Economic Assessment Wade Rousse Economic Outreach Specialist Federal Reserve Bank of Chicago IASET Chicago, IL December 12, 2008

The economy entered a recession in the first quarter of 2008

Home price declines are larger outside the Midwest

Housing starts have fallen sharply

The supply of new single family homes is extremely high

Home price changes over the past year has been mixed

Foreclosure filings are quite high in California, Florida, Nevada and Arizona

Mortgage rates remain low

Housing affordability has improved quite a bit

Lending standards for mortgage loans have tightened considerably

Consumer attitudes for buying a home remain very low

Residential investment growth fell off sharply, subtracting a full percentage point off of GDP growth over the past year

Residential investment as a share of GDP is approaching previous lows

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 currently are at the historical average

Removing the volatile food and energy components from the PCE, “core” inflation has been averaging just above two percent

Employment decreased by 1,870,000 jobs over the past year

The unemployment rate has been rising

Productivity growth remains solid

Real incomes are unchanged with a year earlier

The stock market losses are significant

Consumer spending fell sharply in the third quarter

Third quarter GDP edged lower, weighed down by a decline in consumption and residential investment

Corporate profits have been declining

Given the large trade deficit, the dollar has been under pressure since the beginning of 2002, losing 14.1% of its value over this period

Import growth has been below export growth since early 2005

Net exports contributed quite a bit to GDP growth last year

Manufacturing output has fallen quite sharply

New orders for capital goods has begun to slip and shipments have been edging lower

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

The “flight to quality” drove down Treasury yields

Causing credit spreads between them to increase by more than 200 basis points

The three-month average of the Chicago Fed National Activity Index has weakened substantially over the past couple of months

Concerned that the tightening of credit conditions has the potential to slow economic growth, the Fed lowered the Fed Funds rate by 425 basis points

Real GDP growth is expected to: decline quite considerably in the current quarter; fall by nearly half as much in the first quarter of next year; remain unchanged in the second quarter; and then increase in the second half of 2009 Forecasts are from the Twenty-second Annual Economic Outlook Symposium

With economic growth being well below trend, the unemployment rate is projected to continue rising throughout 2009, reaching 7.8% in the final quarter of next year Forecasts are from the Twenty-second Annual Economic Outlook Symposium

The outlook is for the U.S. economy to struggle through most of next year with an elevated risk of recession Summary Employment is expected to remain weak this year and next, leading to a continued rise in the unemployment rate Slackness in the economy will lead to a lower 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