Proprietary and Confidential. Not for disclosure outside Federal Reserve.

Sorting Out the Current

Economic Situation

Gary W. Tapp, Ph.D.Director, Economic EducationFederal Reserve Bank of AtlantaSept. 25, 2012

The views expressed are mine, and not necessarily those of the Atlanta Fed or the Federal Reserve System.

Framework I: We Live in an Interdependent World Economy

• The world is in the early stages of a new stage of development, driven by global capitalism, instant communication, technology, and financial innovation.

• A doubling of world labor force has lowered the returns from low wage labor and boosted returns from knowledge-based jobs. Workers in export-related industries went from 300m to 800 m.

• China and other developing countries need U.S. spending to keep their exports growing.

• With its dollars, China buys U.S. securities, which offer superior safety and comparable rates. U.S. borrows China’s surplus savings to finance our growth.

• Biggest investment risks going forward are likely to come

from this global linkage.

2

Framework II: One of Worst Recessions Ever

The Fed’s response

• Lowered short-term interest ratesOvernight bank rate cut from 5.25 percent to 0-25 percent in Dec. 2008

• Temporarily extended terms and kinds of collateral for lending to banks and to nonbank marketsCommercial paper, money market funds, ABS (asset-backed securities) markets (various types of consumer loans, commercial real estate, etc.)

• Supported mortgage marketsPurchases of agency MBS (mortgage-backed securities)

• Purchased longer-term Treasuries To help improve conditions in the private credit markets.

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6

QE2MortgageLSAP

New Reserves in the Banking

System

What is QE (Quantitative Easing)? We’ve been buying assets, and using newly created reserves to pay for them.

QE1

But Fed Cannot Do It All

• If needed, the Fed can continue to add liquidity to financial system by purchasing long-term Treasuries.

• If the recovery accelerates and inflation expectations increase, the Fed can withdraw liquidity through a variety of tightening tools (in order to prevent inflation from re-emerging).

• But responsible fiscal policy and increased confidence are also needed to restore sustainable economic growth.

• Global economies are more closely linked than ever.

6

Framework III: Recovery from A Financial Crisis Usually Is Slow

• A study of 26 economic downturns associated with financial crises (Reinhart and Rogoff) found that GDP growth in the recovery was reduced on average from 3.5%/year to 2.3%/year.

• Public and private deleveraging takes time. Financial institutions are cautious about new lending. Consumers and corporations also are cautious about increasing spending.

• In countries where public debt was 90% or more of GDP, the period of slower growth persisted for (on average) 23 years.

• Currently, the CBO forecasts US debt to reach about 70% of GDP at the end of 2012.

8

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12-750

-600

-450

-300

-150

0

150

300

450

600

2.5

3.5

4.5

5.5

6.5

7.5

8.5

9.5

10.5

11.5

Payroll Employment & Unemployment RateJune 2012 percent monthly change, thou-

sands

Unemployment Rate(June 2012 = 8.2%)

Nonfarm Payrolls (June 2012 = 80k)

Source: U.S. Bureau of Labor Statistics

Job Recovery Weak in Last Two Expansions

8

Long-Term Job Growth: Note Weaker Recoveries

-12 -9 -6 -3 0 3 6 9 12 15 18 21 24 27 30 33 36 39 42 45 480.8

1.0

1.2

1.4

1.6

1.8

2.0

2.2

Part-Time for Economic ReasonsIndexed to Start of Recession=1; through

June1973-75 1980 1981-82 1990-91 2001

Months Before/After Peak

Dots represent end of reces-sion

Source: U.S. Bureau of Labor Statistics

And underemployment is significantly higher than in past recessions.

Jobs are being created, but labor force participation fell again – to its lowest level in 43 years. (August 2012 data)

12Source: Bureau of Labor Statistics

Population aging accounts for about 40% of the decline in participation since 2000. Explanations for the rest of the decline: schooling, disability, and some other stuff.

To get an unemployment rate of 6.5% by the end of 2014 . . .

Sources: Federal Open Market Committee, Federal Reserve Bank of Atlanta

With a Labor Force Participation Rate of:

The economy will need to create about this many jobs per month on average:

63.5% (August rate) 181,600

64.0% 218,000

66.0%(pre-recession)

363,700

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http://www.frbatlanta.org/chcs/calculator/

Jobless recoveries and job polarization

• Definition • Job polarization: the disappearance since the 1980s of employment in

occupations in the middle of the skill distribution

• Findings [Based on research by Nir Jamiovich and Henry Siu (2012)]• Job polarization is not a gradual process; mostly occurring during

economic downturns

• Jobless recoveries are associated with the disappearance of middle-skill occupations (most of which involve performing routine tasks)

• Technology is biased against routine tasks

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Consider Four Broad Occupational Groupings

• Non-routine cognitive: management, finance, legal, science, engineering, healthcare practitioner

• tend to be high-skill occupations• Non-routine manual: healthcare support, food prep, janitorial, etc.

