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October 21, 2011

Is the growth tide turning?

It has been a tough year for forecasters, as the Atlanta Fed's President Dennis Lockhart explained in a speech delivered Tuesday evening:

"The basic story of the first half of this year was one of disappointment versus expectations. At the beginning of the year, the consensus forecast had gross domestic product (GDP) growth for 2011 in the range of 3 to 4 percent. Though the Atlanta Fed's forecast was at the lower end of that range, we generally shared the view that the recovery was firmly established…

"A pretty clear picture of just how bad the first quarter was became apparent toward the end of the second quarter, when the FOMC met in late June. At that point, notwithstanding weakness in the early months of the year, the widely held outlook was that growth would rebound in the second half. Many anticipated that the effects of the price and disaster shocks would quickly dissipate…

"As the summer progressed, the data surprises were unrelenting and on the negative side of expectations.

By the time of the early August FOMC meeting it was clear to my Atlanta Fed colleagues and me that we had to rethink our position. The momentum of the economy looked a lot weaker than was our assessment earlier in the summer."

That story is well-captured by a picture of the evolution of Blue Chip consensus forecasts over the course of the year:


As President Lockhart explains, what has been most worrisome is the cumulative nature of the forecast errors implied in the above chart:

"Let me mention parenthetically that, given the complexity and dynamism of the economy, forecasting is fraught with errors and misses. One of my colleagues says the only thing he can forecast with certainty is that his forecast will be wrong. It's when forecasts are persistently wrong in the same direction, and by a substantial measure, that you worry you've missed the real story."

That reality can, of course, work in a positive direction as well as a negative direction. The encouraging news is that the forecasting mistakes have been accumulating in the direction of excess pessimism:

"We at the Atlanta Fed regularly monitor the data series that directly enter into the GDP calculation, along with important other series, including employment… In the months leading up to July, the downside surprises in the data dominated. In August and September, upside and downside surprises were roughly equal. But in October, the surprises have generally been to the upside."

One aspect of this analysis is called a "nowcasting" exercise that generates quarterly GDP estimates in real time. The technical details of this exercise are described here, but the idea is fairly simple. We use incoming data on 100-plus economic series to forecast 17 components of GDP for the current quarter. Those forecasts of GDP components are then aggregated to get a current-quarter estimate of overall GDP growth.

The outcomes of this exercise have been as positive in the third quarter as they were negative for the first two quarters of the year:


At this point, we'll interrupt this blog post to offer a few disclaimers. First, we wouldn't want to put too much weight on the specific number cranked out by this exercise. Also, beyond the usual warnings about the imprecision of statistical estimates, we'll add that much of the data being used in the estimates are subject to revision—and we don't yet have very much information on activity in October. Finally, even with the improvements in performance versus expectations, the view of the moment is still centered on near-term growth that is less than stellar, as President Lockhart described in his remarks:

"[M]ost private sector forecasters envision growth in 2012 approaching 2.5 percent. In the opinion of many economists, that 2.5 percent approximates the steady-state growth rate of the economy's potential. This rate would certainly be an improvement over 2011 as a whole. The problem is without growth measurably better than 2.5 percent, little progress will be made in absorbing slack in the economy—above all, labor market slack."

But after the long run of negative news that has characterized most of this year, we are for now at least moving in the right direction.

David AltigBy Dave Altig, senior vice president and research director at the Atlanta Fed

 

and

Patrick HigginsPatrick Higgins, economist at the Atlanta Fed

 

 

October 21, 2011 in Data Releases, Economic Growth and Development | Permalink

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Whether you’re in the ‘”ore optimistic” or the “less optimistic” camp, the latest improvements in the various forecasts reflect an assumption that there will be no major negative surprises this year. I’m not at all sure that such an assumption is a safe bet this year. There are still plenty of things that can go wrong in this delicate economy and slowly thawing credit environment.

Posted by: Stop Foreclosure | October 23, 2011 at 09:38 AM

I suspect there's been some inventory clearing that has pushed GDP up temporarily.

I also suspect that many people are like me and suffering from Thrift Fatigue. I've been splurging a bit on resaurants and also splurged on a excercise machine (which was marked down 60%) to get me through the winter without having to go to the gym. I also bought a plane ticket to visit family over christmas.

This is cutting into my saving, which are already inadequate, and I will need to really buckle-down this winter.

Posted by: aaron | October 24, 2011 at 07:18 AM

My clothes are also getting threadbare and will need to be replaced.

Posted by: aaron | October 24, 2011 at 07:19 AM

In a word, no. Consumption rose by 2.4% in Q3, hooray! The savings rate in September was 3.6%, compared to 5.3% in June. Sound sustainable to you? Friday's payroll number looks like another whopping 100K. Of course, we need to be vigilant about inflation, right? Let's see the employment cost index in q3 rose at a 2-year low of +0.3%. Core PCE "the Fed's preferred inflation measure" in September came in, uh, negative. Of course it could get better next year except unemployment benefit extensions will expire along with payroll tax breaks.

Dave, are you deliberately trying to foment social unrest and stoke the "occupy wall street" crowd with comments like this?

Posted by: Rich888 | October 29, 2011 at 12:19 PM

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October 17, 2011

State and local fiscal fortunes: Follow the money (collected)

Last week, we found ourselves in conversation with some colleagues discussing the issue of state and local fiscal conditions, which by pure coincidence coincided with the announcement that the city of Harrisburg, Pa., filed for bankruptcy. In the course of conversation, our attention was drawn to an interesting fact. Prior to 2000, according to U.S. Census Bureau data through 2008, annual growth of total revenues at the state and local level was closely aligned with direct expenditures at the same level. Since 2000, however, this pattern has decidedly changed. The main reason is the dramatic volatility of total revenue:

Revenues at the state and local level come from many sources. Taxes from income, sales, and property, of course, but also from various fees and charges associated from education, utilities, ports and airports, and so on. In addition, revenues come from transfers from the federal government and, importantly, asset income from trust fund portfolios.

In fact, the primary source of the increased volatility in state and local government revenues since 2000 is large swings in revenue going into insurance trust funds to finance compulsory or voluntary social insurance programs operated by the public sector.

Insurance trust revenue is derived from contributions, assessments, premiums, or payroll "taxes" required of employers and employees. It also includes any earnings on assets held or invested by such funds. Not surprisingly then, the volatility of insurance trust revenue is partly tied to volatility in financial markets, as the chart below clearly illustrates.

Though fluctuations in insurance fund revenues have been the largest source of fluctuations in overall state and local revenues over the past decade or so, volatility in general revenue is still an issue. Ups and downs in income tax revenues have been particularly sharp since 2000.

Interestingly, Census Bureau data for state government finances show tax revenue growth turned negative in 2009.

In research that focuses specifically on revenue variability at the state level, UCLA law professor Kirk Stark notes the possibility that state revenues have too much reliance on the same income-centric tax base that characterizes the federal revenue code:

"Perhaps the most obvious (yet little discussed) federal inducement for the design of state and local tax systems is the fact that Congress has established an elaborate and detailed legal framework for certain taxes—including, most notably, the individual and corporate income taxes—but not for others. The very existence of the Code, Treasury Regulations, IRS administrative guidance, and federal judicial case law creates an almost irresistible incentive for the states to adopt individual and corporate income taxes. The availability of the federal income tax base as a starting point in calculating state tax liability is an unqualified benefit. …

"At the same time, however, there are potentially significant costs associated with having states piggyback on the federal income tax. Taxes that might be suitable for use by a central level of government are not necessarily appropriate for use by state or local governments. Some of the most volatile state revenue sources are those upon which states rely by virtue of piggybacking on the federal income tax."

The theme of Professor Stark's article is the role that federal policy might play in generating revenue volatility at the state level:

"Through various inducements and limitations embedded in federal law, the federal government has stacked the deck in favor of state revenue volatility, unwittingly exacerbating the subnational fiscal crises that it is then called upon to mitigate through bailouts and general fiscal relief."

