Economic Assessment The Transformer Association William Strauss Rosemont, IL May 13, 2009 William Strauss Senior Economist and Economic Advisor Federal Reserve Bank of Chicago

The three-month average of the Chicago Fed National Activity Index weakened substantially in the second half of 2008

The economy entered a recession in the first quarter of 2008

First quarter GDP was driven down by large decreases in business fixed investment and inventories

GDP growth is forecast to be quite weak this year, but then grow closer to trend in 2010

Potential Historical Context Blue Chip Forecast for Current Episode Average Range Consensus Duration (months) 11 6 to 16 18-24 Change in GDP2 -1.7 -0.4 to -3.1 -3.73 Maximum Unemployment Rate2 7.8 6.1 to 10.8 9.8 Change in payroll employment2 -2.1 -1.3 to -3.1 -4.5 to -5.04 1. Calculated over the 1960-61, 1969-70, 1973-75, 1980, 1981-82, 1990-91, and 2001 recessions. Percent change from peak to trough of GDP. Starting from the peak of GDP in the second quarter of 2008. My guess. – through April 2009 employment is down 4.2% How does this add up? Longer than average – less GDP decline – not a record unemployment rate (though base is likely 1 percentage point less) Max employment losses (though due to less working age population growth, the base is x.x percent lower now)

Inflation has reversed its upward trajectory

In large part due to the movement of oil prices

Adjusted for inflation - current oil prices are well below early 1980s prices

Expenditures on energy increased over the past few years, and they are currently well below the historical average

Removing the volatile food and energy components from the PCE, “core” inflation has entered the “comfort zone”

Inflation is anticipated to moderate this year and then rise by two percent in 2010

Employment has fallen by over 5.7 million jobs since December 2007

The unemployment rate has risen to the highest level since September 1983

The unemployment rate is forecast to peak at 9 The unemployment rate is forecast to peak at 9.8% early next year and then begin to edge lower

Employment recoveries have taken much longer over the past two cycles

Light vehicle sales collapsed

In an attempt to keep inventories in line with falling sales light vehicle production has been cut back quite severely

Consumer attitudes about buying a vehicle is very low

Increases in new domestic production share has offset losses in Detroit-3 market share

Manufacturing production fell off sharply beginning in the second half of 2008

Manufacturing capacity utilization has fallen to the lowest levels in more than 70 years

Purchasing managers’ composite index has improved

The new orders component has improved significantly

Residential investment fell off sharply beginning in 2006

Residential investment as a share of GDP is very low

The supply of new single family homes is extremely high

Housing starts have been cut-back sharply

Housing starts have fallen to a new post WWII low

When you take into account the growth of households, it is an even more dramatic decline

Mortgage rates are very low

Home price declines are large

Home price have fallen by over eight percent over the past year with large differences across regions

Housing affordability has improved dramatically

Yet, consumer attitudes for buying a home remain very low

Lending standards for mortgage loans remain tight

Corporate High Yield rates increased beginning in June 2007

Credit spreads between Corporate High Yield securities and Corporate Aaa securities rose by over 1,400 basis points, but have been improving over the past several months

Last fall’s volatility in LIBOR rates was in large part due to a “flight to quality”

Credit spreads between LIBOR and Treasury rates have substantially improved

The Fed has been very aggressive, lowering the Fed Funds rate by nearly 525 basis points

The Fed’s balance sheet has expanded in size and in composition

Summary The outlook is for the U.S. economy to struggle through most of this year and then grow at a solid pace next year Employment is expected to remain weak this year, leading to a continued rise in the unemployment rate Slackness in the economy will lead to a relatively low inflation rate over the coming year The volatile credit markets and the weak housing market are the biggest risk on the horizon for the U.S. economy

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