December 2007 Thomas Jefferson Institute 2007 Innovations in Government Conference: Economic Update

2 Overview Elevated uncertainty with national growth slow through early next year –Lack of home price appreciation/sub-prime lending issues = drag on consumer spending –No recession; further Fed ease is unlikely Virginia ranked 16 th in the nation (job growth) Northern Virginia not the fastest growing region but creating the most jobs

Real GDP Almost Stalled in 1 st Qtr; 4.9% in 3 rd Quarter Data through 3 rd Quarter Recessions are shaded.

Residential Building Impact on Real GDP

Fed’s Preference? Recession or Accelerating Inflation? “The Federal Reserve sets the nation’s monetary policy to promote the objectives of maximum employment, stable prices, and moderate long-term interest rates. The challenge for policy makers is that tensions among the goals can arise in the short run and that information about the economy becomes available only with a lag and may be imperfect.” The Federal Reserve has supervisory and regulatory authority over a wide range of financial institutions and activities. It works with other federal and state supervisory authorities to ensure the safety and soundness of financial institutions…. August 17 action was sector-specific (liquidity in financial markets) September 18 action acknowledged spillover to the broader economy October 30/31 cut another 25 bps December 11 cut another 25 bps to 4.25%

December 11 FOMC Press Release Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks. Today’s action, combined with the policy actions taken earlier, should help promote moderate growth over time. Readings on core inflation have improved modestly this year, but elevated energy and commodity prices, among other factors, may put upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully. Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Probability of Recession = 29% for May 2008 Data through May Source: Chmura Economics & Analytics.

Will the Fed Ease Further? Inflation is at the top end of the Fed ‘comfort zone’ (argues against easing) –Weaker dollar causes higher import prices –Oil prices Interest rates are accommodative Outside of residential market, economy continues to grow

Federal Funds Rate Target is Neutral

Consumers are Still Spending No Inventory Imbalances Data through November 2007.

Industrial Production Slowed but Still Growing Data through November 2007.

IT Output Still Near 20% Data through November 2007.

Slowdown is Mainly Housing-Related (Production for Housing Materials is Off) Data through August 2007.

Housing Sector is in Recession (Near 14- Year Low, Down 46% From January 2006) Data through October 2007.

National Forecast Actual Forecast Qtr 4Qtr 1Qtr 2Qtr 3*Qtr 4Qtr 1Qtr 2Qtr 3 Quarterly Annualized Rates Real Gross Domestic Product Consumptions Expenditures Residential Investment Nonresidential Investment Equipment and Software Government Expenditure Net Exports, Goods & Services (Billions of 2000 Dollars) Percentage Change from a Year Ago (%) Consumer Price Index Yields (%) Federal Funds Rate Prime Rate Year Treasury Year Conventional Mortgage Source: Chmura Economics & Analytics Note: Yields reported for the average of the quarter

Summary of US Growth Housing contribution to GDP turns slightly positive in 3 rd quarter but housing starts remain flat through 2008 No more Fed ease Overall GDP at 1.9% in 2007 (2.9% in 2006) Risks: –Oil rises further –International investors pull out of bond market –Subprime mortgage leads to broader credit crunch

Credit Crunch? Recent Fed Comments David Kohn, Oct. 5, 2007 –‘..credit availability is likely to be a little tighter than before…’ –‘…we would not have eased policy if the outlook for inflation had not been favorable.’ –‘…you should view these forecasts even more skeptically than usual.’ Chairman Bernanke, Nov. 8, 2007 –“He said the Fed's policy committee sees growth slowing "noticeably" in the current quarter and remaining "sluggish during the first part of next year" but "then strengthening as the effects of tighter credit and the housing correction began to wane.“ (WSJ, 11/9/07)

State Rankings, Employment Year-over-Year October 2007 Utah +4.2%, 51,400 Wyoming +3.4%, Ohio -0.02%, -11,500 Michigan -1.5%, -75,000 VA 1.5%, 56,000 jobs # 16

Employment in VA Back Above National Pace Data through October 2007.

Employment Growth by Sector

Initial Claims are Flat in Virginia Data through October 2007.

Northern Virginia Slows to State Average (20,000 jobs) Data through October 2007.

Employment by Sector

4 th Quarter % (Benchmark) Covered Employment and Wages = -0.1%

Labor Market to Remain Weak in NVA Data through October 2007.

Housing Permits Off 46% From Peak Data through October Source: Chmura Economics & Analytics, U.S. Census.

NVA Housing Activity; Off 58% From Peak Data through October Source: Chmura Economics & Analytics, U.S. Census.

Permits Fell 72% in the Early 1990s Data through May Source: Chmura Economics & Analytics, U.S. Census.

Home Prices Have Risen Data through 2 nd Quarter Source: Chmura Economics & Analytics, Office of Federal Housing Enterprise Oversight

…Making Homes Less Affordable Data through 2 nd Quarter Source: Chmura Economics & Analytics, Office of Federal Housing Enterprise Oversight

Virginia Ranks 23 in Number of Foreclosures; 35 th Based on Per Capita

Imbalances Still Exist…13 Month Supply Source: MLS Data through September 2007.C

Retail Sales Have Slowed Considerably Data through October 2007

Initial Claims are Holding Steady Data through November 2007

Carpenters Filing Unemployment Still Rising Data through November 2007

Carpenters in N.VA Filing Unemployment Claims Data through November 2007

Employment Annual Percentage Change Chmura Economics & Analytics.

40 Take Aways U.S. growth remains sluggish through first half of 2008 No more Fed ease… accelerating inflation is an issue Virginia continues at national average Construction employment dragging down Northern Virginia employment growth Recession not in forecast for early 2008