Strauss final version for posting

Economic Outlook

Central Banking Series 2016: Madrid October 3, 2016

William Strauss Senior Economist and Economic Advisor Federal Reserve Bank of Chicago

GDP expanded by 1.3% over the past year

Real gross domestic product percent

8 6

4 2 0

-2 -4

Percent change from a year earlier

-6 -8

Quarterly change (saar)

-10 1990 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

The Chicago Fed National Activity Index 3-month average remains below zero Chicago Fed National Activity Index 2.0 1.0 0.0 -1.0 -2.0

Three month average

-3.0 -4.0 Monthly

-5.0 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

The Federal Open Market Committee (FOMC) expects GDP to grow around trend over the next three years Real gross domestic product

FOMC Central Tendency (September 2016)

percent change from a year earlier

2016 2017 2018 2019

6 5 4 3 2 1 0 -1 -2 -3 -4 -5

1.7 – 1.9 1.9 – 2.2 1.8 – 2.1 1.7 – 2.0

Longer run

1.7 – 2.0

FOMC

1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19

The path of the current recovery is restrained compared with past deep recession recovery cycles Business cycle recovery path i ndex - business cycl e trough = 100

140

140

135

130 125

120

135

1981-82

130

average annualized growth: 4.5%

average annualized growth: 4.3%

125

120

1974-75

115

110

115

110

2008-09

105

100

105

100

average annualized growth: 2.1%

95 -8 -6 -4 -2 0 2 quarters before trough

4

6

8

10

12

14 16 18 20 22 24 quarters after trough

95 26

28

Employment grew by over 2.4 million jobs over the past 12 months Total employment percent

6 4 2 0

-2 -4

Percent change from a year earlier

-6 -8

Monthly change (saar) 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

The unemployment rate has fallen to 4.9%

Unemployment rate percent

11 10

9 8 7 6 5

4 3 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

Wages and benefit costs continue to increase at a very slow pace Employment cost index percent change from year a go

8 benefit costs

7

6 5 4 3 2

1

wages and salaries

0 1990 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

The FOMC forecasts that the unemployment rate will remain at the natural rate over the next three years Unemployment rate percent

11 10 9 8

FOMC Central Tendency (September 2016) 2016 2017 2018 2019

4.7 – 4.9 4.5 – 4.7 4.4 – 4.7 4.4 – 4.8

Longer run

4.7 – 5.0

7 6

5

FOMC

4 3 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19

Slow productivity growth helps explain why relatively strong employment growth has not translated into higher wages Productivty percent change (20-qtr ra te)

5 4 3 2 1 0 -1 1950

'55

'60

'65

'70

'75

'80

'85

'90

'95

'00

'05

'10

'15

A large part of the weakness in productivity growth has been the weak pace of investment Real private nonresidential fixed investment percent

20

10 0 -10

Percent change from a year earlier

-20 Quarterly change (saar)

-30 1990 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

Inflation is very low

Personal consumption expenditure - chain price index percent change from a year earlier

6 5

4 3 2

1 0 -1

-2 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

In large part due to the collapse of energy prices

Real West Texas Intermediate oil price dol lars per barrel, 2015 dollars

160 140 120 100 80 60 40

20 0 1970

'75

'80

'85

'90

'95

'00

'05

'10

'15

Natural gas prices have also declined and remains low

Real natural gas price dol lars per mmbtu, 2015 dollars

16 14 12 10 8 6 4

2 0 1994 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

Expenditures on energy are well below the historical average Energy goods and services expenditures as a share of percent total consumption 10 9 8

80s

60s

7

70s

1960-2015

6 5 4

10s

00s

90s

3 1960

'65

'70

'75

'80

'85

'90

'95

'00

'05

'10

'15

Removing the volatile food and energy components from the PCE, “core� inflation remains low Personal consumption expenditure - less food and energy chain price index percent change from a year earlier 5 4 3 2

1 0 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

The FOMC anticipates that PCE inflation will be just under two percent by the end of 2019 Personal consumption expenditure - chain price index percent change from a year earlier

6

FOMC Central Tendency (September 2016)

5

4

2016 2017 2018 2019

3

Longer run

1.2 – 1.4 1.7 – 1.9 1.8 – 2.0 1.9 – 2.0 2.0

FOMC

2

1 0 -1

-2 1990

'92

'94

'96

'98

'00

'02

'04

'06

'08

'10

'12

'14

'16

'18

The FOMC anticipates that “core” PCE inflation will reach two percent in 2019 Personal consumption expenditure - less food and energy chain price index percent change from a year earlier 5 FOMC Central Tendency (September 2016)

2016 2017 2018 2019

4 3

1.6 – 1.8 1.7 – 1.9 1.9 – 2.0 2.0

FOMC

2

1 0 1990

'92

'94

'96

'98

'00

'02

'04

'06

'08

'10

'12

'14

'16

'18

Blue Chip International Consensus Forecasts

United States Canada Mexico Japan South Korea United Kingdom Germany France Euro Zone Brazil Russia China India

Real GDP % change Annual 2015 2016 2017 2.6 1.5 2.2 1.1 1.3 2.0 2.5 2.2 2.5 0.6 0.5 0.8 2.6 2.6 2.6 2.2 1.6 0.4 1.5 1.6 1.3 1.2 1.3 1.1 1.6 1.5 1.3 -3.8 -3.4 0.6 -3.7 -0.7 1.1 6.9 6.5 6.2 7.6 7.6 7.6

