rising demand for oil. For example, the Chinese government continues to subsidize consumer energy costs, inviting inefficiency and overuse, particularly in the transportation and agricultural sectors.8 To alleviate pollution, Beijing has begun replacing the country’s coal-fired electricity-generating plants with oil-burning plants. And the Chinese government is now accumulating petroleum reserves to satisfy the International Energy Agency’s (IEA) recommendation of maintaining three months of oil imports.9 These projects have substantially contributed to the country’s overall demand for petroleum. Indian Growth Economic reform also has triggered rapid output growth in India. The Regional Economist April 2007 n In the 1980s, the Indian government instituted reforms that removed restrictions on capacity expansion, eliminated price controls and lowered corporate tax rates. During the 1990s, the government reduced public monopolies and liberalized international trade and investment regulations. These reforms have been very successful. The World Bank reports that today India trails only China as the world’s fastest-growing large economy and is the world’s fourth-largest economy on a purchasing-power adjusted basis. This growth has fueled a commensurate demand for oil. India’s oil consumption increased by 11.9 percent from 2001 to 2006, and it now stands at 2.6 mbd, or 3 percent of global oil consumption.10 India is the sixth-largest crude consumer and the ninth-largest oil importer, relying on other countries for more than 70 percent of its oil. The IEA predicted in 2004 that Indian oil demand would increase by 2.9 percent per year, reaching 5.6 mbd in 2030. This consumption would make India the world’s third-largest oil consumer at current consumption levels. of what it actually was—1.15 mbd rather than twice that amount—then the price of a barrel of oil would have been $5.57 lower; if Indian consumption had been only half of what it actually was, the price would have been 68 cents lower. By comparison, if the demand from the world’s largest oil consumer, the United States, had risen by only half of what it did— by 0.49 million bpd, rather than by 0.97—the price of a barrel of oil would have been $2.37 lower, or about $51.22 If all three countries had cut their consumption in half, world demand would have been 1.78 mbd less and prices would be about $8.62 lower, or $44.97. Thus, if demand from China, India and the United States had risen by only half of what it actually did, the price of oil in January 2007 would have been about $45, instead of $53.59. This $8.62 increase was about 25 percent of the total five-year rise in global oil prices. Of course, all of these calculations are just rough estimates. Oil prices have increased substantially over the past five years. While supply factors have had some impact, increased demand, especially from China, also has played a major role. Simple supply-demand calculations indicate that oil prices would be about 16.1 percent lower if demand growth in the United States, China and India had been half of what it actually was since 2001. The IEA predicted last year that global energy demand would increase by 53 percent between 2006 and 2030. More than 70 percent of this increase is expected to come from the developing world, particularly from China and India. It seems likely, then, that the growth of these Asian economies will continue to significantly influence oil prices for many years. Since 2001, the United States, China and India have increased their demand for oil by 0.97, 2.29 and 0.27 mbd, respectively. Global oil production is about 85.1 million bpd. From Jan. 25, 2002, to Jan. 25, 2007, the price of a barrel of West Texas Intermediate Crude, a common benchmark, rose from approximately $19.73 to $53.59. This thirst for oil surely contributed to the price increase. What would the price of oil have been if consumption growth in those countries had been half of what it actually was over the past five years? A back-of-the-envelope supply/demand calculation can estimate the effect of this growth on oil prices.11 If Chinese oil consumption growth had been only half Christopher J. Neely is an assistant vice president and economist at the Federal Reserve Bank of St. Louis. Justin P. Hauke is a research associate. World Oil Prices ©N]klÜK]pYkÜ@fl]je]\aYl]ª EgeafYdÜFadÜGja[]k I]YdÜFadÜGja[]kÜ©;]^dYl]\ÜZqÜl`]ÜG:<Üaf\]pª Schwartz (2006). 2 Greenspan (2006). 