SF Fed Economic Outlook

Sylvain Leduc of the San Francisco Fed gives the economic outlook for the U.S. along with a forecast of the effects of the stimulus package. The forecast shows that (1) the fiscal stimulus package will help (and note that government spending is preferred to tax cuts), (2) even though the recovery package will help, there will still be a large gap in unemployment in both 2009 and 2010, and (3) if parts of the stimulus package don’t come online until 2010, that is a feature not a bug given the substantial delay expected in the recovery of unemployment. Output growth is expected to recover by 2010 (according to their forecast), but the expectation is that unemployment will take longer than output to recover [and I should have noted that this is based upon a fairly rosy forecast]:

The recovery later this year will largely be based on the effects of a substantial fiscal stimulus package. Clearly, there is a lot of uncertainty regarding the impact of the fiscal stimulus. First, the effects will depend on when it is spent. Analyzing the fiscal stimulus proposal adopted by the House of Representatives in mid-January, the Congressional Budget Office estimated that only a little more than half of that $816 billion package would be spent in 2009 and 2010, partly because of delays in establishing new government programs. It is likely that similar delays will apply to the fiscal package expected to be signed into law.

Second, the impact of the fiscal stimulus also will depend on how tax cuts and government spending affect the economy, an issue subject to debate. Our assessment is that tax cuts are somewhat less effective than government spending in stimulating the economy in the short run, since households typically save part of the increase in disposable income. This may be truer this time because the saving rate is increasing. In contrast, government spending initially affects GDP one-for-one since all of the funds are spent.

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Using the fiscal multipliers estimated by Macroeconomic Advisers, a private forecasting firm, we find that the fiscal stimulus package has a sizeable impact on our growth forecast, particularly in 2009. Moreover, we forecast that the unemployment rate would climb to nearly 10% absent the fiscal initiative. However, while the stimulus package will help reduce the slack in the economy, it will not be enough to bring a return to full employment.

The complete outlook (with this part repeated) is on the continuation page:

FedViews, by Sylvain Leduc, SF Fed:

Incoming data continue to point to a significant contraction in growth this quarter. In turn, the severe decline in economic activity is putting downward pressures on firms’ costs and on inflation.

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The employment data continue to be dismal. Nonfarm payroll employment contracted again sharply in January, posting a decline of nearly 600,000 jobs and the number of payroll positions lost in December was also revised down significantly. Overall, the economy has now lost 3.6 million jobs since the start of the recession in December 2007, with roughly half of those losses occurring in the past three months. The unemployment rate also rose 0.4 percentage point to 7.6% in January, a level last seen in 1992.

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The four-week moving average of initial unemployment claims jumped to more than 600,000 in the week ending February 7, the highest level since November 1982. The behavior of jobless claims suggests that the unemployment rate will continue to rise for some time.

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We anticipate that, with the worsening labor market, the current recession will turn out to be the deepest in terms of job losses seen in 50 years. As of January, employment had contracted 2.6% from the December 2007 business-cycle peak, a little less than job losses posted in the 1981-82 recession. However, employment is expected to contract further, so that by the end of the recession, employment should have decreased by roughly 4% from December 2007. We have to go back to the 1957-58 recession to see a larger percentage drop in employment.

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Growth in labor compensation has slowed. The 12-month change in total compensation declined from 3.3% at the beginning of the recession to 2.6% last December. This slowdown in wage growth is partly reflected in core personal consumption expenditures (PCE) inflation, which experienced a dramatic decline in the 4th quarter, falling to an annual rate of 0.5%. We expect core PCE inflation to stabilize, albeit at a very low level.

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Financial conditions have tightened somewhat recently. In particular, the 10-year Treasury yield has registered a significant run-up, partly reflecting market expectations of higher government borrowing in coming quarters.

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The housing sector continues to plunge. Housing starts and permits fell once again in December, to their lowest level since at least the 1950s, as builders remained quite pessimistic about the economic outlook. The Case-Shiller 10-city home price index fell nearly 20% in November from a year earlier. Market participants are now predicting that the rate of decline in house prices will accelerate in coming months before starting to rebound. Nevertheless, the timing of the rebound remains elusive, as illustrated by comparing house price futures in September 2008 and February 2009.

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The combination of a weak economy, a high level of economic uncertainty and the massive decline in households’ net worth is leading consumers to save more. This change in consumption behavior is having a particularly large impact on the automotive industry, with sales of autos and light trucks continuing to tumble.

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The dismal incoming data follow on the heels of a sharp decline in real GDP growth last quarter. Due to an unanticipated increase in inventories, the 3.8% contraction in real GDP was less than most forecasters had anticipated. However, recent data on manufacturers’ shipments and inventories in December suggest that inventory accumulation, and thus growth, in the 4th quarter is likely to be revised down significantly.

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We expect growth this quarter to contract sharply. Real GDP should continue to decline in the second quarter before recovering in the second half of the year. Nevertheless, the rebound in economic activity should be relatively modest compared with previous recoveries as households and firms rebuild their balance sheets.

The recovery later this year will largely be based on the effects of a substantial fiscal stimulus package. Clearly, there is a lot of uncertainty regarding the impact of the fiscal stimulus. First, the effects will depend on when it is spent. Analyzing the fiscal stimulus proposal adopted by the House of Representatives in mid-January, the Congressional Budget Office estimated that only a little more than half of that $816 billion package would be spent in 2009 and 2010, partly because of delays in establishing new government programs. It is likely that similar delays will apply to the fiscal package expected to be signed into law.

Second, the impact of the fiscal stimulus also will depend on how tax cuts and government spending affect the economy, an issue subject to debate. Our assessment is that tax cuts are somewhat less effective than government spending in stimulating the economy in the short run, since households typically save part of the increase in disposable income. This may be truer this time because the saving rate is increasing. In contrast, government spending initially affects GDP one-for-one since all of the funds are spent.

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Using the fiscal multipliers estimated by Macroeconomic Advisers, a private forecasting firm, we find that the fiscal stimulus package has a sizeable impact on our growth forecast, particularly in 2009. Moreover, we forecast that the unemployment rate would climb to nearly 10% absent the fiscal initiative. However, while the stimulus package will help reduce the slack in the economy, it will not be enough to bring a return to full employment.


Originally published at the Economist’s View and reproduced here with the author’s permission.