Some other examples of how federal tax policy can have an impact on state and local policy according to Stark include "differential treatment of alternative tax sources within the federal income tax deduction for state and local taxes" and "various specific provisions in federal law that limit state taxing authority."
Professor Stark is clear on the point that the research in this area has defied simple generic conclusions about how state and local tax codes can be constructed to minimize revenue volatility. And the work is largely silent on how the volatility question fits into the broader question of optimal tax-system design. But it is hard to argue with this conclusion:

"If the federal government is interested in reducing the likelihood and severity of future state fiscal crises, it should consider changes to federal law that would eliminate the current bias in favor of volatile state tax systems."

David Altig By Dave Altig, senior vice president and research director at the Atlanta Fed



and

John Robertson John Robertson, vice president and senior economist in the Atlanta Fed's research department

October 17, 2011 in Economic Growth and Development, Fiscal Policy, Taxes | Permalink

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Very good blog! Always an interesting read!

This article as well. It's title might be somewhat misleading, however.

To assess the fortunes of States and Cities, spending, or more precisely, what they *should* be spending, appears more relevant than the variance of income.

It is hard to make the numbers work when future pension obligations are included in the liabilities, volatility of earnings notwithstanding (e.g. Illinois).

Again, keep up with the good work!
SamK

Posted by: SamK | October 19, 2011 at 10:01 AM

But volatility of some of local revenues seems to me a good idea because it is anti-cyclical, just like for the Union budget: taxes go down when incomes go down. Since the USA includes a fiscal Union supposedly if a locality has a sudden drop in revenues the Union budget should support distressed localities (with safeguards).

The alternative would be for local taxes to rise sharply as a percentage of income when local economic activity is depressed, which sounds mad to me.

Unless the idea is to shift most of the local taxation burden to low income residents, via taxes on transactions that are largely independent of income and on expenditures that have very little elasticity to price; for example by replacing local taxes on income with local taxes on food sales, or rents, and with masses increases in fees on services like water supply and garbage collection and public transport.

Also, the "insurance fund" story is simply the old accounting strategy: to book "estimated" gigantic expected capital gains and impossibly high returns on the insurance fund, and cut income taxes on wealthy residents with the resulting "savings", and then when the insurance fund investments as expected fail to deliver during a recession, recommend a massive cut in services or a switch from income related to consumption related taxes to cover the shortfall.

Both strategies are not mad, just politics of a very specific sort.

Posted by: Blissex | October 20, 2011 at 05:45 PM

«Not surprisingly then, the volatility of insurance trust revenue is partly tied to volatility in financial markets, as the chart below clearly illustrates.»

There is another note as to this: why ever is there *any* volatility in these insurance funds? USA treasuries have not been that volatile.

Comparing insurance fund assets with stock market valuations seems crazy to me, as it seems to imply that local government insurance funds are invested speculatively instead of prudently, and from the graph it seems that they volatility is even greater than that of the S&P500, which means that they haven't even been invested in index funds, but in stock-picking speculative strategies.

The graph actually seems to suggest a massive breakdown in the fiduciary duties of local government investment managers, as if their goal was not just to book massive gains to justify cutting local taxes, but also to push up stock market prices via extremely leveraged speculation to pursue a further set of political goals. That would be madness.

Posted by: Blissex | October 20, 2011 at 05:57 PM

That the volatility of investment funds is much higher than that of the S&P seems to imply that the funds contain a significant amount of highly speculative leveraged instruments, for example stock derivatives.

I personally think that there is no reason whatever to invest local government funds in anything other than treasuries (like OASDI does) on both prudential and return grounds.

But it seems that politicians of many local governments instead thought that Orange County was a laudable model and Mr. Citron a hero prophet.

Posted by: Blissex | October 21, 2011 at 05:50 AM

I think the biggest inducement to states having income taxes is the federal deduction for state income taxes paid. The deduction causes part of the state's tax burden to be shifted to the federal government. If a small state like Hawaii can impose and administer a highly successful broad-based gross receipts tax, I don't think the mere existence of tax code is enough by itself to attract a state to the net income tax. After all, one state could also copy another's code. Just keeping up with changes in the federal income tax imposes a burden on tax administrators.

Posted by: don | October 27, 2011 at 06:30 PM

The U.S. Census Bureau released 2009 state and local government data on October 31: http://www.census.gov/govs/estimate/

Posted by: Jeff | November 01, 2011 at 10:34 AM

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September 01, 2011

The pull between spending and saving

In a speech on Wednesday, Atlanta Fed President Dennis Lockhart talked about how the economic outlook is being shaped by the process of deleveraging (reducing debt and increasing saving) that is occurring in the economy.

By way of background, President Lockhart emphasized the important role that some amount of debt plays in economic growth: while difficult to measure precisely, research suggests that debt levels that get high enough are associated with extended periods of subpar economic growth.

"Debt is not in and of itself a bad thing. Debt supports economic growth by allowing households, businesses, and governments to smooth their spending and investment over time. Borrowing and lending can help facilitate the allocation of capital to productive uses in the economy. But high debt levels can also result in lower economic growth, a point that Stephen Cecchetti, of the Bank for International Settlements, made in a paper presented at the Kansas City Fed's symposium in Jackson Hole, Wyo., last week."

Relative to the 1990s, the last decade witnessed a surge in borrowing by the nonfinancial sector (comprising households, nonfinancial businesses and governments). Indeed, as President Lockhart noted:

"Relative to the size of the U.S. economy measured in terms of GDP, the total domestic debt of nonfinancial sectors of the economy reached 248 percent in 2009, increasing by almost 75 percentage points over the previous decade alone."

While no longer growing, the overall debt position of the nonfinancial sector has barely declined since peaking in 2009.


How did we get to this point? Much of the increase in total debt during the 2000s was in the form of real estate debt, and most of that was by households and unincorporated businesses (mostly sole proprietorships and partnerships). During the 1990s the mortgage debt of households was relatively stable at around 45 percent of GDP, but it increased to a peak of 76 percent of GDP in 2009. Over the same period, mortgage debt for unincorporated businesses increased from around 12 percent of GDP to almost 20 percent.



Because real estate is relatively expensive, it is not surprising that mortgage debt heavily influences the overall debt burden of individuals. Rapidly rising home values from the late 1990s to 2006 supported the notion that housing was a good asset to purchase…until it wasn't. According to the S&P Case-Shiller national home price index, home values have declined by more than 30 percent from their peak in 2006, after having increased by more than 150 percent compared with the previous decade.


From their peak in 2009, debt levels for households and unincorporated businesses have declined relative to GDP notably by a combined 15 percentage points. Reduced mortgage debt accounted for three quarters of that decline. As President Lockhart notes, repairing the balance sheet of the household sector, just as it does for businesses, can occur through some combination of debt reduction and increased savings.

"Household deleveraging has occurred mostly through a combination of increased savings, debt repayment, and also debt forgiveness. At the same time, there has generally been less access to credit for households as a result of stricter underwriting standards. The inability to qualify for home equity loans and other forms of credit has slowed the pace at which new debt is taken on by households replacing paid-down debt. The effect is to reduce their debt burden over time."

In contrast to households and unincorporated businesses, the amount of debt owed by the nonfinancial corporate sector has not declined very much since 2009. Nonfinancial corporations increased borrowing during the second half of the 2000s. But most of the debt growth was from increased issuance of corporate bonds. Since its historical peak in 2009, the total debt of the nonfinancial corporate sector has remained at around 50 percent of GDP, as continued bond issuance has largely offset declines in other types of corporate borrowing.

If individuals are aggressively reducing their debt burden, and corporations haven't increased their overall borrowing, why hasn't the overall debt burden of the nonfinancial sector of the economy declined since 2009? The primary reason is that the amount of federal government debt has increased sharply in recent years—from 35 percent of GDP in 2007 to about 65 percent of GDP in early 2011.


As President Lockhart observes:

"While the private sector—households and businesses—has made notable progress in lowering its debt burden, discussions of how to reduce public debt have only just begun. The government still needs to introduce major policy changes to put public debt on a sustainable path. Demographic trends, which I referenced earlier, will make public debt reduction even more challenging."

How long will the deleveraging process take to play out? I'm pretty confident that nobody really knows precisely, but President Lockhart suggests that we may be closer to the beginning of the process than the end:

"Rebalancing simply takes time. A 2010 report by McKinsey surveyed 32 international periods of deleveraging following financial crises and found that, on average, the duration of these episodes was about six and a half years. U.S. debt to GDP peaked in the first quarter of 2009. So, by that standard we are much closer to the beginning than the end of our deleveraging process."