3 The International Energy Agency (IEA, 2006) estimates that world energy consumption will require over $20 trillion in investment in the energy sector by 2030 to satisfy future demand. Roughly half of the investment needed is in Middle Eastern countries. For example, it is believed that Saudi Arabia is currently operating at 99 percent of its productive capacity. Jaffee (2005) discusses investment in the oil industry. 4 Aggregate oil consumption numbers reported in this article are from British Petroleum (2006) and the Energy Information Administration (EIA, 2007). 5 IEA, 2004, pp. 82-83. 6 Gallup (2005). 7 This calculation uses net imports to China and Hong Kong over total oil consumption. 8 Andrews-Speed (2006) explains China’s current domestic and international oil policy and the nature of its economic reforms. 9 Neely (2007) discusses China’s strategic petroleum reserves. 10 Indian oil consumption for 2006 was estimated by using IEA figures (IEA, 2004, p. 82). 11 We provide the full details of the supply-demand calculation online at www. stlouisfed.org/publications/re/2007/b/ pdf/asian_nations_appendix.pdf. REFERENCES Andrews-Speed, Philip. “China’s Energy and Environmental Policies and Their Implications for OPEC.” The CEPMLP Internet Journal, July 2006, Vol. 17, pp. 1-17. British Petroleum. “Statistical Review of World Energy 2006.” British Petroleum, 2006. Energy Information Administration. “Short-Term Energy Outlook.” U.S. Department of Energy, February 2007. The Gallup Organization. “Household Income Doubles in China.” As reported by the Chinese Embassy, January 2005. See www.chinaembassy.org/eng/gyzg/t179428.htm. Greenspan, Alan. Testimony before the Committee on Foreign Relations, U.S. Senate. June 7, 2006. International Energy Agency. “World Energy Outlook 2004.” OECD, 2004. International Energy Agency. “World Energy Outlook 2006.” OECD, 2006. Neely, Christopher J. “China’s Strategic Petroleum Reserve: A Drop in the Bucket,” Federal Reserve Bank of St. Louis National Economic Trends, January 2007. ;FCC 8IJ 1 Jaffe, Amy Myers. “The Outlook for Future Oil Supply from the Middle East and Price Implications.” Presented at the Japan/U.S. Joint Seminar on Recent Developments in the Middle East and Future Oil Supply, Tokyo, Japan, July 20, 2005. ENDNOTES Conclusion Growth’s Effect on Oil Prices www.stlouisfed.org Schwartz, Nelson D. “Why Gas Prices Dropped.” Fortune, Vol. 154, No. 9, Oct. 30, 2006, pp. 27-28. ~ ~Ü World Bank. “India Country Overview 2006.” World Bank, 2006. ~Ü ~Ü ~ Ü ~ Ü ~Ü ~Ü Ü EFK<JÜÜK`]Ü^a_mj]ÜaddmkljYl]kÜl`]Üjak]ÜafÜZgl`Ül`]ÜfgeafYdÜYf\Üj]YdÜ©af^dYlagf¥Y\bmkl]\ªÜhja[]Üg^ÜgadÜkaf[]Ü~ÜÜ@f^dYlagfÜ Y\bmkle]flkÜmk]Ül`]ÜG:<Ü\]^dYlgjÜd]n]dÜ^jgeÜl`]Üq]YjÜÜYkÜl`]ÜZYk]ÜÜFadÜhja[]Ü\YlYÜYj]Ü^jgeÜl`]ÜNYddÜJlj]]lÜAgmjfYd [13] Webasto Community Profile Murray Bucks Trends By Susan C. Thomson to webasto roof systems inc. 641 Murray pella corp. kentucky 641 clarks River murray state university 2075 121 121 2594 94 1550 94 INDIANA MISSOURI KENTUCKY EIGHTH FEDERAL RESERVE DISTRICT n betwee to lalnadkes the briggs & stratton 641 ILLINOIS 121 b r i g g s & s t r at t o n courthouse square TENNESSEE ARKANSAS MISSISSIPPI Murray, Ky. BY THE NUMBERS Population . ..........................................City 15,538 (2005) County 35,122 (2005) County Labor Force....................... 17,595 (October 2006) County Unemployment Rate..... 4.2 percent (October 2006) County Per Capita Income...................... $22,422 (2004) Major Employers Murray State University..............................................1,400 Pella Inc.......................................................................1,000 Briggs & Stratton Inc..................................................1,000 Murray-Calloway County Hospital.................................850 Murray, Ky., is a contrary place. While the nation’s manufacturing muscle has been wasting, the town and surrounding Calloway County have been bulking up together, adding about 300 manufacturing jobs between June 2001 and June 2006, according to the Bureau of Labor Statistics. Put another way, during a period in which the United States lost 14 percent of its manufacturing jobs, the number of manufacturing jobs in Calloway County increased by about 10 percent. The 3,300 manufacturing jobs in June 2006 accounted for about 20 percent of all of the area’s jobs, double the national percentage. Service industries such as retailing and education employed more people, but manufacturing accounted for a disproportionate 23 percent of the area’s wages. That