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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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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

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?

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.

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.


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.

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.[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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June 01, 2011

Should we even read the monthly inflation report? Maybe not. Then again...

In a recent issue of Economic Synopsis, our colleague Dan Thornton of the St. Louis Fed questions the usefulness of the traditional core inflation statistics—the consumer price index (CPI), or the personal consumption expenditure price index that strips out food and energy costs. Specifically, Dan asks whether the core inflation statistic is a better predictor of future inflation over the medium term (say, the next two or three years), than the headline inflation statistic. His conclusion is that:

"[F]or the most recent period, there is no compelling evidence that core inflation is a better predictor of future headline inflation over the medium term."

But Dan also invites the following:

"[I]n the interest of greater transparency and to allow the public to better understand its focus on core measures, the FOMC [Federal Open Market Committee] should provide evidence of the superior forecasting performance of the core measure it uses."

Well, of course neither writer of this blog post is on the FOMC, and equally obvious is the fact that we don't speak for anyone who is. Moreover, we're not very big fans of the traditional core measures, and we much prefer trimmed-mean estimators of inflation when thinking about recent price behavior.

Nevertheless, we'd like to attempt an answer to Dan's call, even if it wasn't aimed at us.

Here's the experiment run by Dan: He used the past 36-month trend in the traditional core inflation measure and the ordinary headline inflation measure and tested which one most accurately predicted the next 36 months of headline inflation. He found that they're about the same. A similar look at 24-month trends yielded a similar result.

The upshot of these experiments can be seen in the figure below (which is a figure of our construction, not his).

The chart shows how accurately we can predict headline CPI inflation over the next three years using only headline CPI price data or, alternatively, using only core CPI price data. The essence of the conclusion reached in the Economic Synopsis is summarized within the shaded box. The forecast accuracy of the two- and three-year trends of the core CPI price measure doesn't seem to be a significant improvement to the plain-vanilla headline CPI.

But we wonder whether the contribution of the core inflation statistic is being accurately reflected in this experiment. For us, the power of a core inflation measure—whether it be the traditional ex-food and energy measure, or some more statistical construct like the trimmed-mean estimators—can't be seen by comparing data trends of this sort. The volatility of an inflation statistic, what we would characterize as "noise," dissipates rather quickly, generally within a few months (although for food and energy, it could play out over a longer period of time, we understand).

At issue is how much the most recent month's or quarter's inflation data should inform one's thinking about the future path of inflation. Implicit in the experiments reported above is that they shouldn't—well, only as much as the most recent monthly or quarterly data influence the trend of the past two or three years.

It may be that the most recent monthly or even quarterly data are so noisy that they have nothing useful to contribute to our perception of the future inflation trend. But then again, an experiment that assumes there is no useful information in the most recent inflation data does not necessarily make it so.

We'd like to call your attention to the remainder of the figure above, where we ask the question, what happens if you try to predict headline CPI inflation over the next three years using only the most recent price data? For example, what if we restrict ourselves to looking only at the most recent month's CPI report? What we see is that the core inflation statistic provides a much improved prediction of the future inflation trend compared to the headline measure. Specifically, forecast accuracy is improved by nearly 50 percent if you use the core inflation measure. (For you wonks, the root mean square error, or RMSE, of the core CPI prediction is about 1.4 percent, compared with a RMSE of 2.7 percent for headline CPI inflation.)

Now consider the behavior of CPI prices over the past three months. How informative of the future inflation trend are these prices? Well, the accuracy of the headline inflation statistic improves relative to the one-month percent change because averaging the data over time in this way necessarily reduces the transitory fluctuations in the data. But again, the three-month core CPI price statistic provides a much better prediction of future headline inflation than does the three-month trend in the ordinary CPI statistic. In other words, if you're wondering what the past-three months of data tell you about developing inflation pressure, you're much better off considering the core statistic than you are the headline number.

Here's another observation we'd like to make: The most recent three-month trend in the core CPI inflation measure appears to be a more accurate predictor of future inflation than the 12-month headline CPI trend. Moreover, the three-month trend in the core measure is roughly as accurate as its longer-term trends. This observation suggests that paying attention to the core measure may allow you to spot changes in the inflation trend much more quickly than using headline alone.

Again, to be clear, we aren't endorsing the core inflation statistic. We're fans of trimmed-mean estimators and think they do an even better job of informing thinking about what the most recent price data tell us about the likely future path of inflation. (As evidence, we included in the chart above the same forecasting results for the median CPI.) We only want to make one simple point—the usefulness of a core inflation measure is best seen in the monthly and quarterly intervals that span FOMC meetings, not in the two- or three-year trends which are, by construction, largely silent about the most recent data.