Lockhart also makes the point that this necessary structural adjustment has consequences for the medium-term outlook:

"When economies are deleveraging they cannot grow as rapidly as they might otherwise. It is obvious as consumers reduce spending they divert more of their incomes to paying off debt. This shift in consumer behavior increases the amount of capital available for financing investment. But higher rates of business investment are not likely to fully offset weakness in consumer spending for some time, as businesses continue to grapple with uncertainties about the future."

From a monetary policy perspective, slower growth as a result of deleveraging raises important challenges:

"To my mind, it's becoming increasingly clear the challenge we policymakers face is balancing appropriate policy responses for the near to medium term with what's needed for the longer term. In other words, we must continue to help the economy achieve a healthy enough cyclical recovery, especially with unemployment high and consumer spending lackluster. At the same time, we must recognize the longer-term need for directionally opposite structural adjustments, including deleveraging."

How does President Lockhart size up the role of monetary policy in this context?

"Given the weak data we've seen recently and considering the rising concern about chronic slow growth or worse, I don't think any policy option can be ruled out at the moment. However, it is important that monetary policy not be seen as a panacea. The kinds of structural adjustments I've been discussing today take time, and I am acutely aware that pushing beyond what monetary policy can plausibly deliver runs the risk of creating new distortions and imbalances.

"We may find, as economic circumstances evolve, that policy adjustments are required. In more adverse scenarios, further policy accommodation might be called for. But as of today, I am comfortable with the current stance of policy, especially considering the tensions policy must navigate between the short and long term and between recovery and the need for longer-term structural adjustments."

John Robertson By John Robertson, vice president and senior economist in the Atlanta Fed's research department

 

September 1, 2011 in Economic Growth and Development, Federal Debt and Deficits, Monetary Policy, Real Estate | Permalink

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This post clearly shows that movements in household leverage (a rise in the last expansion and a fall that began in the recession) are a signature of the latest economic cycle. However, there are a number of important 'why' questions that the aggregate time series cannot answer. It is unlikely that a change in the 'taste for debt' alone can explain the changes in leverage. Moreover, different explanations for the levering up have very different policy prescriptions and forecasts for deleveraging going forward. Just to name two examples, Atif Mian and Amir Sufi have several papers that suggest the loosening of the supply of credit led to the levering up. In contrast, Tyler Cowen in the The Great Stagnation points to the over-confidence of households and other agents about income prospects. There are other possible explanations and the truth may be a combination. So while the post raises some interesting questions with aggregate time series, there is a lot of empirical work that can and should be done with micro data, like the Survey of Consumer Finances and the American Life Panel.

Posted by: Claudia Sahm | September 01, 2011 at 07:10 PM

Sumner writes a lot of crap, but let's face it, he's right on at least two counts:

1. There's no such thing as neutral monetary policy. Before 'waiting to act' for fear of causing "new distortions", consider the distortions you may presently be causing.

2. Monetary policy should target the forecast. Why, for example, are you doing this to inflation expectations
http://research.stlouisfed.org/fred2/graph/?g=1WL
with one-off programs of limited duration announced in advance?! I could come up with a better monetary policy in my basement.

Once you stabilize inflation expectations, consider raising them to 4% for a while, to ease the burden of the above household debt, help correct our foreign trade imbalances (Sumner is also right that international trade is not a zero-sum game), and spur corporate investment.

Then tell Barney Frank to cut the crap and stop letting people like me buy houses at 30:1 margin, as I just did in June. The greater the portion of a loan that is secured by the asset it purchases, the stronger the feedback loop between willingness to lend and prices (about the only thing Soros gets right), which is the only way you got those curves above.

Sure, there are political problems around creating inflation. That's where Bernanke needs to start eating his oysters and stop standing around blinking his eyes like a toad lickin' lightning. I'll tell you a secret: Bernanke is smarter than Rick Perry. Why let such facts go unnoticed? But as is obvious from the above speech, he can't even defeat his critics in his own organization (not that Lockhart is one, but it seems to me he's addressing some of them).

Posted by: Carl Lumma | September 01, 2011 at 10:33 PM

I think the problem with society today is the inability to defer gratifcation that is until recently. Get a collage degree borrow to pay for it' buy a new car borrow to pay for it' need a bigger house borrow to pay for it' why save to pay when you can play now would be a good way to decribe things up until about five years ago.

Posted by: dennis the menace | September 06, 2011 at 02:48 PM

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August 26, 2011

Lots of ground to cover: An update

If you have to discuss a difficult circumstance, I guess Jackson Hole, Wyo., is as nice as place as any to do so. This morning, as most folks know by now, Federal Reserve Chairman Bernanke reiterated the reason that most Federal Open Market Committee (FOMC) members support the expectation that policy rates will remain low for the next couple of years:

"In light of its current outlook, the Committee recently decided to provide more specific forward guidance about its expectations for the future path of the federal funds rate. In particular, in the statement following our meeting earlier this month, we indicated that economic conditions—including low rates of resource utilization and a subdued outlook for inflation over the medium run—are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. That is, in what the Committee judges to be the most likely scenarios for resource utilization and inflation in the medium term, the target for the federal funds rate would be held at its current low levels for at least two more years."

There are two pieces of information that emphasize the economy's recent weakness and potential slow growth going forward. The first is this week's revised forecasts and potential for gross domestic product (GDP) from the Congressional Budget Office (CBO), and the second is today's revision of second quarter GDP from the U.S. Bureau of Economic Analysis (BEA). Though estimates of potential GDP have not greatly changed, the CBO's downgrade in forecasts and BEA's report of much lower than potential growth in the second quarter have the current and prospective rates of resource utilization lower than when macroblog covered the issue just about a month ago.

Key to the CBO's estimates is a reasonably good outlook for GDP growth after we get past 2012:

"For the 2013–2016 period, CBO projects that real GDP will grow by an average of 3.6 percent a year, considerably faster than potential output. That growth will bring the economy to a high rate of resource use (that is, completely close the gap between the economy's actual and potential output) by 2017."

The margin for slippage, though, is not great. Assuming that GDP ends 2011 having grown by about 2.3 percent—as projected by the CBO—here's a look at gaps between actual and potential GDP for different, seemingly plausible growth rates:


Attaining 3.5 percent growth by next year moves the CBO's date for closing the output gap up by about a year. On the other hand, a fall in output growth to an average of 3 percent per year moves the date for eliminating resource slack back to 2020. If growth remains below that—well, let's hope it doesn't.

David Altig By Dave Altig, senior vice president and research director at the Atlanta Fed

 

August 26, 2011 in Business Cycles, Economic Growth and Development, Employment, Forecasts, Saving, Capital, and Investment | Permalink

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«economic conditions—including low rates of resource utilization and a subdued outlook for inflation over the medium run—are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.»

The exceptionally low funding rates to financial intermediaries are not resulting in equally low rates for customers of those intermediaries, because the Fed has repeatedly hinted that they want to rebuild the balance sheet of the finance sector boosting their profits by granting them a huge spread (and hoping that at least half of those profits go into capital instead of bonuses).

Bernanke's statement then may be interpreted as saying that the Fed does expects the financial sector to need another several years of extra profits resulting from the Fed "subsidy" because the finance sector seem unlikely to be able to make any profit if market conditions prevailed, and indeed it seems that the capital position of many finance sector "national champions" is still weak considering the cosmetically hidden capital losses they have.

As to inflation, wage inflation is indeed well contained (wages are declining in real terms) even if cost of living inflation seems pretty rampant; in a similar country like the UK where indices are less "massaged" the RPI has been running at over 5% and on an increasing trend:

http://www.bbc.co.uk/news/uk-14538167

Posted by: Blissex | August 26, 2011 at 05:28 PM

Why can't the Federal Reserve tell the public the obvious: Growth will only come about by hiring people with livable wages.

If we don't raise incomes nationally we will be forced to liquidate on a massive scale. It doesn't matter who does the hiring, just that it is done.

It isn't the deficit. It isn't the debt. It's the incomes, stupid.