makes manufacturing a big driver of the local economy, says Mark A. Manning, president of the Murray-Calloway County Economic Development Corp. “The community could survive without much manufacturing. But the community cannot thrive without much manufacturing.” By all outward signs, Murray-Calloway County—frequently hyphenated and spoken of in one breath—is thriving. The unemployment rate tended to be below the state’s all last year. Homes in the county sold last year for an average of $123,577, compared with $115,940 in 2005, according to local real estate agent Kathy Kopperud. The area is witnessing “as big a building boom as we’ve had in our history,” says Tab Brockman, executive director of the MurrayCalloway County Chamber of Commerce. [14] A $40 million addition in the works at Murray-Calloway County Hospital will nearly double its size. Murray State University is constructing a $13 million residence hall and a $50 million science building. A 72-room Hampton Inn will open in a few months. Toys R Us No More The growth is all the more striking given the pullout of Mattel Inc. A mainstay manufacturer since 1973, the company announced in April 2001 that it would phase out its Murray plant, its last in the United States, and move the production of riding electric toys to Mexico. Keith Travis, now vice president for human resources at the hospital but then the head of human resources at Mattel, recalls the meeting at which the employees got the bad news. “You could hear the breath go out of people. … You could see people’s lives change.” The rest of the community took hard the prospect of losing, in one devastating smack, 1,000 manufacturing jobs and their $30 million in annual payroll. Those jobs accounted for close to one-third of all area manufacturing jobs at the time. Sure, there was still Briggs & Stratton, the town’s other major manufacturing citizen, accounting for another 1,000 or so jobs at its engine-making plant in Murray, plus a smattering of smaller industries. Rather than rest on what was left, community leaders got together and took immediate steps not just to recover but to grow. They cut the Economic Development Corp. loose from the Chamber of Commerce, The Regional Economist April 2007 n www.stlouisfed.org pella m u r r ay s tat e in Manufacturing which had shared staff and an executive director, and hired Manning to head up the newly independent EDC. He arrived that August, while Mattel was winding its factory down and the area’s economic future appeared to hang ominously in the balance. Unbeknownst to him or anybody else there then, Pella Corp., the Iowa-based maker of doors and windows, was already scouting Murray for the site of a new plant. Finally, in June 2002, in a ballroom at Murray State, came the nick-of-time public announcement, followed by a huge public sigh of relief: Pella had chosen the area for its new operation and would immediately begin setting up for production in a 733,000square-foot building that Mattel had almost finished vacating. University’s Role That building’s availability was one factor in that decision, according to Jim Nieboer, who headed the company’s site selection committee. He says the company also weighed operating costs and the quality of local labor, leadership, schools and amenities. (The Murray area, like so many other communities, also uses state grants and local incentives to attract businesses.) Nieboer singled out Murray State, which he said is not widely known for being involved in economic development. “But it was very evident that the university plays a vital role in driving regional economic growth.” The EDC promotes that role by reserving one slot on its 12-member board for a university representative. The university puts its weight behind EDC initiatives by, for instance, hosting prospective employers and, in Pella’s case, providing space for the company’s big announcement and its interviews with job candidates as well as temporary on-campus housing for its executives. Just by being there with its 10,300 students, Murray State contributes to the local economy in many ways—for one thing, cushioning it against recession, says Ronnie Gibson, chairman of the EDC board and of the $170 million-asset Murray Bank. A growing number of well-off retirees, immigrants from as far off as California, also add economic stability. He recalls the trend “The community could survive without much manufacturing. But the community cannot thrive without much manufacturing.” starting with a