By Mike Bryan, a vice president in research at the Federal Reserve Bank of Atlanta, and Brent Meyer, a senior economic analyst at the Federal Reserve Bank of Cleveland


June 1, 2011 in Forecasts, Inflation | Permalink


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You can't test whether core is useful this way. For example, if a central bank is targeting 2% total inflation at a 2-year horizon, and if it is doing it right, then *nothing* should forecast 2-year ahead inflation. This is an immediate implication of rational expectations on the part of the bank. Deviations of total inflation from 2% are the bank's forecast error, which should be uncorrelated with anything in the bank's information set 2 years prior.

More in my post here:

Posted by: Nick Rowe | June 02, 2011 at 07:31 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 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 (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


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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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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January 04, 2011

Looking back, looking forward

Kicking off the new year, the latest edition of the Atlanta Fed's EconSouth magazinecontains our annual review of the year past and our bravest guess about the one to come (articles in this issue include outlooks for the national, international and Southeast economies and features on small business and other topics). If we are looking for enduring lessons about the national economy from the previous year, I nominate the time-tested but oft-ignored advice to be wary of reading too much into short-term economic ups and downs:

"Better-than-expected increases in several economic indicators in the spring led many economists to revise up their growth estimates. A quick snap-back in the economy, as has been typical in most other deep recessions in the post–World War II era, seemed a distinct possibility.

"However, such a snap-back was not to be. It is now clear that some of the rebound in growth stemmed from a rebuilding of depleted inventories in the first quarter and the waning influence of various government spending programs. By summer, the incoming economic data had weakened considerably, and the pace of expansion in the major expenditure categories raised the specter of a step backward into contraction…

"Bumpy growth for an economy transitioning out of a recession is not unusual. For example, GDP [gross domestic product] jumped by 3.5 percent in the quarter immediately following the end of the 2001 recession, but it then slowed to just 0.1 percent three quarters later. To date, that pattern of growth proceeding in fits and starts has certainly been representative of this recovery."

In fact, it now appears that the U.S. economy grew in 2010 by somewhere in the range of 2.5 percent to 3 percent, just where the Blue Chip consensus was at the beginning of the year (and, incidentally, somewhat better than what we at the Atlanta Fed were expecting). Still…

"Despite these improvements, economic performance has been somewhat disappointing. The recovery has not been strong enough to meaningfully reduce the unemployment rate. Throughout the year, the unemployment rate has remained well above 9 percent. Income growth (excluding transfer payments made by the government) has been weak—up less than 1 percent for the year on an inflation-adjusted basis. The housing market is struggling in the face of continuing foreclosures despite a variety of tax incentives and historically low mortgage rates, and the commercial real estate sector likewise has not recovered. This theme of improvement in some areas and ongoing weakness in others illustrates the unevenness of the recovery and more uncertainty than normal about future economic prospects."

Will 2011 be a different story? Quantitatively, probably yes—growth should take another step up this year. But the story, we think, remains essentially the same:

"The incoming data as well as reports from the Atlanta Fed's business contacts are broadly consistent with a relatively restrained growth trajectory. There are, in fact, several factors that will plausibly inhibit the pace of the expansion. Weakness in residential and commercial real estate is ongoing. Business and consumer attitudes are still extremely cautious, and slow spending growth by businesses and households is continuing to hold back inflation. Over the near term, additional business spending appears likely to be geared primarily toward activities such as targeted mergers and acquisition and further increases in efficiency rather than toward pure expansion. Slow and uneven sales, opportunities to reduce costs through increased productivity, structural adjustments in labor markets, and uncertainty over government policy—including changes in labor and environmental rules, tax policy, and financial regulations—are restraining job creation. Slow job growth, naturally, implies that unemployment could remain elevated for some time."


"Of course, risks lurk on both the upside and downside for the outlook, but there are reasons for optimism. Financial firms and households have made significant headway in repairing their severely compromised balance sheets, and most are in a much better financial position than they were a year-ago. Businesses in particular have substantially more liquidity and significant capacity to deploy capital to new projects. Some of the uncertainties that have vexed private decision makers, such as the course of near-term tax policy, may finally be abating…

"Recent surprises in the economic indicators have been predominantly to the upside, which is a very good sign. If such positive surprises persist, and confidence in the economic environment grows, it could be that current estimates for only slight improvement in 2011 have been too modest."

Here's hoping.

Note: For more perspective on the 2010 economic outlook and monetary policy, stay tuned for Atlanta Fed President Dennis Lockhart's speech to the Rotary Club of Atlanta, scheduled for Monday, January 10. The text will be posted on the Bank's website.