Inflation % change Annual Consumer Prices 2015 2016 2017 0.1 1.2 2.3 1.1 1.7 2.1 2.7 2.9 3.3 0.7 -0.3 0.5 0.7 1.0 1.6 0.0 0.7 2.2 0.1 0.4 1.4 0.1 0.3 1.1 0.0 0.2 1.2 9.0 8.5 5.6 15.5 7.2 5.3 1.4 2.0 2.0 4.9 5.4 5.2

Blue Chip Economic Indicators Forecast September 9, 2016

Exchange Rate Against US Dollar End of Year 2016 2017 1.32 1.30 18.55 18.16 102.8 108.2 1,189 1,216 1.28 1.29 1.09 1.08 1.09 1.08 1.09 1.08 3.45 3.51 66.4 63.7 6.36 6.41 69.3 70.3

Interest Rates 3-Month End of Year 2016 2017 0.30 0.90 0.68 1.08 4.19 4.75 -0.04 -0.04 1.29 1.29 0.31 0.33 -0.22 -0.07 -0.22 -0.07 -0.22 -0.07 13.65 11.22 10.24 7.94 2.89 2.99 6.80 6.66

Manufacturers’ Purchasing Managers Indexes S e p-15

Oct-15

N ov-15

D e c-15

Ja n-16

Fe b-16

Ma r-16

Apr-16

Ma y-16

Jun-16

Jul-16

Aug-16

Globa l

50.6

51.4

51.2

50.7

50.9

50.0

50.5

50.1

50.0

50.4

51.0

50.8

U nite d S ta te s

53.1

54.1

52.8

51.2

52.4

51.3

51.5

50.8

50.7

51.3

52.9

52.0

Ca na da

48.6

48.0

48.6

47.5

49.3

49.4

51.5

52.2

52.1

51.8

51.9

51.1

Me xico

52.1

53.0

53.0

52.4

52.2

53.1

53.2

52.4

53.6

51.1

50.6

50.9

E urozone

52.0

52.3

52.8

53.2

52.3

51.2

51.6

51.7

51.5

52.8

52.0

51.7

Ge rma ny

52.3

52.1

52.9

53.2

52.3

50.5

50.7

51.8

52.1

54.5

53.8

53.6

Fra nce

50.6

50.6

50.6

51.4

50.0

50.2

49.6

48.0

48.4

49.6

48.6

48.3

Ita ly

52.7

54.1

54.9

55.6

53.2

52.2

53.5

53.9

52.4

53.5

51.2

49.8

S pa in

51.7

51.3

53.1

53.0

55.4

54.1

53.4

53.5

51.8

52.2

51.0

51.0

UK

51.5

55.2

52.7

51.9

52.9

50.8

50.7

49.4

50.4

52.4

48.2

53.3

R ussia

49.1

50.2

50.1

48.7

49.8

49.3

48.3

48.0

49.6

51.5

49.5

50.8

Ja pa n

51.0

52.4

52.6

52.6

52.3

50.1

49.1

48.2

47.7

48.1

49.3

49.5

China

47.2

48.3

48.6

48.2

48.4

48.0

49.7

49.4

49.2

48.6

50.6

50.0

India

51.2

50.7

50.3

49.1

51.1

51.1

52.4

50.5

50.7

51.7

51.8

52.6

Bra zil

47.0

44.1

43.8

45.6

47.4

44.5

46.0

42.6

41.6

43.2

46.0

45.7

The Baltic Exchange Dry Index remains low

Baltic Exchange Dry Index i ndex: Ja nuary 4, 1985=1,000

12,000 10,000

8,000 6,000 4,000

2,000 0 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

The real trade-weighted U.S. dollar increased by 19.7%, but has fallen by 4.2% since January Trade-weighted exchange value of the U.S. dollar (real) i ndex: Ma rch 1973=100

115 110 105 100 95 90 85 80 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

Manufacturing output is just below its level compared with a year earlier Industrial production - manufacturing percent

40 30

Monthly change (saar) Percent change from a year earlier

20 10

0 -10 -20

-30 -40 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

Industrial production is forecast to improve this year but expand at a pace below its historical rate Total industrial production percent

10 Percent change from a year earlier

Q2-2016

5 0 -5 -10 Blue Chip IP Forecast

-15

-20

Quarterly change (saar)

Actual 2015 -1.6

Forecast 2016 2017 0.4 2.3

-25 2000 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17

While the probability of recession within the next 6 months has increased, it remains well below the level that has been associated with a recession Probablility of a recession - two quarters ahead percent (Survey of Professional Forecasters) 60 50 40 30 20 10 0 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

The credit spread between Corporate High Yield and Corporate Aaa has been falling after peaking in the middle of February Credit spreads between Corporate High Yield and Corporate Aaa percent

18

16 14 12

10 8 6 4

2 0 2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

Monetary policy has been very aggressive, keeping the Fed Funds near zero since December 2008 Fed Funds rate percent

9 8 7 6 5

4 3 2 1 0 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16

The Federal Funds rate is expected to remain below the neutral rate through 2019 Target Federal Funds Rate percent

9

FOMC Central Tendency (September 2016)

0.6 – 0.9 1.1 – 1.8 1.9 – 2.8 2.4 – 3.0

7

2016 2017 2018 2019

6

Longer run

8

2.8 – 3.0

5 4

3 2

FOMC

1

0 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19

Summary •The outlook is for the U.S. economy to expand at a pace around trend through 2019 •Employment is expected to rise moderately with the unemployment rate remaining at the natural rate •Disappearing slack in the economy will lead to a gradually rising inflation rate

www.chicagofed.org www.federalreserve.gov