Posted by: beezer | August 27, 2011 at 06:10 AM

Ken Rogoff says 3-5 years of 1-2% GDP and Carmen Reinhart thinks 5-6 years of 2%. =(

Posted by: DarkLayers | August 27, 2011 at 11:19 PM

In terms of econometrics, annual increment of real GDP per capita is constant over time http://mechonomic.blogspot.com/2011/08/revised-gdp-estimates-support-model-of.html . Therefore, the rate of real GDP per capita growth has to decay as a reciprocal function of the attained level of GDP per capita. The exponential component in the overall GDP is fully related to population growth which has been around 1% per year in the U.S. Currently, the rate of population growth falls and the trajectory of the overall GDP lags behind the projection which includes 1% population growth. If to look at the per head estimates, there is no gap between "potential" and observed levels.
In no case should an economist mix the growth in population and real economic growth.

Posted by: kio | August 28, 2011 at 04:03 AM

It's going to be a long time. Do you know how hard it will be for a person to live in the same town for 30 years?

Our money game will need new rules because 30 years at the same job/house/town is over.

But once that issue is fixed, watch out. Technologically America is so far ahead that earning a 100k(todays $$) salary can be done in 6 months.

To keep the NYC banks from leeching on it will be a task.

Posted by: FormerSSResident | August 31, 2011 at 07:00 PM

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August 15, 2011

The GDP revisions: What changed?

Prior to the U.S. Bureau of Economic Analysis's (BEA) benchmark gross domestic product (GDP) revisions announced three Fridays ago, we were devoting a fair amount of space—here, in particular—to picking apart some of the patterns in the data over the course of the recovery. Ahh, the best-laid plans. As noted in a speech today from Atlanta Fed President Dennis Lockhart:

"It's been an eventful two weeks, to say the least. Let's now look ahead. The $64,000 question is what's the outlook from here?...


"Whether we're seeing a temporary soft patch in an otherwise gradually improving growth picture or a deeper and more persistent slowdown, most of the arriving economic data lately have caused forecasters to write down their projections. Also, and importantly, the Bureau of Economic Analysis in the Department of Commerce has revised earlier economic growth numbers. These revisions paint a different picture of the depth of the recession and the relative strength of the recovery."


Beyond keeping the record straight, revisiting the charts from our previous posts in light of the new GDP data is a key input into answering President Lockhart's $64,000 question. Here, then, is that story, at least in part.

1. Even ignoring the depth of the recession, the first two years of this recovery have been slow relative to the early phases of the past two recoveries.

I wasn't so sure this was the case to be made prior to the new statistics from the BEA, but the revisions made clear that, while still broadly similar to the slower growth pattern of the prior two recoveries, the GDP performance has been pretty easily the slowest of all.

Real GDP

2. Consumption growth has been especially weak in this recovery, and the pattern of consumer spending has been more concentrated in consumer durables than has been the case in prior business cycles.

Change in consumption expenditures

The consumer spending piece of this puzzle has President Lockhart's attention:

"I'm most concerned about the effect of the wild stock market on consumer spending. Volatility alone could have a negative impact on consumer psychology at a time of already weakening spending. Last Friday, it was reported that the University of Michigan's Survey of Consumer Sentiment fell sharply in early August to its lowest level in more than 30 years. Furthermore, if the loss of stock market value persists, the effect from the loss of investment value could combine with the loss of value in home prices to discourage consumers more and longer."


On the bright side, the GDP revisions did not of themselves alter the household spending picture. Though the benchmark revisions contained significant changes in consumer spending, those changes were concentrated during the recession in 2008 and 2009. Personal consumption expenditures were actually revised upward from 2009 on, with the big negative changes coming in net exports and government spending:

GDP revisions

Are there other rays of hope? I might add this:

3. The revisions show that the momentum that seemed to fade through 2010 was more apparent in total GDP than in final demand. In other words, the basic storyline—a good start to 2010 with a soft patch in the middle and a stronger finish—still emerges if you look through changes in inventories.

Pattern of final demand

That observation does not, of course, help salve the pain of the very anemic first half of this year. Nonetheless (from Lockhart, again):

"At the Atlanta Fed, we have revised down our near and intermediate gross domestic product (GDP) growth forecast, but we are holding to the view that the economy will continue to grow at a very modest pace. In other words, we do not expect the onset of outright contraction—a recession—but I have to say the risk of recession is higher than we perceived a month or two ago...


"The rapid-fire developments of the last several days, along with some troubling data releases, have shaken confidence. People are worried. Investors, Main Street businessmen and women, and consumers are wondering which way things will tip. The public—and for that matter, policymakers—are operating in a fog of uncertainty that is thicker than normal."


That fog of uncertainty was made thicker by the GDP revisions, and thicker yet by the volatility that followed. But I would still pass along this advice from President Lockhart:

"At this juncture, we should not jump to conclusions. A clearer picture of economic reality will be revealed in time as immediate uncertainties dissipate. It's premature, in my view, to declare these important questions relating to our economic future settled."


David Altig By Dave Altig, senior vice president and research director at the Atlanta Fed

August 15, 2011 in Business Cycles, Economic Growth and Development, Forecasts, Saving, Capital, and Investment | Permalink

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I think it is important to remember that the BEA only has comprehensive data on income and consumer spending in 2009 and earlier. With this annual revision they folded in mandatory census like surveys on retail trade and services. On the income side they incorporated IRS tax return data which led to substantially lower estimates of asset income. Data from the Michigan survey suggests that the current estimates of personal income in 2010 and later might be overstated. The BEA does a very important job as best they can, but the source data is slow to roll in. We probably have a good picture of the recession now, but the recovery is still a work in progress in the NIPAs. In my opinion, if you want to understand the slow recovery in consumer spending...look at the income expectations (or lack thereof) in the Michigan survey.

Posted by: Claudia Sahm | August 16, 2011 at 04:48 AM

Interesting, as always. I'd like to see point 2 done for fixed investment, too.

Posted by: Dave Backus | August 16, 2011 at 05:37 PM

I think we should not begin to accept the pace of recovery in the last two recessions as a "new normal." The last two recessions have featured very little fiscal stimulus, and increasing emphasis on monetary means. Also, what fiscal stimulus there has been is of dubious value, particularly some of the tax policy measures.

These observations reflect a transition from a political economic theory that government spending should fill the gap created by falling consumer and business spending during times of recession to a political economic theory based accounting (i.e., that spending should not exceed revenues). The latter is leading to larger and larger output gaps, and will eventually lead to permanent recession.

This is why it should not be accepted as the "new normal."

Posted by: Charles | August 17, 2011 at 11:02 AM

Looks like the market is now firmly the master. Everybody has become an economist, we elect an Economist for Governors and Presidents, because we have lost control. The Tea Party is a reaction to this, a desperate one.

If the Fed/America can't re-gain control, someone else will.

Posted by: FormerSSresident | August 17, 2011 at 01:43 PM

Inventories are no longer helping and government will be a drag. It is difficult to see where growth comes from in this environment.
We should measure private sector GDP (without Government) as it is the engine that must support the economy and the government.
The economy has been off track for some 15 years as consumer debt has been the engine and that source is over. Debt is a burden and it should not be used for basic consumption or stimulus. All it does is remove future growth. We are in for a sustained period of slow growth.

Posted by: GASinclair | August 19, 2011 at 06:25 PM

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August 01, 2011

Is the economy hitting stall speed?

The news that the U.S. economy is not only growing slowly but has grown more slowly than anyone even knew has justifiably rattled some nerves. The sentiment is captured well enough by this article from Bloomberg:

"The world's largest economy has yet to regain the ground it lost during the recession and may be vulnerable to a relapse.


"Gross domestic product [GDP] expanded at a 1.3 percent annual rate in the second quarter, after a 0.4 percent pace in the prior period, the worst six months since the recovery began in June 2009, Commerce Department figures showed yesterday. Economists said the slowdown leaves the recovery susceptible to being knocked off course by shocks at home or abroad."


At Reuters, James Pethokoukis makes those concerns quantitative:

"...we're in the danger zone for another recession. Research from the Federal Reserve finds that that since 1947, when two-quarter annualized real GDP growth falls below 2 percent, recession follows within a year 48 percent of the time. (And when year-over-year real GDP growth falls below 2 percent, recession follows within a year 70 percent of the time.")


