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1
DOMESTIC ECONOMIC
CONDITIONSJeff Fuhrer
Director of ResearchFederal Reserve Bank of Boston
Equipment Leasing and Finance AssociationCredit and Collections Management Conference
June 12, 2007
2
Overview• Monetary policy is balancing risks
– Risk of a slowing real economy• Although there are some upside risks to growth as well
– Risk that inflation will remain a bit elevated
• Risks to spending– Effects of the housing slowdown– Slower business investment?– Stronger consumer spending?
• Inflation risks– Recent data have been reassuring– But it’s too early to say that success has been achieved– High resource utilization is a potential risk for inflation
3
The good news: Much of the economy is doing well
• Most sectors– Particularly consumer spending, net
exports
• The exceptions– Housing– Uncertainty about investment in equipment
and software
4
Improvements in net worth and income have supported consumer spending …
35000
40000
45000
50000
55000
60000
2001:Q1 2002:Q1 2003:Q1 2004:Q1 2005:Q1 2006:Q1
10000
12000
14000
16000
18000
20000
22000
Household net worth (FOF, right scale)
Net worth in Owner-occupied housing (left scale)
… including continued improvements in housing equity
Consumer spending: Slowing, but still growing
0
1
2
3
4
5
6
7
8
2001:Q1 2002:Q1 2003:Q1 2004:Q1 2005:Q1 2006:Q1 2007:Q1-2
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.54-qtr. % chg. in wage and salary income (left scale)
4-qtr. % chg. in nonfarm employment (right scale)
… as has growth in labor income, supported by continued employment growth
5
50.0
60.0
70.0
80.0
90.0
100.0
110.0
120.0
1979:Q1 1985:Q1 1991:Q1 1997:Q1 2003:Q1
-2
-1
0
1
2
3
4
5
6
7
8
Consumer sentiment (left scale)
4-qtr. % chg. in real consumerspending (right scale)
Overall, consumers are well-positioned to continue spending in 2007-8
6
U.S. export growth will be boosted by sustained strength in our trading partners
0
12
34
56
7
1994q1 1996q3 1999q1 2001q3 2004q1 2006q3
4-q
uar
ter
% c
han
ge
-15
-10-5
05
1015
20
4-q
uar
ter
% c
han
ge
Avg GDP growth of largest trading partners (left scale)
Growth in U.S. exports (right scale)
70
100
130
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006
Ind
ex
Real, trade-weighted exchange value of the dollar
Recent declines in the dollar will also support U.S. exports.
Sources: Bureau of Economic Analysis, IMF, Federal Reserve, FRBB Calculations
What’s doing well: Net exports
7
The Risks: Housing
Housing sales have fallen 30% from their peak …
…prompting reductions in construction
3.0
4.0
5.0
6.0
7.0
8.0
9.0
1999:Jan 2001:Jan 2003:Jan 2005:Jan 2007:Jan
Months’ supply of new homes for sale at current sales rate
Builders still have a large stock of unsold homes to move
500600700800900
100011001200130014001500
199501 199601 199701 199801 199901 200001 200101 200201 200301 200401 200501 200601 2007011000
1200
1400
1600
1800
2000
2200
2400
New Home SalesPermits
8
The Risks: 1. Housing
Sources: Census, OFHEO, National Association of Realtors, FRB
-4-202468
1012141618
1996:Q1 1997:Q1 1998:Q1 1999:Q1 2000:Q1 2001:Q1 2002:Q1 2003:Q1 2004:Q1 2005:Q1 2006:Q1 2007:Q1
4-qtr. % chg., OFHEO
4-qtr. % chg., Census
Still, house prices have yet to decline nationally
If they did, that would be the “other shoe” dropping
The housing correction has resulted in limited spillovers to the rest of the
economy to date• Consumer spending remained robust
even as housing plummeted• Employment growth has been strong
9
Price increases have slowed, albeit with significant regional variation.
Source: Office of Federal Housing Enterprise Oversight, FRBB Calculations
Four-Quarter Growth Rates in OFHEO House Price Index12.7
9.8
7.987.7
2.3
0.45
2.39
10.33
0
2
4
6
8
10
12
14
US New England MA Providence
Per
cen
t
2005:Q4
2006:Q4 MA pricesslowed earlier
than some otherregions
10
MUCH recent attention has focused on the unraveling of the subprime mortgage market
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
Q1-98 Q1-00 Q1-02 Q1-04 Q1-06
Prime Fixed Prime AdjustableSubprime Fixed Subprime Adjustable
Source: Mortgage Bankers Association
Foreclosures initiated in quarter as a percentage of loans – US through Q4-06
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
Q1-98 Q1-00 Q1-02 Q1-04 Q1-06
Prime fixed Prime adjustableSubprime fixed Subprime adjustable
Foreclosures initiated in quarter as a percentage of loans – RI, through Q4-06
It’s happened earlier inRI, perhaps becauseprices turned down earlier
Implications: (1) Some homeowners will suffer; (2) Subprime mortgages hard to get (3) Macro effects: Limited spending effect or financial spillover
due to market segmentation
US RI
11
The risks: 2. Capital spending has been weaker than
expected.
0123456789
10
2001:Q1 2002:Q1 2003:Q1 2004:Q1 2005:Q1 2006:Q1 2007:Q1
0.0
1.0
2.0
3.0
4.0
5.0
6.0
Profit share of GDP (left scale)
Nonfarm productivity growth (right scale)
Weak capital spending is a bit of a puzzle, as underlying supports for investment still appear solid
-8-6-4-202468
101214
2000 2001 2002 2003 2004 2005 2006
Ye
ar-
to-y
ea
r %
ch
an
ge Actual
Forecast
Global Insight Forecast forReal spending on Equipment and Software
12
Possible explanations for slowing capital spending
1. Capital spending shifting overseas
2. Capital spending is slow in sectors with
slow employment growth (doesn’t seem
to explain much)
3. Capital spending was associated with a
one-time improvement in technology
The boom is over now?
13
Servicing foreign markets
Servicing U.S. markets
Capital installedabroad
Capital installed
domesticallya b d c
• What’s happening?– c decreasing because domestic demand
weak?– a increasing, raising share in total
capital spending?– b substituting for c?– a substituting for d?– Import substitution (foreign producers)
Foreign producers
14
Most of the surprise came in high-tech investment goods
Predictedexceeds
actual overpast 3-4
years
15
The Risks:3. Inflation may not moderate as expected
The expected moderation in inflation is not compelling in the data yet
Sources: Department of Energy, Bureau of Labor Statistics
-10
-8
-6
-4
-2
0
2
4
6
19802 19832 19862 19892 19922 19952 19982 20012 20042
Per
cen
t
Actual Output / CBO Potential Output(with ± 1% uncertainty range)
Unemployment is low and actual output is near potential, posing some upside risk to inflation.
0
0.5
1
1.5
2
2.5
3
3.5
4
2001:Jan 2002:Jan 2003:Jan 2004:Jan 2005:Jan 2006:Jan 2007:Jan
CPI 12-mo
CPI 6-mo
CPI 3-mo
*s indicatetrends without
March data
16
Summary
• Risks to the real economy– Key downside risks
• Housing sector, capital spending– But some upside risk too
• Consumer spending is projected to slow quite a bit, with a rise in the saving rate
• The rise in savings doesn’t have to happen
• Risks to inflation as well– Recent data do not conclusively show a downtrend in
inflation– The economy is at or near full employment
• Policy is attempting to balance these risks at its current setting