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Overview

Using the book to understand the state of the U.S. economy 14.02 – last class, December 14, 2005 Francesco Giavazzi. Overview. Despite significant disturbances… additional large energy price increases major hurricanes … the US economy keeps growing. GDP Growth: Remarkable Stability.

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Overview

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  1. Using the book to understand the state of the U.S. economy14.02 – last class, December 14, 2005Francesco Giavazzi

  2. Overview Despite significant disturbances… • additional large energy price increases • major hurricanes … the US economy keeps growing

  3. GDP Growth: Remarkable Stability % Change - Annualized Rate % Change - Annualized Rate Top 10 May 2005 Consensus Forecast October 2005 Consensus Forecast Actual Bottom 10 Source: Bureau of Economic Analysis and Blue Chip Economic Indicators Note: Dashed lines represent average of the top and bottom 10 forecasts.

  4. … the US economy keeps growing, but • is this growth rate consistent with stable inflation? • are imbalances building up?

  5. Trying to answer these questions using our model • Aggregate demand growth Y = C + I + G ΔY/Y = ΔC/C * C/Y + ΔI/I * I/Y + ΔG/G * G/Y • Okun’s law u – u-1 = - b (ΔY/Y - ΔYn / Yn) = - b (ΔY/Y - 0.03) • Phillips curve (with πe = π-1 ) π – π-1 = - a (u – un ) • CA = S private + S public - I

  6. AD • Y = C + I + G • ΔY/Y = ΔC/C * C/Y + ΔI/I * I/Y + ΔG/G * G/Y • ΔY/Y = ΔC/C * 0.7 + ΔI/I * 0.2 + ΔG/G * 0.1

  7. Consumer Spending Remains Robust % Change - Year to Year % Change - Year to Year Real Personal Consumption Expenditures Note: Shading represents NBER recessions. Source: Bureau of Economic Analysis

  8. But Consumer Confidence Has Dropped Sharply Index Index Conference Board Consumer Confidence Michigan Consumer Sentiment Source: University of Michigan and the Conference Board Note: Shading represents NBER recessions.

  9. Investment: Housing Starts and Home Prices Remain Strong Thousands of Units % Change - Year to Year OFHEO Home Price Index (Right Axis) Single-Family Housing Starts (Left Axis) Source: Census Bureau and Office of Federal Housing Enterprise Oversight Note: Shading represents NBER recessions.

  10. Investment Growth Has Recovered Well % Change - Year to Year % Change – Year to Year All Other Info Processing Equipment and Software Source: Bureau of Economic Analysis Note: Shading represents NBER recessions.

  11. T - G: Changes in the full employment budget balance(percent of potential output) GRH-1 85 GRH-2 87 BEA 90 OBRA 93 BEA 97 Fiscal Year Source: Congressional Budget Office Note: Shading represents NBER recessions.

  12. Federal budget forecasts Percentage of GDP Percentage of GDP Optimistic Forecast Pessimistic Source: Congressional Budget Office and Goldman Sachs. Note: Shading represents NBER recessions.

  13. AD • ΔY/Y = ΔC/C * C/Y + ΔI/I * I/Y + ΔG/G * G/Y • ΔY/Y = ΔC/C * 0.7 + ΔI/I * 0.2 + ΔG/G * 0.1 • ΔY/Y = 3 * 0.7 + 8 * 0.2 + ? = 3.7 + ?

  14. Forecast Comparison: May and November 2005 FRBNY Forecast Source: Federal Reserve Bank of New York

  15. Is current growth rate consistent with stable inflation? Okun’s law u – u-1 = - b (ΔY/Y - 0.03) 0.03 derived from assumptions: • productivity growth, 2% • labor force growth, 1% Phillips curve π – π-1 = - a (u – un ) un= ? π – π-1 = 0  u = un ΔYn / Yn =ΔY/Y

  16. Labor Market • Until the hurricanes, solid employment growth • Latest headline numbers are off, but distorted by hurricane effects • Productivity growth remains solid • Labor costs edging up

  17. Employment Solid Until the Hurricanes Hit Change in Private Employment, Three-Month Moving Average Thousands Thousands Source: Bureau of Labor Statistics Note: Shading represents NBER recessions.

  18. Unemployment Drifting Down, Participation Leveling Percent Percent Unemployment(Left Axis) Source: Bureau of Labor Statistics Note: Shading represents NBER recessions.

  19. Unemployment Drifting Down, Participation Leveling Percent Percent Unemployment(Left Axis) Participation(Right Axis) Source: Bureau of Labor Statistics Note: Shading represents NBER recessions.

  20. Is current growth rate consistent with stable inflation? u – u-1 = 0 ( or even < 0 ) Other evidence on potential output growth ? u – u-1 = b (ΔY/Y - 0.03) 0.03 : depends on productivity growth

  21. 1003 Productivity Growth Nonfarm Business Sector % Change - Year to Year % Change - Year to Year Output per Hour Source: Bureau of Labor Statistics Note: Shading represents NBER recessions.

  22. 1003 Productivity Remains Solid, Unit Labor Costs UpNonfarm Business Sector % Change - Year to Year % Change - Year to Year Output per Hour Unit Labor Costs Source: Bureau of Labor Statistics Note: Shading represents NBER recessions.