The research being referred to is work done by the Federal Reserve Board's Jeremy Nalewaik, a careful researcher who is clear that the results should be read with, well, care.

"The dynamics at play in the early part of the 1990s and 2000s expansions may have been different than the dynamics at play in the more-mature part of those and other expansions, and our stall speed models may have omitted an additional phase of the business cycle that has appeared in recent decades, namely the sluggish, jobless recovery phase. If so, the applicability of these stall speed models may be somewhat limited at certain times, such as in the middle of 2010 when the economy evidently slowed while still in the early stages of recovery from the 2007-9 recession."


With caveats like that in mind, Dennis Lockhart, the president of the Atlanta Fed, counseled patience in a speech he delivered on Friday:

"My staff and I have recently been pondering the following questions: Are we experiencing a temporary slowdown—a soft patch—on a recovery path that should return to a rate of 3 to 4 percent GDP growth? Or, instead, are we dealing with an inherently slower pace of economic growth that, because of some combination of persistent economic headwinds and deeper structural adjustment requirements, has the potential to be of much longer duration and more intractable?"


Lockhart said his base case forecast is in line with the greater-strength view.

"I am expecting greater strength in the second half of 2011 and into 2012, accompanied by inflation numbers that converge to around 2 percent. But, as I said, I don't dismiss the possibility that we're in the alternative, more problematic world I described of low and slow growth improving only very gradually. At this juncture, I think we have to wait and see what the incoming data indicate...


"But to try to put some time limit on indecision, I think a continuing flow of weak numbers through the third quarter and into the fourth will call for a serious reconsideration of the situation. The weight of cumulative data could point to a different order of problem—that is, different than just a passing slowdown—if indicators show continued weakness much past year's end."


Of course, Nalewaik's research shows that things could become considerably less comfortable if the 2 percent threshold persists, or the yield curve flattens, or the housing market tanks again. At that point, history is on the side of the recessionists. While Lockhart and our Reserve Bank don't believe we're there yet, it's fair to say we'd feel more comfortable if the incoming third quarter data were a little more positive. And on that count, this morning's Institute for Supply Management report for manufacturing isn't a very promising first step.

David Altig By Dave Altig, senior vice president and research director, and



Mike Bryan Mike Bryan, vice president and senior economist, both of the Atlanta Fed

August 1, 2011 in Business Cycles, Data Releases, Economic Growth and Development, Employment | Permalink

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I think a problem with the US economy these days is the amount of debt and leverage involved in all markets. Even if you're not highly leveraged yourself, you can bet most of the other market participants will be, and that makes for an unstable investment (through no fault of your own) when the global economy has another dip and all asset classes get the jitters.

My biggest fear as an investor right now would be China. A drop in Chinese asset values would not only shake confidence in China's economic vitality, but it would also open debate about whether or not the global economy is over-leveraged and over-reliant on the success of China (it is).

Excessive leverage is partly what made the property bubble aftermath so devastating for Japan, America and Ireland. There's a lot of talk about the Chinese economic bubble and it's potential impact on the global economy. Several months ago, so-called Chinese 'expert' Nick Lardy dismissed worries about what he called the "so-called property bubble" - this was during a conference held at Peterson Institute in DC. However, he now concedes that says a real estate downturn may cause a significant in China, and this is an opinion shared by many other mainstream economic analysts.......

So what changed his opinion? I would suggest a dawning realisation that most of the massive Chinese stimulus, lending and spending during 2009/10 just ended up in property purchases, which drove real estate prices in an alarming and totally unsustainable manner. Also, a realisation that China's economic system frequently produces bubbles, and that's not very likely to change in the near future!!

To understand why excessive debt and leverage is going to have a hugely negative impact on all asset classes going forward, read up on some of the work by Professor Steve Keen (see http://australianpropertyforum.com/blog/main/3567572 ). He's the Australian guy who predicted the GFC, and he has also shown that unsustainable debt to GDP ratios in a country (which you definitely have in the USA, and we have in Australia too) will always result in deflation or depression.

Charles B.

Posted by: Charles Bandridge | August 02, 2011 at 08:26 PM

Hi Dave & Mike, I pop in occasionally but haven't felt the need to kibitz, but I'm lost over what the FED has left in its bag. But first, the working world, at least those in the private sector are way beyond needing to know why "excessive debt & leverage is going to have a hugely negative impact on them". They've been living it for five years, since their spiggots were closed.
My question is, has the FED been largely rendered helpless to turn the mess around that it was so much involved in creating? I'll be the first to admit, I don't know a lot (although I spent many months barking warnings of the impending mortgage implosion), but my guesses are: a QE3 will be toothless & the housing bear market has years to go. So, what's left to encourage Banks to lend & buyers to borrow?

Posted by: bailey | August 10, 2011 at 10:30 PM

Let me toss out what the FED can do to encourage Banks to lend - make it more costly for them NOT to lend. Unfortunately, that raises a better question - if the FED works for the Banks, is it really in its best interest to act to constrain Banks profit?
So, maybe the question is best left to Congress? Oops, isn't that what got us here.

Posted by: bailey | August 14, 2011 at 08:42 AM

Understanding that when all you have is a hammer, everything looks like a nail, I still find it mystifying how monetary policy can be expected to alter business fundamentals by anyone with an ounce of sense, except in illusory ways such as via inflation.

I've never seen an answer to the question whether the US economy can grow at what is considered "reasonable" rates without the aid of a housing bubble, an internet bubble, a finance bubble, or some new kind of bubble, when US wages are being driven down by globalization and costs of production are being driven up by global growth in oil consumption. Unless we can accelerate conversion to natural gas and ultimately renewable energy, this contraction seems likely to last for a long time.

Posted by: George McKee | August 14, 2011 at 07:21 PM

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July 28, 2011

Lots of ground to cover

In my last post I noted that the pace of the recovery, now two years old, is in broad terms similar to that of the first two years of the previous two recoveries. The set-up included this observation:

"Though we have grown used to thinking of the rebound from the most recent recession as being spectacularly substandard, that impression (which I share) is driven more by the depth of the downturn than the actual speed of the recovery."

The context of the depth of the downturn is not, of course, irrelevant. One way of quantifying that context is to look at measures of the "output gap," that is, the difference between the level of real gross domestic product (GDP) and the economy's "potential." An informal way to think about whether or not a recovery is complete is to mark the time when the output gap returns to zero, or when the level of GDP returns to its potential.

There are several ways to estimate potential GDP, but for my money the one constructed by the Congressional Budget Office (CBO) is as good as any. And it does not tell a pretty story:

Real GDP-Real Potential GDP

It is worth noting that the CBO's measure is not a just a simple extrapolation of a constant trend, but a calculation based on historical relationships among labor hours, productivity growth, unemployment, and inflation. Their trend in potential GDP growth rates implied by this methodology, described here, is anything but linear:

Real Potential GDP

Note that the output gaps in the first chart are at historical lows (by a lot) despite the fact that potential GDP growth is at historical lows as well.

These estimates provide one way to assess the pace of the recovery. For example, the midpoints of the Federal Open Market Committee's (FOMC) most recent consensus forecasts for GDP growth are 2.8 percent (2011), 3.5 percent (2012), and 3.85 percent (2013). If those forecasts come to pass, approximately 60 percent of the CBO-implied gap will be closed. This would still leave, in real terms, more resource slack than existed at the lowest point in the past two recessions.

Put another way, if the economy grows at 4 percent from 2012 forward, the output gap won't be closed until sometime in 2015. At a growth rate of 3.5 percent—the lower end of FOMC participants' projections for the next two years—the "full recovery" date gets pushed back to 2016. If, however, the FOMC projections are too optimistic and the economy can only manage to grow at an annual pace of 3 percent (which is currently the consensus view of private forecasters for 2012) output gaps persist until 2020.

The conventional view of the macroeconomy that motivates the CBO estimates of potential GDP (and hence output gaps) at least implicitly embeds the assumption that time heals all wound. But the healing won't necessarily be fast.

David Altig By Dave Altig, senior vice president and research director at the Atlanta Fed

July 28, 2011 in Business Cycles, Economic Growth and Development, Employment, Forecasts, Saving, Capital, and Investment | Permalink

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July 20, 2011

Is consumer spending the problem?