big influx of them after Rand McNally named Murray the top U.S. retirement community a couple of decades ago. For all its progress of late, the area remains restfully small-town, rural and outdoorsy. Downtown Murray’s centerpiece is a classic old-time courthouse square, some of its buildings dating back more than a century. Depending on the season, fields just outside of town grow green with soybeans, corn, winter wheat and tobacco, once the area’s prime crop, its acreage now limited by the national tobacco settlement. Within a half hour’s drive lies Land Between the Lakes, formed in the 1940s when the Tennessee Valley Authority dammed the nearby Tennessee River, creating Kentucky Lake and Barkley Lake. The area remains a vast and largely undeveloped land-and-water playground. [15] Today, TVA provides parts of seven states, including southwestern Kentucky, with electricity that’s inexpensive, relative to what’s paid in many other parts of the country. That was “a big deal” to Webasto Roof Systems Inc. when it was comparing locations for a new plant, says John Gragg, commercial manager for the company’s Kentucky operations. A railroad spur, abandoned since Mattel decamped, also helped sway the company’s decision to build a 110,000-square-foot plant in Murray, he says. The plant, a stamping facility for automobile sun roofs, began gearing up for production not quite two years ago and now has close to 100 employees. Gragg says the company, a unit of automotive equipment maker Webasto AG of Stockdorf, Germany, is still in the building-up phase in Murray and hopes to get “bigger and bigger” there. Webasto joined two trucking companies, a medical supplies distributor and a textbook wholesaler in the EDC’s industrial park north of town just east of Highway 641, the area’s north-south axis. With only 10 of the park’s more than 80 acres left now, the EDC has taken options to buy 150 acres for industrial development west of the highway. Meanwhile, a little more than a mile to the south, Pella is going great guns, having fulfilled its promise of 500 jobs after just two years of operations. More than 1,000 people now work at the automated plant, one out of nine of the company’s total workforce. On two full shifts and a partial third, they run machines that do everything from cutting glass to wrapping finished vinyl and fiberglass windows in plastic for shipping. Pella has turned out to be better than community leaders could have hoped for, says Manning, because it offered jobs with better pay and benefits than Mattel did. In an expression of appreciation, the county renamed the street leading into the plant— from Poor Farm Road to Pella Way. The Little Engine That Could And there is still Briggs & Stratton. The Milwaukee-based company, weathering a rough patch owing to a drop in demand for its engines, shut down the Murray plant’s third shift, laying off 110 workers in January. Even so, almost 1,000 remain, making the company just as critical to the local manufacturing economy as it was in the Mattel days. With Briggs & Stratton and Pella the twin stalwarts now, it’s still very much a twocompany economy. Even with Webasto and an incrementally growing group of smaller industries in fields like chemicals, foodprocessing and plastics varying the mix in the past six years, Manning worries about “too many eggs in too few baskets.” To spread the risk, he says, “we need five to six more companies in (Webasto’s) size range with good product diversity.” Susan C. Thomson is a freelance writer. District Overviews LITTLE ROCK | Louisville | MEMPHIS | ST. LOUIS Zones Revised Data Show Larger Job Gains for Eighth District Metro Areas By Michael R. Pakko and Howard J. Wall A great deal of effort goes into forecasting future levels of economic activity, and many people understand the difficulties that are faced in making such forecasts. There is significantly less understanding, however, of the difficulties faced in determining economic performance in the recent past. In fact, all kinds of economic data undergo revisions over time, meaning that our view of the past is constantly changing. Sometimes, the revised data tell a story that differs greatly from what was told by original data. This is especially true of employment data for metro areas. On March 8, the Bureau of Labor Statistics (BLS) released its latest annual benchmark revisions to the payroll employment data for every metro area in the United States. Monthly employment estimates going back to April 