1. 1

2. FED ECONOMIST
2012
Jeff
2

3.  The outlook
 Tepid growth likely
 Recent data suggest growth of 2-2.5% in second half
 High unemployment for a while—Structural?
 Housing likely to be weak for some time
 Elevated inflation (how to interpret recent rises?)
 Concern over developments in Europe
70000 500
 Some recent positive signs 67500 400
65000 300
 Initial claims down, capital goods 62500 Cap. Goods orders 200
orders up, ISM up a bit 60000 Initial Claims 100
ISM index
 Suggests continued slow growth 57500
2011:Jan 2011:May
0
2011:Sep
3

4. (cats and dogs living together—a sign
of the Apocalypse)
4

5. 4.5
4.0
GDP growth
3.5
Long-run sustainable growth
3.0
2.5
2.0
1.5
1.0
0.5
0.0
2009:Q3 2010:Q1 2010:Q3 2011:Q1
Sources: Bureau of Economic Analysis, Haver Analytics 5

6. Labor markets
400 11
3-month average change in employment
Civilian unemployment rate, % of labor
200 10
0 9
-200 8
force
Employment growth
-400 Total Private 7
August 0 17
-600 June-Aug avg 35 83 6
3-mo. Avg. change, total employment
-800 3-mo. Avg. change, private employment 5
Unemployment rate (right scale)
-1000 4
2008:Jan 2008:Sep 2009:May 2010:Jan 2010:Sep 2011:May
Sources: Bureau of Labor Statistics (employment, initial claims), Haver Analytics 6

7. Peak-to-trough employment declines during the recession
were large and widespread, across almost all sectors
Government
Leisure and hospitality
Educ. And Health
Prof. and Bus. Services
Financial
Information
Transportation
MV
Retail trade
Wholesale trade
Manufacturing
Construction
-30 -25 -20 -15 -10 -5 0 5
Sources: Bureau of Labor Statistics, Haver Analytics Percent 7

8.  Wages have decelerated noticeably over the
past two years
 Despite rather strong productivity growth
4.5 8.0
4 7.0
3.5 6.0
3 5.0
Avg. hourly earnings
2.5 4.0
ECI (right scale)
2 3.0
Productivity growth
1.5 2.0
1 1.0
0.5 0.0
0 -1.0
2006:Q1 2007:Q1 2008:Q1 2009:Q1 2010:Q1 2011:Q1
8
Sources: Bureau of Labor Statistics , Haver Analytics

9.  Likely some increase in structural
unemployment
 But most of the rise has been due to very weak
demand
 However, a prolonged state of weak demand
could turn cyclical unemployment into structural
unemployment
 This is a risk to monitor
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10. I know you were expecting me to huff and puff and all that.
But it is the 21st century, so I’m just going to foreclose on you.
And then roast you with a nice honey glaze.
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11. Housing
1800 20
Single-family sales (left)
1600 Single-family permits 15
National house price index excl. distressed sales (Core Logic, right scale)
1400 10
including distressed sales (right scale)
12-month pctg. change
1200 5
Thousands
1000 0
800 -5
600 -10
400 -15
200 -20
0 -25
2006:Jan 2008:Jan 2010:Jan
Sources: Census Bureau (permits), National Association of Realtors (home sales), Core Logic (house price indexes), Haver Analytics 11

12.  Low housing demand, sizable vacant stock
 1/3-1/2 of existing home sales are REO, etc.
 Why is demand weak?
 Unemployment
 Fear of job loss
 Low and falling house prices
 Weak house price expectations mute demand
 Low house prices affect equity
 What will help?
 We will return to this
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13.  Eliminates
Equity position as of 2011:Q2
(Core Logic)
some down
payments
and thus
weakens
22.5
Negative equity
sales
5
72.5 Near-negative  Limits or
Positive equity
eliminates
refinancing
options
Sources: Core Logic 13

14. Real residential investment spending
900
800
Historical data
700 Macro Advisers Forecast
600
500
400
300
2004:Q1 2006:Q1 2008:Q1 2010:Q1 2012:Q1
Sources: Census Bureau, Macroeconomic Advisers 14

15. 24.0
Sovereign spreads over comparable German rates
Greece
19.0 Ireland
Portugal
14.0 Spain
Italy
9.0
4.0
-1.0
20080101 20080729 20090224 20090922 20100420 20101116 20110614
Sources: Reuters, Haver Analytics 15

16.  Both overall and so-called “core” measures have risen
of late
4
3.5
3
2.5
2
1.5
1 Core CPI, 3-mo. Chg
0.5 Core CPI, 6-mo. Chg.
Core CPI, 12-mo. Chg.
0 Cleveland Fed weighted median, year-over-year
-0.5
2005:Jan 2006:Jan 2007:Jan 2008:Jan 2009:Jan 2010:Jan 2011:Jan
Sources: Bureau of Labor Statistics (CPI), Federal Reserve Bank of Cleveland (weighted median), Haver Analytics 16

17.  Many temporary factors—auto prices
(Japan), energy, food—have led to spikes in overall
inflation
 But no acceleration in wages—2/3 of production cost
4.5
4
3.5
3
2.5
2 ECI (right scale)
1.5 Avg. hourly earnings
1
0.5
0
2006:Q1 2008:Q1
Sources: Bureau of Labor Statistics , Haver Analytics
2010:Q1 17