In answer to the question posed in the title to this post, The New York Times's David Leonhardt says absolutely:

"There is no shortage of explanations for the economy's maddening inability to leave behind the Great Recession and start adding large numbers of jobs…

"But the real culprit—or at least the main one—has been hiding in plain sight. We are living through a tremendous bust. It isn't simply a housing bust. It's a fizzling of the great consumer bubble that was decades in the making…

"If you're looking for one overarching explanation for the still-terrible job market, it is this great consumer bust."

Tempting story, but is the explanation for "the still-terrible job market" that simple?

First, some perspective on the pace of the current recovery. Though we have grown used to thinking of the rebound from the most recent recession as being spectacularly substandard, that impression (which I share) is driven more by the depth of the downturn than the actual speed of the recovery. The following chart traces the path of real gross domestic product (GDP) from the trough of the last three recessions:


In the first two years following the 1990–91 and 2001 recessions, output grew by about 6 percent. Assuming that GDP grew at annual rate of 1.5 percent in the second quarter just ended—a not-unreasonable guess at this point—the economy will have expanded by about 5.3 percent since the end of the last recession in July 2009. That's not a difference that jumps off the page at me.

Directly to the point of consumption spending, it is certainly true that consumer spending has expanded at a slower pace in the expansion to this point than was the case at the same point in the recoveries following the previous two recessions. From the end of the recession in the second quarter of 2009 through the first quarter of this year (we won't have the first official look at this year's second quarter until next week), personal consumption expenditures grew in real terms by just under 4 percent. That growth compares to 4.8 percent in the first seven quarters following the end of the 2001 recession and 5.9 percent in the first seven quarters following the end of the 1990–91 recession.

That difference in the growth of consumption across the early quarters of recovery after the 1990–91 and 2001 recessions with little discernible difference in GDP growth across those episodes illustrates the pitfalls of mechanically focusing on specific categories of spending. In fact, the relatively slower pace of consumer spending in this expansion has in part been compensated by a relatively high pace of business spending on equipment and software:


If you throw consumer durables into the general notion of "investment" (investment in this case for home production) the story of this recovery is the relative boom in capital spending compared to recent recoveries:


And what about that "still-terrible job market"? You won't get much argument from me about that description, but here again the reality is complicated. Focusing once more on the period since the end of the recession, the pace of job creation is not out of sync in comparison to recent expansions (though job creation after the last two recessions was meager as well, and we are, of course, starting from a much bigger hole in terms of jobs lost):


So, relative to recent experience, at this point in the recovery GDP growth and employment growth are about average (if we ignore the size of the recession in both measures). The undeniable (and relevant) human toll aside, the current recovery seems so disappointing because we expect the pace of the recovery to bear some relationship to the depth of the downturn. That expectation, in turn, comes from a view of the world in which potential output proceeds in a more or less linear fashion, up and to the right. But what if that view is wrong and our potential is a sequence of more or less permanent "jumps" up and down, some of which are small and some of which are big?

In addition, investment growth to date has been strong relative to recent recoveries and, as Leonhardt suggests, consumption growth has been somewhat weak. So here's a question: Would we have had more job creation and stronger GDP growth had businesses been more inclined to add workers instead of capital? And if that had occurred, might the consumption numbers have been considerably stronger?

David Altig By Dave Altig, senior vice president and research director at the Atlanta Fed

 

July 20, 2011 in Business Cycles, Economic Growth and Development, Employment, Forecasts, Saving, Capital, and Investment | Permalink

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This is an excellent contribution to elevating the quality of commentary on the current expansion. It is time to recognize the cycles experienced in the 60s, 70s, and early 80s were fundamentally different from those since. Because of this, the earlier cycles are not part of the relevant benchmark for making comparisons to current behavior. Three cheers for taking them out of the baseline used for comparisons.

Posted by: Douglas Lee | July 21, 2011 at 10:22 AM

David,
Let me ask a supplemental question. Following the '91 recession, the US created something like 20mm jobs. Following the '01 recession, perhaps 8.5mm jobs were created. How many jobs will be created in this decade?
Stewart

Posted by: stewart sprague | July 21, 2011 at 10:40 AM

The payroll employment chart suggests that just looking at the path for the level of employment from the end of a recession is not the relevant metric. How about looking at net jobs lost during the recession versus net jobs regained during the recovery? Then, the metric captures the essence of what the graph should indicate -- and what the blog offers in words. That the immense job loss of the recent recession is the big difference, and the recent sluggish job creation is akin to recoveries in 1991 and 2001. From this perspective, we have a problem that has been around for a few business cycles.

Posted by: ET_OC | July 21, 2011 at 02:44 PM

The obvious deficiencies in GDP this time have been net exports and government spending.

While the Fed has done its best to promote both, the politicians in Washington have done their best in the opposite direction by promoting an over-valued dollar and reduced federal spending, despite interest rates on the federal debt that are universally lower than during the years of the federal budget surplus.

Posted by: Paul | July 21, 2011 at 04:19 PM

I find it highly annoying that the the obvious is invisible to everyone.

http://research.stlouisfed.org/fred2/series/CMDEBT

Households were pulling $1.2T/yr of new mortgage debt during the boom 2004-2006. This was all cut off in 2007-2008.

Corporate debt take-on was another $800B/yr during this time, for a $2T/yr stimulus to the economy.

THAT IS TWENTY MILLION $100k/yr jobs!

Previous recessions in my life were all prompted by the Fed raising interest rates to throttle debt growth. What killed debt growth this time was the collapse of the ponzi lending structure and the bubble machine it was powering.

Posted by: Troy | July 22, 2011 at 01:58 AM

If you look at percent job losses since peak employment (not only since end of recession), then you can see how bad this recession is. At this point of the cycle after all prior recessions since WWII, the employment has recovered to pre-recession levels. In this recession, we are still 5% down.
http://cr4re.com/charts/charts.html

Posted by: Nino | July 22, 2011 at 05:29 PM

I look at PAYEMS (see below) and what do I see ? I see PAYEMS moving sideways since 2000/2001 so that after a decade of nonsense we find ourselves with 29,502.4 (Thousands (!)) less jobs than we would have had had the pre-2000/2001 trend continued to date.

http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=PAYEMS&log_scales=Left

Posted by: In Hell's Kitchen (NYC) | July 23, 2011 at 09:04 AM

Of course the comparison matter. your comparison against the 1990-91 and 2001 make 2007 look average. When comparing against all post WWII recession/recoveries all three of those recoveries look below average (with all recoveries since 1990 looking very weak indeed). Even then the down-turn was the worst putting the starting point at a very, very low level.

Posted by: RangerHondo | July 26, 2011 at 08:48 AM

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May 13, 2011

Just how out of line are house prices?

In Wednesday's post, I referenced commentary from several bloggers regarding the sizeable decline in housing prices reported by Zillow earlier this week. As I discussed yesterday, the rat-through-the-snake process of working down existing and prospective distressed properties is likely far from over, and how that process plays out will no doubt have an impact on how much prices will ultimately adjust.

Recently, Barry Ritholtz's The Big Picture blog featured an update of a New York Times chart that suggests there will be a significant adjustment going forward:


Prior to the crisis, I was persistently advised that the better way to think about the "right" home price is to focus on price-rent ratios, because rents reflect the fundamental flow of implicit or explicit income generated by a housing asset. In retrospect that advice looks pretty good, so I am inclined to think in those terms today. A simple back-of-the envelope calculation for this ratio—essentially comparing the path of the S&P/Case-Shiller composite price index for 20 metropolitan regions to the time path of the rent of primary residences in the consumer price index—tells a somewhat different story than the New York Times chart used in the aforementioned Ritholtz blog post:


According to this calculation, current prices have nearly returned to levels relative to rents that prevailed in the decade prior to the housing boom that began in the late 1990s.

Of course, the price-rent ratio is not the most sophisticated of calculations. David Leonhardt shows the results from other such calculations that suggest prices relative to rents are still elevated, at least relative to the average that prevailed in the 1990s. But the adjustment that would be required to bring current levels back into line with the precrisis average is still much lower than suggested by the Ritholtz graph.