2005 were affected by these revisions. In addition, new population controls resulted in small revisions to the data further back in time. Compared with the initial estimates released in January, the latest revisions result in a significant upgrading in the perceived economic health of metro areas in the Eighth District.1 The table presents the pre- and post-revision estimates of employment growth in 2006 for all 18 metro areas in the Eighth District. Summing over the 18 metro areas, the benchmark revisions greatly increased estimated job growth: The initial estimate across all of the metro areas in the Eighth District was an increase of 34,900 jobs, whereas the new, post-benchmark estimate indicates 60,700 more jobs. All four of the largest metro areas in the District saw upward revisions in the estimates of their employment growth. The St. Louis and Louisville metro areas saw dramatic improvements in their employment estimates, while the revisions in Memphis and Little Rock were more measured. Before the revisions, the employment estimates suggested that St. Louis and Louisville both experienced relatively grim years in 2006. St. Louis was said to have seen a loss of 400 jobs (–0.03 percent), while Louisville was thought to have seen an increase of only 3,900 (0.6 percent). The new estimates, however, present completely different pictures. St. Louis and Louisville are now seen as having generated 13,600 jobs (1.0 percent) and 11,900 jobs (1.9 percent), respectively. The new story is that St. Louis saw positive but slow employment growth that was somewhat below the rate for the United States (1.7 percent), while employment in Louisville grew somewhat faster than it did for the country as a whole. Before the revisions, employment in the Memphis metro area was thought to have increased last year by 6,100 (1.0 percent), while the corresponding employment growth in Little Rock was 5,900 (1.7 percent). The new estimates indicate that the Memphis metro area generated 9,300 more jobs (1.5 percent), which puts its performance much closer to the national rate. For Little Rock, the new estimate of the net number of jobs created in 2006 is 6,800 (2.0 percent), which now puts the area as an above-average job producer for the year. Some very large revisions, both up and down, occurred for the employment growth estimates of the 14 small and medium metro areas in the Eighth District. Three large upward revisions, each of which was of greater than one percentage point, occurred for Bowling Green, Elizabethtown and Fort Smith. [16] Bowling Green saw its employment picture change from slightly below the national average to well above it, while Elizabethtown and Fort Smith saw their employment pictures completely reverse. Each had initially been thought to have experienced mild job losses in 2006, but now are estimated to have experienced job gains well above the national rate. At the other end, Evansville, Hot Springs and Pine Bluff all saw significant downward revisions (one percentage point or more) in their employment growth rates for last year. For Hot Springs, the downward revision meant that its 2006 performance was downgraded from startlingly good to only above average. Evansville and Pine Bluff, on the other hand, went from having positive to negative job growth for the year. The revision was especially dismal for Pine Bluff, which went from above-average job growth to significant job losses. Jobs Data and Benchmarking So how is it that the pictures of local economies can change so much? The payroll employment in a metro area—the number of jobs—is provided by the Current Employment Statistics (CES) program of the BLS. According to the BLS, each month it surveys “about 160,000 businesses and government agencies, representing approximately 400,000 individual work sites,” from around the United States. Although the survey covers hundreds of thousands of employers, these employers make up only a small percentage of all businesses and work sites in the country. (According to the BLS, there were more than 8.8 million such establishments in the United States in June 2006.) To calculate a comprehensive measure of metro area employment, the BLS needs to estimate the num- The Regional Economist April 2007 n www.stlouisfed.org St. Louis Little Rock ber of establishments in the area. This is the primary reason for the sometimes-large revisions to the CES data: the difficulty in estimating the number of establishments. When the economy is in recovery, for