18.  Commodity price pressures are easing
 We will see a gradual decline in inflation to
somewhere between 1 and 2%
160
150 Copper
140 Wheat
Index, Jan 2011 = 100
130 Oil
120 Cotton
110
100
90 Jan. 2011
80
70
60
20110103 20110214 20110328 20110509 20110620 20110801 20110912
Sources: The Wall Street Journal, Haver Analytics 18

19. 14.0 Civilian unemployment rates
RI
12.0 US
CT
10.0
New England
8.0 MA
ME
6.0 NH
VT
4.0
… although
2.0 the states
vary
0.0 significantly
2007:Jan 2007:Jul 2008:Jan 2008:Jul 2009:Jan 2009:Jul 2010:Jan 2010:Jul 2011:Jan
Sources: Bureau of Labor Statistics, Haver Analytics 19

20. 280
House prices indexes, 1995=100
Boston (Case-Shiller)
260
NE (FHFA)
240
Index, 1995:Q1=100
US (Case-Shiller)
220 CT (FHFA)
200
180
160
140
120
100
1995:Q1 1998:Q1 2001:Q1 2004:Q1 2007:Q1 2010:Q1
Sources: Case-Shiller, FHFA, Haver Analytics 20

21. 6 Delinquent 90 days or more, % of all mortgages
RI
5 US
NE
4 CT
3
2
1
0
2007:Q1 2008:Q1 2009:Q1 2010:Q1 2011:Q1
Sources: Mortgage Bankers’ Association, Haver Analytics 21

22.  HAMP has not worked as well as hoped, HARP has
not worked as well as hoped, Hope for Homeowners
didn’t work at all
 HAMP-UP has had very limited take-up
 What to do?
 Forbearance for unemployed/economically stressed
homeowners
 Expedite unavoidable foreclosures
 Incentives to convert owner-occupied stock to rental stock
 House price insurance that limits exposure to severe price
declines
 Limit late “push-backs” by Fannie/Freddie (e.g. after 2 or 3
years)
 More dramatic measures?
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23. 23

24.  Quick tour of our liquidity and alternative
monetary policy efforts
 The Crisis evolved in two phases:
1. Liquidity crisis (shortage of short-term funds)
2. Macro crisis
 Made more complicated by the Zero Lower Bound
 We responded to the two phases with two
types of tools
 Lending to institutions that couldn’t get short-term
funds
 Pursuing policies to lower longer-term interest rates
(QE1, QE2, “Twist”)
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25.  Enormous effort to fix short-term credit markets
(“liquidity”)
1200
Assets on the Federal Reserve Balance Sheet
1000
CB Swaps CPFF TAF
800
Billions of $
600
400
200
0
2009:Jan 2009:May 2009:Sep 2010:Jan 2010:May 2010:Sep
Sources: Federal Reserve Board H.4.1 Release, Haver Analytics 25

26. Target federal funds rate
6
5
4
3
2
1
At the “zero lower bound”
0
2007:Jan 2008:Jan 2009:Jan 2010:Jan
Sources: Haver Analytics 26

27.  Liquidity policies phase out, macro stimulus
policies phase in, viz our balance sheet
3000000
Agency and MBS
2500000
CB Swaps
2000000
CPFF
1500000 TAF
Treasuries
1000000
500000
0
2008:Jan 2008:Jul 2009:Jan 2009:Jul 2010:Jan 2010:Jul 2011:Jan 2011:Jul
Sources: Federal Reserve Board H.4.1 Release, Haver Analytics 27

28.  We’re stuck at the ZLB
 How do we normally affect the economy?
 By moving the federal funds rate
 This in turn affects key borrowing rates:
 Auto loans
 Mortgages
 Business loans
 Education loans
 Also effects equity valuations, the exchange value of
the dollar
 When stuck at the ZLB, pursue policies to
affect these rates directly
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29.  Leaves size of balance sheet the same
 Sell short-term Treasuries, buy long-term
 Goal: to lower long-term interest rates
Fed Balance Sheet: Assets
Before Twist After Twist
Short-term Treasury securities $535B $135B
(3 years or less, incl. Bills)
Long-term Treasury securities $567B $967B
(6 years or greater)
Mortgage-backed securities $995B $995B
 Likely effects
 Lower long-term rates (15-25bps)—pretty confident
 Spur spending, increase jobs 0.5-0.7M—less confident
Sources: Federal Reserve Bank of New York, http://www.newyorkfed.org/markets/soma/sysopen_accholdings.html 29

30.  Re-investing maturing/prepaid MBS back into MBS
 Reverse some of the widening spread between
mortgage rates and Treasuries
5.5 2.4
5.0 2.2
4.5
30-year fixed rate mortgage (left scale) 2.0
4.0
3.5 Spread, 30-year mortage over 10-year Treasury (right scale) 1.8
3.0 1.6
2.5
2.0 1.4
1.5 1.2
20110103 20110228 20110425 20110620 20110815
Sources: Federal Reserve Board H.15 Release (10-year Treasury yield), NY Times (30-year mortgage rate), Haver Analytics 30

31.  It has been a fascinating period
 The Fed has done things it never did before
 To accomplish two goals:
 Keep financial markets working, so that business can
continue
 To directly stimulate the economy, to create
economic growth and employment
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