How much farther prices fall is, I think, critical in the determination of how the economy will fare in the immediate future. Again, from President Lockhart:

"The housing sector also has indirect impacts on the economy. In particular, the direction of home prices is important for the economy because changes in home prices affect the health of both household and bank balance sheets. …

"The indirect influence of the housing sector on consumer activity and bank lending would almost certainly aggravate housing's impact on growth."

Here's hoping my chart is more predictive of housing prices than the alternative.

Update: The Calculated Risk blog does a thorough job and concludes that we don't have "to choose between real prices and price-to-rent graphs to ask 'how far out of line are house prices?' I think they are both showing that prices are not far above the historical lows."

Update: The Big Picture's Barry Ritholtz points me to his earlier argument against reliance on price-rent ratios.


Photo of Dave Altig By Dave Altig
senior vice president and research director at the Atlanta Fed



May 13, 2011 in Economic Growth and Development, Forecasts, Housing, Real Estate | Permalink

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I am trying to sell a house myself right now, and was shocked at the crash in housing values we see in our area (midwest). I'm seeing projections of 25% - 33% loss of value since 2006.

Unfortunately, I think prices have a ways to go before bottoming out. In my area, there are 18 months of housing stock on the market right now. We're competing with cheap foreclosures and short sales (both are at historic highs right now, I believe). In 2004, it took about 30 days to sell a house. Now it takes about 250 days. Try selling when you need to move immediately for a job opportunity.

Linking housing prices to rents might work in the "normal" environment. But we're so far outside of normal now that I think you're over-optimistic in your projections.

What historical period has had such a number of underwater mortgages? And isn't that all thanks to the models that assumed housing prices never diminished?

Economic models need to be revised to reflect current reality. Using a model that "is not the most sophisticated of calculations" won't get us out of this catastrophe. But it's certainly nice wishful thinking....

Posted by: Main Street Muse | May 13, 2011 at 11:52 AM

As long as we live in a world where interest rates never deviate from the current level, then "prices are in line with rent" If, however, for any reason interest rates may move towards long term trend lines...then it would be prudent to look at prices as a derivative of interest rates...in which case they are probably still far higher than a "normal" market could bare.

Posted by: Jay | May 13, 2011 at 12:59 PM

My neck of the woods, Sonoma, Calif property provides an indication of what direction other markets might experience when if ever foreclosure/distressed homes become a small percentage of the market. My upscale 55+ area has a good number of homes for sale and few are selling, prices continue to decline slowly but on a steady pace. Economist and others expect prices to hold or go up once the foreclosure process has run its course but the reality is that home prices are way out of line with income including price rent ratios. When using a price rent ratio use 100 times monthly rent as a baseline to get a good idea what local home prices should be. In my area most of these homes rent for about $1600 a month and owners try and sell between 350K and 500K, so based on the rent market these homes need to sell in the 160K range which is a long way from there bubble high of 650K or even current market prices which reflects a slow market. Maybe when and if these properties get down to reasonable price rent ratios they will sell.

Posted by: Ron Caldwell | May 13, 2011 at 04:30 PM

House price to rent is analogous to stock P/E ratio, and we know this can spend long periods of time well distant from its average value. So how much overshoot might we expect?

Posted by: dunkelblau | May 13, 2011 at 07:10 PM

"Here's hoping my chart is more predictive of housing prices than the alternative."

Isn't there something odd about senior employees of the Federal Reserve, the institution charged with primary responsibility for preserving the purchasing power of our currency, cheering (asset price) inflation?

Posted by: PatR | May 13, 2011 at 07:52 PM

Over and over again analysts use price/rent as if RENT was some kind of cosmic truth telling measure of value. Rents are quite volatile. Every bit as volatile as housing prices (if not more so). They very tremendously even within a small geographic area. The types and quality of rental housing also varies depending on when properties were built.

RIGHT NOW RENTS ARE WAY UP (in many areas) and vacancies are down. This is out of line with historical employment vs rent trends. These high rents obviously distort the price/rent ratio and there is no reason whatsoever to imagine that rent levels provide more truth of value than the housing prices themselves.

Posted by: Max Rockbin | May 13, 2011 at 11:30 PM

I think the above comments are a better indicator of what is really happening in today's real estate market than are models based upon historical data that is not likely to be repeated anytime soon.

I use proprietary software from foreclosureradar.com (I have no financial interest in the site) and the volume of REO inventory, both current and in the pipeline is staggering in California. As short sales and REO re-sales re-set the comparable prices, sellers are being forced to accept lower and lower prices because their homes otherwise won't appraise at the contracted sales price.

Based upon this data, prices are now back to 2000 and the "deals" can be had for 1996 prices. I suspect we have a few more years, and perhaps another recession, before it will be time again to buy.

Posted by: Jeff Goodrich | May 14, 2011 at 11:42 AM

The interesting thing about price to rent measures is how different they are geographically. The areas that are clearly in a housing oversupply situation are incredibly cheap to buy vs rent (think of renting as buying plus buying a put on the house struck at the market) whereas other areas that are in "relative" equilibrium are not at all cheap on a buy vs rent measure. As an example take a look on zillow at the price of a three bedroom house in Dearborn Mi. How this all sorts itself out will be an interesting experiment. In the absence of easy (IE: high LTV-No doc) lending, the most reasonable hypothesis is much lower prices.

Posted by: Steve Fulton | May 14, 2011 at 12:03 PM

In parts of metro-Denver, rents are above my value to rent formula: value/income = 1 percent. I have used this formula for over 40 years so I haven't purchased but only a few Denver properties in the last 20 years. Now I am purchasing properties again but one has to be keenly aware of declining value neighborhoods and rising expenses but property taxes are declining.

Posted by: ron glandt | May 14, 2011 at 12:37 PM

@Main Street Muse. The price to rent ratio is just that, a ratio independent of interest rates at the time. I believe your suggestion is more in line of a housing affordability index, which takes into consideration the interest rate and therefore monthly payment at the time. Using that measure of affordability, buying a house is actually more affordable now than in the past because of current low rates. In other words, we are back to long term trend in price to rent ratio, but still below long term trend in interest rates, which indicates we have some padding to absorb an increase to historical 7%.

Another thought about the "bottom." Distressed properties pulling prices down significantly. Agreed. But, doesn't the price of new construction ultimately determine the long term "price point" of the market with "used" homes selling on average 15-20% below new construction for the same quality and square footage? Assuming a continued expansion in the population, the recycling of current inventory, or washing out of the shadow inventory will only last so long before new houses must be built. New construction has an absolute cost in terms of labor and commodities. Would be interesting to see a trend line of the cost of new construction per square foot over time.

Posted by: Virginia | May 14, 2011 at 04:15 PM

Property prices in desirable parts of California probably will never stabilize at 100 months rent because of combination of premiums buyers are willing to pay and the distortions caused by prop 13. However, long-term prices have tracked around 4x income and hit around 10x during the bubble. So that might predict a $650K bubble house going for about $250k

Posted by: doug liser | May 15, 2011 at 10:42 AM

Erik Hurst from the University of Chicago uses a different methodology than Case-Schiller. He says CS overstates moves.

Based on his predictions of a couple of years ago, we only have around 10% left on a macro basis. Individual markets might be different.

Posted by: Jeff Carter | May 15, 2011 at 11:19 AM

ACCOUNT FOR DEMOGRAPHICS THO AND A BULL DOZER FOR AS MANY AS 50 PERCENT OF THE HOUSES IS NOT A UNREALITY UNLESS THE NEO CULTURALISM OF IMMIGRATION IS ADDED

Posted by: MILE | May 16, 2011 at 12:27 AM

I am rather puzzled as to what the rent valuations are based on. AFIK there is no mechanism that requires landlords to report to any centralized statistical agency what rents their tenants are actually paying, along with information that would permit comparison to actual sale prices for comparable homes. Here in the northwest suburbs of Chicago, at bubble peak there were hardly any single-family homes for rent, and none comparable to mid- to high-end properties. Homes that in the past might have been rentals had been bought up by flippers and were being rehabbed -- or torn down to be replaced with million-dollar McMansions.

