February 21, 2008Kevin L. Kliesen 1 The Outlook for the U.S. Economy Professors Conference, Federal Reserve Bank of St. Louis St. Louis, Missouri February 21, 2008 Kevin L. Kliesen Economist Not an official document

February 21, 2008Kevin L. Kliesen 2 Outline of Talk 1.The Fed’s Operating Strategy 2.The Big Picture and Current Developments 3.What Do the Recession Indicators Say? 4.The Near-Term Consensus Forecast 5.Risks to the Outlook

February 21, 2008Kevin L. Kliesen 3 Disclaimer

February 21, 2008Kevin L. Kliesen 4 Release Date: January 30, 2008 For immediate release The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 3 percent. Financial markets remain under considerable stress, and credit has tightened further for some businesses and households. Moreover, recent information indicates a deepening of the housing contraction as well as some softening in labor markets. The Committee expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully. Today’s policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity. However, downside risks to growth remain. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risks.

February 21, 2008Kevin L. Kliesen 5 From the Fed’s perspective, the big picture is an assessment of where: 1.The economy currently is relative to its potential; and 2.Current inflation is relative to what is expected over the near-term and over the longer-term. The Big Picture

February 21, 2008Kevin L. Kliesen 6 First, the economy relative to its potential: The Big Picture NOTE: Potential GDP measured by the Congressional Budget Office.

February 21, 2008Kevin L. Kliesen 7 Second, inflation relative to expectations. NOTE: Shaded area is the FOMC’s central tendency forecast for PCE and core PCE inflation in The Big Picture

February 21, 2008Kevin L. Kliesen 8 The Fed operates in a data dependency framework. Also called “risk management.” Two key aspects of this approach to policymaking are worth noting: –Policymakers give higher weight to low-probability damaging outcomes, than to lower probability, less damaging outcomes. (Bayesian) –Continual updating of “best guess” scenario for the economy as more information becomes available. Risk Management

February 21, 2008Kevin L. Kliesen 9 Recent Economic Developments. 1.The U.S. labor markets deteriorated sharply, and unexpectedly, in January. 2.A key measure of economic activity in the nonmanufacturing sector fell sharply in January. 3.Factory orders and shipments were unexpectedly strong in December. Exports a source of strength. 4.Auto sales weakened in January; non-auto retail sales rose unexpectedly, but... 5.Housing sales, construction and prices appear uniformly weak. 6.Banks still lending, but tightening standards and terms. 7.Financial market strains improve in some areas. 8.Fiscal stimulus package passes, but how important? 9.Recession probabilities on the rise.

February 21, 2008Kevin L. Kliesen 10 Recent Economic Developments

February 21, 2008Kevin L. Kliesen 11 Recent Economic Developments

February 21, 2008Kevin L. Kliesen 12 Feb. 2008

February 21, 2008Kevin L. Kliesen 13 What are the Recession Indicators Telling Us?

February 21, 2008Kevin L. Kliesen 14 21%

February 21, 2008Kevin L. Kliesen 15 53% 11%

February 21, 2008Kevin L. Kliesen 16 18%

February 21, 2008Kevin L. Kliesen 17 Results from a Forward-Looking Probit Model (i.e., estimating the probability of a recession over the following four quarters) The model uses the term structure (3-mo Treasury-bill less the 10-year Treasury note) and the nominal federal funds rate. Estimates from March 2007 (using data through 2007:Q1); probability of the economy being in a recession in 2008:Q1:  58% Estimates from February 2008 (using data through 2007:Q4); probability of the economy being in a recession in 2008:Q4:  9%

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February 21, 2008Kevin L. Kliesen 19 SOURCE: Blue Chip Consensus Forecast

February 21, 2008Kevin L. Kliesen 20 Recent Price and Wage Developments. 1.Inflation in 2007 was 3.5%, the highest in 17 years! 2.Ex food and energy, though, inflation was about the same as last year (about 2.25%). 3.Nonpetroleum import prices rise 3% in 2007, largest increase in three years. 4.Commodity prices surging. $12 per bushel soybeans, $10/bushel wheat and nearly $5 per bushel corn! 5.Crude oil prices still remain high and fairly volatile. 6.A bright spot: Productivity and unit labor costs improved markedly in 2007 (vs. 2006). 7.Inflation expectations—a mixed bag.

February 21, 2008Kevin L. Kliesen 21 Chairman Bernanke’s View At present, my baseline outlook involves a period of sluggish growth, followed by a somewhat stronger pace of growth starting later this year as the effects of monetary and fiscal stimulus begin to be felt. At the same time, overall consumer price inflation should moderate from its recent rates, and the public's longer-term inflation expectations should remain reasonably well anchored.

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February 21, 2008Kevin L. Kliesen 25 1.Economic growth looks to be fairly weak over the first half of the year—well below trend growth. 2.As far as a recession goes... It’s a coin toss. 3.Price pressures may moderate if growth remains weak for a few quarters, but no guarantees (Plosser). 4.Further declines in the dollar, continued strength in commodity prices, a seasonal upturn in oil prices, and an over aggressive easing all have the potential to keep inflation above the Fed’s preferred range. The Near-Term Outlook

February 21, 2008Kevin L. Kliesen 26 The Near-Term Outlook

February 21, 2008Kevin L. Kliesen 27 The Near-Term Outlook

February 21, 2008Kevin L. Kliesen 28 The Near-Term Outlook

February 21, 2008Kevin L. Kliesen 29 1.Spillovers from the housing downturn spread to the consumer and deepen. 2.Consensus forecasts does not assume a recession. 3.Fiscal and monetary stimulus boost economic growth by more than expected, boosting long-run inflation expectations even higher. 4.Foreign economic growth weakens. Risks to the Outlook

February 21, 2008Kevin L. Kliesen 30 Questions?