example, new firms might be setting up and hiring workers very quickly. The BLS doesn’t find out about the new firms or jobs until the unemployment insurance records are updated, which can take several months or more. This lag is compounded by the fact Louisville Memphis that small firms, which provide the bulk of jobs, might need to provide unemployment insurance information only once a year rather than monthly or quarterly, as is required of larger firms. To estimate the number of establishments, the BLS relies on the Quarterly Census of Employment and Wages (QCEW). The QCEW is a tabulation of employment information for workers covered by state and federal unemployment insurance Metro Area Employment Growth 2006 December 2005 to December 2006 thousands (percent change) Metro Area Original Estimate, as of January 2007 Revised Estimate, as of March 2007 Large Metro Areas St. Louis, Mo.-Ill. Little Rock-North Little Rock, Ark. Louisville, Jefferson County, Ky.-Ind. Memphis, Tenn.-Ark.-Miss. –0.4 5.9 3.9 6.1 (0.0) (1.7) (0.6) (1.0) 13.6 6.8 11.9 9.3 (1.0) (2.0) (1.9) (1.5) 0.9 2.0 –0.3 1.4 5.5 –0.4 3.0 1.2 –0.6 1.1 0.7 0.9 3.5 0.5 (1.5) (2.2) (–0.6) (0.8) (2.7) (–0.3) (8.1) (1.9) (–0.8) (2.3) (1.4) (2.2) (1.8) (0.9) 1.7 1.8 1.4 –0.3 4.0 2.9 0.9 0.7 0.6 0.8 0.9 –0.6 3.8 0.5 (2.8) (2.0) (3.0) (–0.2) (2.0) (2.4) (2.4) (1.1) (0.8) (1.6) (1.8) (–1.5) (1.9) (0.9) programs. Because of its comprehensive nature, data from the QCEW cannot be produced as quickly as data from the CES: Initial data are released six to seven months after the end of a quarter and are subject to subsequent revision. To fill in the blanks, the BLS estimates the number of establishments using the QCEW as a benchmark. Each year, the BLS establishes new benchmarks using updated data from the QCEW. Because of the lags and revisions to the QCEW data, the yearly benchmarking affects employment data from the CES going back 21 months. This is why the estimates just released have affected the yearly employment changes for 2005 and 2006. Note also that the estimates for job growth in 2006 will change again in March 2008 because much of the data for 2006 will be affected by the benchmark revisions that will occur then. Michael R. Pakko and Howard J. Wall are both economists at the Federal Reserve Bank of St. Louis. Joshua Byrge, a research associate, and Kristie Engemann, a senior research associate, provided substantial research assistance. Small and Medium Metro Areas Bowling Green, Ky. Columbia, Mo. Elizabethtown, Ky. Evansville, Ind.-Ky. Fayetteville-Springdale-Rogers, Ark. Fort Smith, Ark.-Okla. Hot Springs, Ark. Jackson, Tenn. Jefferson City, Mo. Jonesboro, Ark. Owensboro, Ky. Pine Bluff, Ark. Springfield, Mo. Texarkana, Texas-Ark. SOURCE: Bureau of Labor Statistics [17] endnote 1 A detailed analysis of these revisions and the recent history of benchmark revisions is provided by Michael R. Pakko and Howard J. Wall in,“Post-Casting Employment in the Eighth Federal Reserve District: Revised Data for Metro Areas,” CRE8 Occasional Report No. 2007-01, March 2007. See http://research.stlouisfed.org/regecon/op/ CRE8OP-2007-001.pdf. National Overview By Kevin L. Kliesen D ata over the past few months remained consistent with an economy that is growing below its trend and with a level of core inflation that is slightly above what policymakers desire. Below-trend output growth largely reflected the ongoing slowdown in the housing and automotive sectors. As these imbalances wither away, the economy should begin to rebound, and the pace of growth should return to its trend rate—about 3 percent, say most economists—sometime toward the end of this year. Bolstered by lower energy prices and past efforts by the Federal Open Market Committee (FOMC) to keep inflation and inflation expectations from accelerating, core inflation is expected to recede slowly from last year’s 2.3 percent rate, which most policymakers have deemed unacceptably high. When the advance estimate (released Jan. 31) indicated that real GDP had increased at a better-thanexpected 3.5 percent annual rate in the fourth quarter of 2006, some economists saw that as an indication that the economy was faring quite well outside of the housing and auto sectors. This increase was even more impressive given that real business fixed investment declined slightly. The housing slowdown, it seemed, had not affected other key parts of the economy. Fast forward one month to when the “preliminary”report on fourthquarter growth was released. This