Now, there is a glut of homes for rent, but nearly all at prices that reflect not what the market will pay, but rather what the homeowner needs to pay their mortgage and taxes. As the owners are not business-people and are in a state of denial, they refuse to lower the asking rent, preferring zero income to any income less than mortgage plus taxes. So one finds the same homes on the MLS rental pages six months, nine months, or even more. Recently, one sees an occasional reduction in asking rent --- but not enough to move the property. I suspect that many of the homes that have disappeared from the MLS rental listings have disappeared not because they were rented, but because they were finally foreclosed upon. But if they were rented, I suspect it was at a monthly rate well below the asking rent.

So if the rents used for the price-to-rent ratio calculation are the MLS asking rents, they are probably significantly overstated.

Moreover, since the market is obviously not clearing at the rents being currently being asked, actual rents will have to end up significantly lower than the rents currently being paid for the homes that do rent, if the additional homes (which are effectively a "shadow inventory") are ever going to actually be rented.

Posted by: jm | May 16, 2011 at 03:24 AM

Zillow is half the problem. They estimate my house on the basis of never seeing it, nor ever seeing the improvements I've made. They have a statistical model they follow, but I own a ranch house on a full ace, and in my area there are probably 1 or 2 similar houses for sale, so there is no statistically valid sample to put into their model.

The other half is the estimators that do the same thing. They don't look at a house, they don't have a valid statistical sample, so there numbers are irrelevant.

The value of a house is what a buyer and seller say it is. The only other basis to use is build or rebuild cost. So, let's be honest, the system is the problem.

If you really want to solve he problem, reenact Glass Steagall, thereby forcing the banks to lend money in order to make a profit instead of gambling on derivatives. They don't lend, they die. As Ben Johnson said, "The prospect of hanging has a way of concentrating the mind."

Posted by: Don Hiorth | May 16, 2011 at 08:30 AM

@Virginia - "Using that measure of affordability, buying a house is actually more affordable now than in the past because of current low rates."

If you are a first time buyer, this could be an okay time to buy - but prices are still significantly higher than in the late 1990s, and it seems that they will continue to decline through the next 12 - 18 months. And employment uncertainties/wage stagnation could make buying a bit tricky today.

If you are NOT a first time buyer, but a homeowner looking to sell, the price to rent ratio is irrelevant. The market value of your home has tanked significantly in the last few years. That's a serious decline in the net worth of a middle-class home owner.

Posted by: Main Street Muse | May 16, 2011 at 12:20 PM

But when bubbles burst don't prices normally overshoot to the downside? If house prices are "average" now, wouldn't this suggest that they still have a lot further to fall?

Posted by: John Smith | May 17, 2011 at 07:17 AM

The price/rent ratio probably should not compare the price to rent of equivalent houses. I am a renter now, but if I ever do decide to buy a house, I would buy a house much larger than the one I am renting now.

Posted by: skr | May 31, 2011 at 05:15 PM

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May 11, 2011

Is housing hurting the recovery?

Though the week is only half over, I'm going to nominate Stan Humphries and Zillow as bearers of the week's most distressing economic news:

"Home values fell three percent in the first quarter of this year, marking a pace of decline not seen since 2008 when the housing recession was at its worst. Home values fell one percent between February and March and 8.2 percent from March 2010."

Calculated Risk provides a handy table of how prices have affected equity values in homes by locale, as the Zillow Real Estate Research blog predicts the price-decline end is not so near:

"Previously, we anticipated a bottom in home values by the end of 2011. But with values falling by about 1 percent per month so far, it's unlikely that will happen. We now believe a bottom will come in 2012, at the earliest."

At The Curious Capitalist, on the other hand, Stephen Gandel says he's not so sure:

"To be sure, housing prices have fallen this year. But the Zillow numbers out today make the housing market look worse than it is. The problem is with how Zillow tracks home prices. Unlike other measures of the housing market, Zillow's numbers are not based on actual sales, but on estimates of what its model thinks your house, along with every other house in America is worth. Zillow's model is similar to how an appraiser figures out what your house is worth. It looks at past sales of houses that are similar to yours and then guesses what your house is worth. But by the time those sales are fed into Zillow's system they are months old. … If the housing market is turning, Zillow is going to miss it."

Is the housing market turning, particularly with respect to prices? Tough to say. If you want your glass half full, these words from the New York Fed's Liberty Street Economics might be the tonic for your tastes:

"This post gives our summary of the 2011:Q1 Quarterly Report on Household Debt and Credit, released today by the New York Fed. The report shows signs of healing in household balance sheets in the United States and the region, as measured by consumer debt levels, delinquency rates, foreclosure starts, and bankruptcies…

"Delinquency rates are generally down…

"New foreclosures fell nationally and in the region. About 368,000 individuals in the United States had a foreclosure notation added to their credit report between December 31 and March 31, a 17.7 percent decrease from the 2010:Q4 level. New foreclosure rates fell from 0.19 percent to 0.15 percent for all individuals nationwide…"

What may be the most important aspect of the report is highlighted by the Financial Times's Robin Harding: "…fewer new mortgages going bad, and some bad mortgages getting better." In fact, for the first time since the crisis began, the percentage of mortgages transitioning from 30 to 90 days delinquent to current exceeds the percentage transitioning to seriously delinquent (90-plus days).


There is, of course, plenty of material for the housing-price bears. For example, the flow of seriously delinquent mortgages is quite elevated.


According to estimates from CoreLogic, the supply of "distressed" homes is greater than 15 months at the current pace of sales:


Kevin Drum thinks this all adds up to problems for the recovery (hat tip Free Exchange):

"Most analysts now expect that the housing market won't bottom out until sometime next year. Until that happens, it's unlikely that that the sluggish economic recovery we're seeing right now will improve much."

The view here at the Atlanta Fed—and the answer to the question posed in the title of this post—was provided earlier today by our president, Dennis Lockhart, in a speech given to the Atlanta Council for Quality Growth:

"…can we have high-quality growth while the residential real estate and commercial real estate sectors continue to be so weak? Not completely, in my opinion. The recovery will progress, but it will not be robust until we work through the economy's serious imbalances, including those in the real estate sector.

"As I look ahead, I think the most reasonable assumption is that improvement of the real estate sector will lag an otherwise improving economy. But I am encouraged by the fact that the economy is increasingly on firmer footing."

I will let you decide whether that glass is half-empty or half-full.

Photo of Dave Altig By Dave Altig
senior vice president and research director at the Atlanta Fed



May 11, 2011 in Economic Growth and Development, Forecasts, Housing, Real Estate | Permalink

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Comments

the accelerating decline in housing prices is really old news, and its not just zillow that's been reporting it; corelogic reported a 1.5% decline in March, which put their index 4.6% below the 2009 lows; the NAR index has fallen 7% YTD, and is also 4.6% below last years reading; and just last week, clear capital declared an official double dip, after their index fell 4.9% from the previous quarter and 5.0% YoY...

Posted by: rjs | May 12, 2011 at 05:49 AM

I'm voting for half empty. And I think it will take more than just a year before housing recovers to the point it will have a significant positive impact on the economy. So I’m projecting a slow choppy recovery for the U.S. economy.

Posted by: Phil Aust | May 16, 2011 at 11:44 AM

US government has stimulate the economy with 4.5 trillions of dollars or so and its only stimulated the economy half cos it bail out the big co. only . The main contributor of US economy , consumers are left in debt . They need to be bailed out so that economy will be balanced.

Posted by: Win | May 24, 2011 at 12:29 AM

I'm going to have to agree with the half empty comment. I think it is true that we are a long ways away from the economy going up. Not only is housing suffering, but business owners as well. Hopefully change will come soon.

Posted by: Stephanie | June 01, 2011 at 03:07 PM

Another hand for half empty. It's really hard to recover from economic downfall. I don't think housing is the mainstream of this. Rapid growth of population and cost cutting also affect the chance of regaining it back.

Posted by: makati for rent | August 03, 2011 at 08:38 PM

Im agree with the half empty comment and also the rapid growth of population and cost cutting affect of our economy downfall.

Posted by: cavite housing | August 22, 2011 at 12:15 AM

Housing has definitely hurt our economy, people are unable to pay rents and loans of there houses

Posted by: iphone 6 | February 12, 2012 at 12:49 PM

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