Testimony for Hearings on FY 2008 Revenues Yolanda K. Kodrzycki Senior Economist and Policy Advisor Federal Reserve Bank of Boston Presented to: Massachusetts House and Senate Ways and Means Committees January 16, 2007

2 Summary of testimony Massachusetts economy poised to show moderate output and income growth in CY Projection premised on U.S. economy growing at or a little below its trend rate. Housing sector will put a damper on overall U.S. and MA economic growth in CY Labor force slowdown in MA poses longer-term uncertainties, but implications for revenue estimates not clear.

3 U.S. economic outlook for CY 2007 Moderate growth expected –2006: GDP grew at approximately its potential (trend) 2007: growth expected to be similar or a little weaker Energy prices –Recent declines boost real income and ease inflation Housing market –Presents a challenge

4 Sales are down, but they appear to be flattening… Source: Census Bureau. Construction has slowed significantly, and will continue to slow… New single-family sales (left scale) Existing single-family sales (right scale) Thousands of units, annual rates Single-family permits Single-family housing starts Thousands of units, annual rates Weak housing market is slowing the economy

5 … until the large stock of unsold homes are purchased Nationwide, house prices have flattened. Months’ supply of new 1-family homes at current sales rate Ratio OFEHO U.S. House Price Index (right scale) New Home Sales, Median Price (left scale) DollarsIndex, 1980:Q1 = 100 Source: Office of Federal Housing Oversight (house price index) and Census Bureau :Q32003:Q12003:Q32004:Q12004:Q32005:Q12005:Q32006:Q12006:Q

6 But the consumer remains upbeat Employment continues to expand steadily Source: Bureau of Labor Statistics. Recent job growth has been a bit above the rate consistent with maintaining full employment Monthly employment growth consistent with growth in the labor force Total nonfarm employment (left scale) Private nonfarm employment (right scale) Thousands Change, 3-month moving average Total nonfarm employment average 3-month change Private nonfarm employment average 3-month change

7 Strong job growth and declining energy prices are boosting real incomes Dollars per barrel Real disposable personal income (right scale) Domestic spot oil price (left scale) Growth, previous 12 months Sources: Wall Street Journal (oil) and Bureau of Economic Analysis (real DPI).

8 Capital spending fundamentals remain reasonable Orders are running a bit ahead of shipments, suggesting modest investment growth Source: Census Bureau (top panel) and Bureau of Economic Analysis (bottom panel). Profits and productivity continue to promote investment $ Millions, SAAR Manufacturers’ shipments of nondefense capital goods excluding aircraft Manufacturers’ new orders for nondefense capital goods excluding aircraft Growth, previous 4-quartersShare of GDP Profit Share (right scale) Nonfarm productivity (left scale)

9 Financial conditions remain supportive Broad stock price indexes are up over the past year And the 10-year Treasury remains below 5%, with corporate yields maintaining recent spreads Sources: Wall Street Journal (Dow Jones and Wilshire), Standard and Poor’s (S&P 500), Board of Governors of the Federal Reserve System (treasury yield) and Merrill Lynch (Corporate yield). Index, 6/1/2006 = 1.0 Dow Jones Industrial Average Wilshire 5000 S&P year Treasury rate, constant maturity 7-10 year Investment grade corporate yield Percent

10 Massachusetts economic conditions Employment recovery has been only so-so… -Since recession low point, MA has added 56,000 jobs, or 1.8 percent (vs. 4.8 percent nationally). But personal income growth is now on track. And forward-looking indicators point to solid economic growth for CY 2007.

11 Massachusetts’ job growth has been up and down on a monthly basis, but fairly steady year-over-year. Monthly Employment Change in Massachusetts, Thousands of Jobs Employment: Percent Change from Year Earlier Source: U.S. Bureau of Labor Statistics United States Massachusetts Note: Gray shaded area indicates 10 and 90 percentile boundaries for the 50 states. Source: U.S. Bureau of Labor Statistics.

12 Sectors with highest job gains: education & health services, professional, scientific & business services, financial activities. Employment by Industry: Percent Change, Nov 2005 – Nov 2006 Source: Bureau of Labor Statistics

13 Source: Bureau of Economic Analysis Note: Gray shaded area indicates 10 and 90 percentile boundaries for the 50 states. United States Massachusetts MA real personal income now rising at almost the same pace as national. Real Personal Income: Percent Change from Year Earlier Source: Bureau of Economic Analysis.

14 Forward-looking indicators such as AIM business confidence and U Mass leading index are solidly in positive territory. Source: Associated Industries of Massachusetts and the University of Massachusetts. U Mass Leading Index (left scale) AIM Business Confidence (right scale) Predicted growth over next six-months Readings above 50 are generally optimistic

15 Source: Census Bureau. Existing single-family sales Thousands of units, annual rates Single-family permits Housing units, seasonally adjusted Massachusetts housing sales and construction have slowed.

16 Repeat Sales Home Price Index: Percent Change from Year Earlier Source: Office Of Federal Housing Enterprise Oversight United States Massachusetts Home price appreciation has downshifted: MA house prices fell in the 2nd and 3rd quarters. Note: Gray shaded area indicates 10 and 90 percentile boundaries for the 50 states.

17 United StatesMassachusetts Foreclosures have risen in recent months, especially in subprime market. Foreclosures initiated in quarter, as a percent of loans in pool. Source: Mortgage Bankers Association

18 Construction accounts for a relatively small share of the MA economy. Source: Bureau of Labor Statistics

19 Sources: National Real Estate Index, CB Richard Ellis. United States Boston Note: Shaded areas indicate 10 and 90 percentile boundaries for 60 selected metropolitan areas. Recovery in commercial real estate markets may provide a boost to offset softer housing. Office Vacancy Rates, DowntownOffice Vacancy Rates, Suburban Adjusted Asking Rent per S/F, DowntownAdjusted Asking Rent per S/F, Suburban

20 The MA labor force has not grown since constraint on future job growth? Source: Bureau of Labor Statistics Index, 1996 = 1.00 **Assuming zero net in-commuting in 1996, then increasing gradually to 60,154 in Source of 2004 net in-commuting estimate: Massachusetts Institute for a New Commonwealth. Mass Economy: the Labor Supply and Our Economic Future, Table 8, page 38. *2006 annual average estimated as average of January-October seasonally adjusted data. US MAMA, adjusted for cross- state commuting**

21 Concerns focus on loss of 25- to 44- year olds. Source: Census Bureau

22 For FY revenue estimates: LF slowdown is occurring nationwide may not constrain income growth. Source: Bureau of Labor Statistics