update of the “advance estimate” indicated that real GDP rose at only a 2.2 percent annual rate in the fourth quarter. What happened? First, the Bureau of Economic Analysis (BEA) reported that there was a much larger decline in business inventory investment than it had originally assumed. Second, a smaller decline in imports caused the BEA to lower its contribution from net exports. However, a closer examination revealed only a slight downward revision to consumer outlays, but a healthy upward revision to real exports, which were key drivers of economic growth during the fourth quarter. Going forward, developments in the housing sector may continue to restrain the pace of GDP growth for a bit longer. Earlier this year, the number of unsold, new single-family homes remained quite high relative to the pace of sales. As a result, the number of new housing starts will probably continue to wane a bit longer. This situation may be exacerbated by the sharp deceleration in new home prices that has occurred over the past year in most major urban areas. Accordingly, Blue Chip forecasters expect that real GDP, following a 3.1 percent increase last year, will increase by about 2.75 percent this year and then by 3 percent next year. This forecast is little changed from late last year. One risk, noted earlier, is that the step down in the pace of business capital outlays over the second half of last year will persist. In this vein, January’s larger-than-expected drop in new orders for nondefense capital goods was worrisome. In the Federal Reserve’s biannual Monetary Policy Report to Congress, Chairman Ben Bernanke noted that the governors and Reserve bank presidents projected that real GDP would increase by between 2.5 percent and 3 percent this year and by between 2.75 percent and 3 percent next year. These projections are broadly in line with those of the Blue Chip forecasters noted earlier. [18] Bernanke also revealed that Fed policymakers project that core PCE (personal consumption expenditure) inflation was expected to continue falling slowly. Following a 2.3 percent increase last year, core prices are projected to increase by between 2 percent and 2.25 percent this year and then by between 1.75 and 2 percent next year. However, policymakers continue to note that the “predominant policy concern” is that inflation will not ease to the degree most expect. Several developments will probably exert some restraint over the near-term inflation rate. First, with oil prices no longer on an upward trajectory, firms may face less pressure to raise prices to offset higher energy costs. Second, the slower pace of economic activity may spur firms to compete more aggressively on the price side. Third, the FOMC’s commitment to price stability should help temper future price increases. If, however, core inflation plateaus at a rate above 2 percent, then many policymakers would likely press for further action. Kevin L. Kliesen is an economist at the Federal Reserve Bank of St. Louis. Joshua A. Byrge provided research assistance. The Regional Economist April 2007 n www.stlouisfed.org National and District Data Selected indicators of the national economy and banking, agricultural and business conditions in the Eighth Federal Reserve District Commercial Bank Performance Ratios fourth quarter 2006 U.S. Banks by Asset Size ALL $100 million$300 million Return on Average Assets* 1.35 1.20 1.10 1.35 1.22 1.32 1.27 1.37 Net Interest Margin* 3.48 4.34 4.34 4.27 4.31 3.92 4.11 3.25 Nonperforming Loan Ratio 0.79 0.76 0.80 0.69 0.74 0.60 0.67 0.84 Loan Loss Reserve Ratio 1.16 1.25 1.27 1.22 1.24 1.21 1.23 1.13 less than $300 million $300 million$1 billion less than $1 billion $1billion$15 billion Return on Average Assets * Net Interest Margin * 1.18 1.19 1.19 1.15 .50 .75 1 1.25 4.18 4.20 Arkansas 3.63 3.73 3.63 3.49 Illinois Indiana 1.20 1.27 1.14 1.16 1.22 1.22 1.25 1.24 .25 3.90 3.87 Eighth District 1.02 1.08 0.98 1.01 0 Kentucky 3.75 Missouri 3.39 3.56 Tennessee 1.50 percent 0.75 1 .25 .5 2 2.5 3 3.5 Arkansas Illinois Indiana 1.15 Kentucky 1.11 Mississippi Missouri 0.68 .75 1 4 4.5 5 1.23 1.28 1.36 1.45 1.22 1.20 1.29 1.46 1.13 1.44 1.25 1.35 1.35 1.35 Eighth District 0.96 0.99 0 1.5 Loan Loss Reserve Ratio 0.45 0.42 0.59 4.06 4.12 4.18 4.09 3.99 Mississippi Nonperforming Loan Ratio 0.77 0.85 0.92 0.86 0.90 0.80 0.93 More less than than $15 billion $15 billion 0.95 0.89 Tennessee 1.25 Fourth Quarter 2006 NOTE: Data include only that portion of the state within Eighth