  23. The Phillips Curve π – π-1 = a (u – un ) un= ? π – π-1 = 0  u = un ΔYn / Yn =ΔY/Y

  24. Which inflation rate should we look at ? • Headline inflation reflects oil price surge • Core inflation excludes food and energy: it moves closer to wages

  25. Nominal Wages % Change - Year to Year % Change - Year to Year ECI: Private Industry Wages and Salaries Total PrivateAverage Hourly Earnings Source: Bureau of Labor Statistics Note: Shading represents NBER recessions.

  26. PCE Deflator: Total Up Sharply, Core Relatively Flat % Change - Year to Year % Change - Year to Year Total PCE Core PCE Source: Bureau of Economic Analysis Note: Shading represents NBER recessions.

  27. Oil Prices Remain Elevated Crude Oil Futures Prices $/Barrel $/Barrel May 13 (Last EAP) Source: Bloomberg

  28. Oil Prices Remain Elevated Crude Oil Futures Prices $/Barrel $/Barrel August 26 (Pre-Katrina) May 13 (Last EAP) Source: Bloomberg

  29. Oil Prices Remain Elevated Crude Oil Futures Prices $/Barrel $/Barrel August 30 (Post-Katrina High) August 26 (Pre-Katrina) May 13 (Last EAP) Source: Bloomberg

  30. Oil Prices Remain Elevated Crude Oil Futures Prices $/Barrel $/Barrel August 30 (Post-Katrina High) August 26 (Pre-Katrina) November 3 (Current) May 13 (Last EAP) Source: Bloomberg

  31. Can we measure inflation expectations? TIPS Percent Percent 0-2 Years 2-3 Years 3-5 Years Note: Data from 8/19/05 to 8/31/05 is currently unavailable Source: Bloomberg, 8:40AM quotes and FRBNY Calculations

  32. So, what should the Fed do ? • In 2 years the Federal Funds rate has been raised from 1,5 % to 4,25 % • And financial markets expect more rate increases, with Fed Funds stabilizing around 4,5 %

  33. Funds Rate Rate Percent Percent Last rate hike December 13 Actual Fed Funds Rate Source: FRBNY.

  34. Higher nominal rates have raised real rates as well (TIPS Yields) Percent Percent Ten-Year Yield Five-Year Yield Constructed Two-Year Yield Note: Two-year yield was constructed from a combination of interpolating and extrapolating yields of ten-year bonds maturing 1/15/2007 and 1/15/2008. Yields are not adjusted for carry. Source: Bloomberg and FRBNY Calculations

  35. What do financial markets expect? Expected Funds Rate Path Has Risen, Steepened Percent Percent May 13 May 13 – Last EAP August 8: Day Before August FOMC September 19: Day Before September FOMC November 1: Current Source: Federal Reserve Board

  36. Expected Funds Rate Path Has Risen, Steepened Percent Percent August 8 May 13 May 13 – Last EAP August 8: Day Before August FOMC September 19: Day Before September FOMC November 1: Current Source: Federal Reserve Board

  37. Expected Funds Rate Path Has Risen, Steepened Percent Percent August 8 September 19 May 13 May 13 – Last EAP August 8: Day Before August FOMC September 19: Day Before September FOMC November 1: Current Source: Federal Reserve Board

  38. Expected Funds Rate Path Has Risen, Steepened Percent Percent November 3 August 8 September 19 May 13 May 13 – Last EAP August 8: Day Before August FOMC September 19: Day Before September FOMC November 1: Current Source: Federal Reserve Board

  39. But how powerful is the Fed ? • Investment depends on “long” rates • but the Fed only controls “short” rates

  40. The Yield Curve Has Risen and Flattened Percent Percent November 3 October 24 May 13 Maturity Date (Years) Source: FRBNY Calculations *Estimated using off-the-run Treasury securities

  41. But “Conundrum” Remains in Forward Rates Percent Percent November 3 October 24 May 13 Maturity Date (Years) Source: FRBNY Calculations

  42. Short-Term Real Rates Up, Long-Term FlatTreasury Yield minus Philadelphia Fed Survey Inflation Expectations Percent Percent 10-Year 1-Year Source: Federal Reserve Board and Philly Fed Note: Shading represents NBER recessions.

  43. NX • Export growth has strengthened • But imports keep running faster than exports • Current account deficit has leveled off (as percent of GDP)

  44. Importazioni e esportazioni

  45. CA = S private + S public - I Net National Saving = (Private + Public Saving) – Investment = Current Account = (Exports – Imports) + Net Investment Income

  46. Households Saving % Change - Year to Year % Change - Year to Year Real PCE Forecast Real Disp. Personal Income Percent Percent Personal Saving Rate (% of DPI) Source: U.S. Bureau of Economic Analysis. Note: Shading represents NBER recessions.

  47. Public SavingsChanges in the full employment budget balance (% of potential output) GRH-1 85 GRH-2 87 BEA 90 OBRA 93 BEA 97 Fiscal Year Source: Congressional Budget Office Note: Shading represents NBER recessions.

  48. The Current Account Deficit SAAR, Bill$, BOP Basis % of GDP % of GDP (Right Axis) Current Account Balance (Left Axis) Source: Bureau of Economic Analysis

  49. US external debt: 25% of gdp

  50. Who finances the United States?

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