Presentation at the Economic Development Conference, Lynchburg College, March, 2011, Dr. Shea

1. U.S. Economy Developments and OutlookMarch 4, 2011

3. Output growth: decent overall; encouraging details

4. Labor market: slowly recovering, ways to go

5. Inflation: remains low despite rising commodity prices

6. Where is the economy heading in 2011?

7. Recent forecasts have improved

8. Incoming data: mixed signals

9. Some upside and downside risks

10. Normal business cycle dynamics

11. Oil prices

12. Fiscal drag 2

13. 3 WHERE IS THE ECONOMY CURRENTLY?

15. Q4-over-Q4 growth rate for 2010 was 2.7 percent—a bit higher than long-run potential GDP growth, but not much

16. Recovery comparable to two most recent recessions, but lags recovery from previous deep recessions of 1975, 1982.4

18. Can break level of GDP up into its component parts: consumption, investment, government and net exports

19. Can do the same thing for GDP growth rate—can break it into parts due to growth of each component

23. Consumption accelerated sharply in Q4, led by almost 30 percent annualized growth in auto sales

24. Equipment and software slows down a little in Q4 but remains solid

25. Residential and nonresidential construction have not joined party

26. Net exports extremely volatile quarter to quarter—partly measurement problems with oil imports, but exports grew 8.5 percent annualized in Q46

28. Will get new jobs report on Friday morning

29. However, we still have over 7 million fewer jobs than we did in December 2007.

30. As with GDP, employment recovery is following contour of the milder 1991 and 2001 recessions, rather than the more severe 1975 and 1982 episodes. 7

32. Recent decline robust to alternative unemployment indicators

33. Long-term unemployment remains high—could increase long-run “natural rate” of unemployment

34. Okun’s Law: Need GDP to grow 2 percent faster than long-run potential to reduce unemployment rate by 1 percentage point8

36. But impact of commodity prices diminishes as goods move up production chain towards retail level, because labor market slack is keeping wages down.

37. Wholesale inflation 0.8 percent in January, 3.6 percent over last 12 months

38. Headline CPI inflation: 0.4% in January, 1.6% over 12 months. Gas prices up 13% over last 12 months.

39. Core CPI inflation (excluding food and energy) 0.2% in January, 1.0% over last 12 months.

40. Inflation expectations have remained stable9

41. 10 WHERE IS THE ECONOMY HEADED?

43. Michigan, Conference Board measures now at highest level since early 2008.

44. Institute for Supply Management (ISM) manufacturing growth index highest since May 2004

45. Employment component of ISM highest since 1973; export component highest since 1988

46. Nonmanufacturing ISM out today; January index highest since 2005

47. Unemployment Insurance claims have dropped to lowest levels since July 2008

48. Other data also show drop of inflows into unemployment12

50. Core durable goods shipments (excluding defense, aircraft) down 2 percent in January; new core orders down 7 percent.

51. Taken at face value, limited data so far suggests equipment and software spending will fall in Q1

52. Private payrolls up only 50K in January, well below expectations for 150-200K private payroll jobs.

53. February jobs report will be released tomorrow morning

54. How to reconcile weak hard numbers with strong survey evidence?

55. Bad weather in January depressed payrolls, and possibly PCE

56. In recent quarters, durables spending has been weak in first month, grown strongly in 2nd and 3rd month.

57. We look for numbers to bounce back strongly in February.

58. February auto sales jump sharply: over 6 percent in just one month 13

60. Case-Shiller/S+P house price index down 2.4 percent in 2010 (December to December); FHFA index down 3.3 percent; CoreLogic down 5.5 percent.

61. Recent forecasts call for continued declines in 2011 and 2012, although at a much slower pace than in 2007-2009.14

63. Home sales have been weak since expiration of home buyer tax credit in April 2010, although they did jump in December

64. Supply is elevated because of overbuilding during mid-1980s, and because of large overhang of distressed properties

65. Mortgage delinquency rates fell sharply in Q4, suggesting that inflows of new homes into distress will slow down.15

67. Direct effect: residential construction will remain low until excess supply worked off.

68. Indirect effect: declining prices could slow down PCE growth by reducing home equity.

69. Fortunately, recent price declines have been mostly concentrated in distressed homes, limiting impact on consumer spending.16

70. 17 UPSIDE AND DOWNSIDE RISKS TO THE ECONOMY

72. Following the 1982 recession, real GDP grew 7.7 percent (Q4 over Q4) in 1983, and 5.6 percent in 1984. Following the 1975 recession, economy grew 5.0 percent in 1977 and 6.7 percent in 1978.

73. Typical business cycle dynamics that support rapid growth during a recovery:

74. The virtuous cycle: as businesses create more jobs and expand capacity, consumption and investment demand will accelerate…which will businesses to create more jobs and further expand capacity.

75. Will surge in PCE in Q4 trigger strong hiring in 2011?

76. Durable goods catch-up: should promote sharp acceleration of consumer durables, business equipment and (eventually) residential investment.

77. Consumer durables surged 21 percent in Q4, led by cars.

78. Rising population and household formation will drive housing demand in the long run. 18

80. Gas prices are up about 25 cents to $3.44 per gallon over past 2 weeks.

81. Sustained $10 increase will reduce real GDP about 0.1 percentage point this quarter, about 0.25 ppt after one year.

82. Most of the effect comes through consumption.

83. Gasoline is about 5 percent of typical household’s budget.

84. An 8 percent price increase reduces household resources available for spending on other goods and services by about 0.3 percentage point. 19

86. Local government has lost 366K jobs since September 2008, and is continuing to decline

87. December tax cut deal prevented federal fiscal drag for 2011, but sharp spending cuts could undo stimulus from December package

88. A $61 billion dollar spending cut concentrated into the last 7 months of FY2011 would reduce aggregate demand by roughly 0.7 percentage point.

89. A one-week shutdown would reduce Q1 GDP by 0.1-0.2 percent, mostly due to lost federal work hours and delayed defense purchases. 20