District boundaries. SOURCE: FFIEC Reports of Condition and Income for all insured U.S. commercial banks. *Annualized data 0 .25 .50 .75 1 1.25 Fourth Quarter 2005 For additional banking and regional data, visit our web site at: www.research.stlouisfed.org/fred2/ 1.50 1.75 The Regional Economist April 2007 n www.stlouisfed.org Regional Economic Indicators Nonfarm Employment Growth* year-over-year percent change fourth quarter 2006 Total Nonagricultural Natural Resources/Mining Construction Manufacturing Trade/Transportation/Utilities Information Financial Activities Professional & Business Services Education & Health Services Leisure & Hospitality Other Services Government united states eighth district arkansas illinois indiana kentucky mississippi missouri tennessee 1.7% 8.3 2.2 -0.4 0.8 0.3 2.3 2.9 2.8 3.4 0.9 1.2 1.1% 3.0 1.9 -1.4 0.9 -0.2 1.1 2.2 2.3 3.1 0.6 0.8 1.4% 7.8 2.2 -2.9 1.4 2.4 2.1 2.2 3.2 2.6 2.7 2.6 1.2% -2.2 1.4 -0.3 0.7 -0.7 1.0 2.1 3.0 3.4 0.5 -0.3 0.4% 1.9 0.4 -1.8 0.1 -0.2 0.8 1.6 1.2 2.0 0.3 0.9 0.8% 3.3 -1.2 -0.8 0.3 0.5 2.5 2.2 1.4 2.0 -0.4 1.0 2.4% 9.7 4.1 -1.0 2.8 -3.6 -1.5 3.0 4.1 6.0 0.9 2.3 1.3% -3.1 1.0 -1.4 1.2 -2.5 1.5 3.2 1.9 2.9 1.0 1.4 1.1% 0.8 6.6 -2.7 1.2 3.1 0.8 1.6 2.4 3.1 0.8 0.1 Unemployment Rates Eighth District Payroll* percent employment by industry–2006 IV/2006 III/2006 IV/2005 4.5% 5.4 4.1 4.8 5.6 6.9 4.9 5.0 4.7% 5.4 4.4 5.0 5.7 6.7 5.0 5.2 5.0% 5.1 5.3 5.2 6.2 8.9 5.1 5.5 United States Arkansas Illinois Indiana Kentucky Mississippi Missouri Tennessee Professional & Business Services Financial Activities 5.6% Information 1.8% Trade/ Transportation/ Utilities Education & Health Services 11.6% 12.7% 9.3% 20.3% 15.5% 13.9% Leisure & Hospitality Other Services 4.0% Manufacturing Government Construction 4.8% Natural Resources & Mining 0.4% fourth quarter third quarter Housing Permits Real Personal Income ‡ year-over-year percent change in year-to-date levels year-over-year percent change –14.5 –22.5 –25.5 4.1 1.0 Illinois 12.6 Indiana –2.9 1.3 20.3 –4.3 –11.0 5.5 –2.1 –35 –30 –25 –20 –15 –10 –5 2006 3.7 0 Mississippi 7.3 –2.1 Missouri 3.2 1.6 3.0 2.4 Tennessee 5 10 15 20 25 30 percent –4 –3 –2 –1 0 1 2005 2006 *NOTE: Data have been converted from the 1987 Standard Classification (SIC) system basis to a 2002 North American Industry Classification (NAICS) basis. 3.5 2.1 2.2 2.1 2.7 Kentucky –12.2 3.8 1.9 Arkansas 9.1 –12.9 –23.4 United States 6.1 ‡ 2 3 4 5 6 7 8 9 2005 NOTE: Real personal income is personal income divided by the PCE chained price index. The Regional Economist April 2007 n www.stlouisfed.org Major Macroeconomic Indicators Consumer Price Inflation Real GDP Growth percent percent 8 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 6 4 2 0 –2 02 Additional charts can be found on the web version of The Regional Economist. Go to www.stlouisfed.org/publications/re/2007/b/pdf/04_07_data.pdf. 03 04 05 06 NOTE: Each bar is a one-quarter growth rate (annualized); the green line is the 10-year growth rate. 07 all items all items, less food and energy 02 03 04 05 06 Feb. 07 NOTE: Percent change from a year earlier Civilian Unemployment Rate Interest Rates percent percent 7 6.5 6 6.0 5 5.5 4 5.0 3 fed funds target 2 4.5 1 Feb. 4.0 02 03 04 05 06 0 07 NOTE: Beginning in January 2003, household data reflect revised population controls used in the Current Population Survey. Feb. three-month t-bill 02 03 04 05 06 07 NOTE: Except for the fed funds target, which is end-of-period, data are monthly averages of daily data. Farm Sector Indicators U.S. Agricultural Trade Farming Cash Receipts billions of dollars 45 40 35 30 25 20 15 10 5 0 billions of dollars 130 125 exports 120 115 crops 110 imports livestock 105 trade balance 100 95 Jan. 02 03 05 04 06 90 07 NOTE: Data are aggregated over the past 12 months. Nov. 02 03 04 05 06 07 NOTE: Data are aggregated over the past 12 months. U.S. Crop and Livestock Prices index 1990-92=100 145 135 crops 125 115 105 95 livestock 85 75 1993 Feb. 94 95 96 97 98 99 00 01 02 03 04 05 06 07 Next Issue Industrial loan companies have been part of America’s financial landscape for a century with little fanfare. But lately, they’ve been the subject of much legislative debate, sparked by Wal-Mart’s proposal in 2005 to open such a bank. Facing mounting criticism and scrutiny, Wal-Mart withdrew its application last month. But the controversy continues since other large retailers already run such financial institutions. 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