• tend to be low-skill occupations• Routine cognitive: sales-related, office and admin support

• tend to be middle-skill occupations• Routine manual: production, material moving, construction

• tend to be middle-skill occupations

15

Change in Employment Shares by Job Type Over The Last 3 Decades Shows Hit to Routine Jobs

16Source: Jamiovich and Siu (2012)

Education Is The Key!

• August 2012 Unemployment Rates (age 25+)

• Less than High School: 12.0%• High School Graduates: 8.8%• Some College or Associate: 6.6%• College Graduates: 4.1%

• Source: Bureau of Labor Statistics, Sept. 7, 2012

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Is Housing Finally Rebounding?

SUMMARY

Economic and Financial Highlights

• HOUSING

•The National Association of Realtors reported total existing home sales increased 2.3 percent from June to July and increased 10.4 percent compared with a year ago.

• 

188/22/2012

00 01 02 03 04 05 06 07 08 09 10 11 123,000

4,000

5,000

6,000

7,000

3

4

5

6

7

8

9

10

11

12

Sales and Months' Supply of Existing Single-Family Homes

SFR Sales Months' Supply

Source: National Association of Realtors

thousands, SAAR months, NSA

through July 2012

20

Nationally, prices are recovering.

21

In Atlanta, not so much.

22Sources: Bureau of Economic Analysis; Blue Chip Economic Indicators April 2012, July 2012, and August 2012

Outlook: Private forecasters have lowered GDP growth estimates for the balance of the year and for early 2013.

Fiscal Cliff: CBO Estimated Impact: If no change in current law, the CBO estimates about a 3% decline in real GDP growth in the first half of 2013 and a recession for the year as a whole.

Source: Bureau of Economic Analysis; Congressional Budget Office 23

01 02 03 04 05 06 07 08 09 10 11 12-3

-2

-1

0

1

2

3

4

5

6

Consumer Price Indexyear-over-year % change

through June 2012Source: Bureau of Labor Statistics

Head-line

Core FOMC Objective

24

CPI annualized % change

1-month

3-month

6-month

Headline 0.5 -0.8 1.4Core 2.5 2.6 2.4

Trimmed-mean 1.9 1.6 2.0Sticky Price 2.3 2.3 2.3

Inflation Currently Appears Under Control

GDP: U.S. Recovering Better Than Europe

Sources: Eurostat, Bureau of Economic Research

IV: What Next? Stock Market Often A Leading Indicator

Through 9/11/2012

Near-Term Uncertainties for Economy and Markets

• What will drive an economic recovery?• Banks, businesses, consumers are all cautious

• Fiscal policy seems paralyzed• Possible debt contagion from overseas• Possible slowing of export demand from Europe and

China• Stock market is up 100% from 2009 low; bull market will

be 4 years old in March. Is it ahead of itself?

29

Longer-Term Issues

• Is part of UE rate structural?• Global markets and economies linked more than ever• Will debt crisis be addressed?• Can political parties work together on SS, Medicare, etc.?• Will increasing income inequality raise social unrest?• How to deal with systemically threatening institutions?• Is the “unproductive” part of financial sector too large?• Internet + increased global capacity pressure corporate profit

margins• Markets: Disillusionment of individual investor: a long-term issue?• Markets: Rise of high frequency trading distorting market?

Positive Long-Term Driving Forces for U.S. Economy• Culture of Risk and Innovation in U.S Drives New Business

Creation.

• Free-Enterprise Economy with Well-Established Judicial and Regulatory systems.

• U.S. government owns only 2.2% of U.S. market cap vs. China (67%), Russia (35%), India (29%), Brazil (14%).

• A Nation of Immigrants: Population Growth is Key to GDP Growth. 1.2m immigrants per year. 1/3 of U.S. population growth is due to immigration. 1995-2005, immigrants created 25% of U.S. high tech start-ups

• U.S. working age population will grow 16% from 2000-2025 vs. Russia (-16%), Japan (-15%), Italy (-15%), Germany (-11%).

• Over 60% of U.S. households are still homeowners.31