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

January 4, 2011 in Economic Growth and Development, Forecasts | Permalink


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I used to think Ron Paul was crazy. But I no longer believe anything that comes from the FED. The FED doesn't follow the "Blue Book's" governmental accounting, auditing, and financial reporting standards, & would obviously not pass any normal corporate audit of its books. The on-line Federal Reserve Bulletin now has effectively eliminated the "paper trail".

Posted by: flow5 | January 09, 2011 at 04:27 PM

Good work with the FRBA forecasts in 2010. Very close to the mark in the short term. Hope you are on the mark for inflation over the medium and long term.

Posted by: Williamrsmith | January 10, 2011 at 07:04 PM

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October 07, 2010

Using TIPS to gauge deflation expectations

In the recent Survey of Professional Forecasters, economists were asked to give their subjective probability of deflation during the next year. Specifically, they were asked about the chances that the quarterly consumer price index excluding food and energy (core CPI) will decline in 2011. According to the respondents, the probability of core CPI deflation in 2011 was only 2 percent.

This rather sanguine view of the probability of deflation is encouraging. But is it a view shared by noneconomists? While there are many sources used to measure inflation expectations, there aren't many that gauge inflation uncertainty or the risk of deflation. However, one might estimate a probability of deflation as seen by investors by exploiting the different deflation safeguards of a pair of Treasury Inflation Protected Securities (TIPS), which have about the same maturity date but different issue dates.

Here's the idea: A TIPS cannot pay less than its face value at maturity, so the principal repayment of a five-year TIPS issued today is not reduced if the five-year rate of inflation is negative over the life of the security. But a 10-year TIPS issued five years ago will have its capital gain from accrued inflation reduced if there is a net decline in the CPI over the next five years. As a result, part of the real yield spread between the 10-year and five-year TIPS issues should reflect the value of the better deflation safeguard of the latter security.

In a comment on a paper by Campbell, Shiller, and Viceira, Jonathan Wright derives a very simple formula for calculating a lower bound on the probability of deflation using this real yield spread. (The lower-bound formula is rm/ln(CPI5yr/CPI10yr), where r is the yield spread between the 10-year and five-year TIPS real yields, m is the number of years until the midpoint of the maturity dates of the two TIPS, and CPI5yr/CPI10yr are the levels of the NSA CPI on the issue dates of the five-year and 10-year year TIPS. These reference CPIs are available here. Deflation is defined as the level of the CPI being lower than its value on the issue date of the five-year TIPS.) Wright's calculation makes a number of simplifying assumptions, some of which are counterfactual, but it is easy to compute—almost literally a back-of-the-envelope calculation if you have two real TIPS yields in hand. The formula also has the advantage that it does not require any assumptions about the probability distribution of inflation.

To get exact probabilities of deflation instead of a lower bound, I developed a simple model for TIPS pricing. The model is an extension of the TIPS pricing model developed by Brian Sack. One has to make a lot of assumptions to derive these estimates—which you can read about in the appendix to this post (link provided in last paragraph)—but let's get to the main results. The figure below plots the probability that the level of the reference CPI on April 15, 2015, is lower than its April 15, 2010, level. (The reference CPI is the nonseasonally adjusted consumer price index interpolated to a daily frequency; it is calculated by taking a weighted average of the CPI two months ago and three months ago.) If the April 2015 reference CPI ended up below this threshold, then the deflation safeguard for the five-year TIPS would kick in. Also included in the graph is the lower bound of this "deflation probability" calculated using Wright's formula.


An alternative way of generating deflation probabilities is to exploit the estimated "confidence interval" from a forecasting model of inflation. When I use a variant of the inflation model proposed by Stock and Watson (for those interested in more detail, the model I am using is the Stock-Watson unobserved components with stochastic volatility, or UC-SV model), it says there is about a 10 percent chance that average CPI inflation over the next five years will be below zero.

Is this the last word on estimating deflation probability? Of course not; there are more than a few pitfalls in this method of calculating a deflation probability, some of which are described in the aforementioned technical appendix posted on the Atlanta Fed's Inflation Project. But this approach does have the advantage of exploiting information from market prices on traded securities. As such, it may prove a valuable addition to our toolkit of indicators. Consequently, we intend to update these estimates and post them on the Inflation Project web page every Thursday afternoon.

By Patrick Higgins, an economist in the Atlanta Fed's research department

October 7, 2010 in Forecasts | Permalink


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Even though point is pretty neat, personally I wouldn't rely on this too much. Liquidity of 5year TIPS markets would be higher now relative to the pre-crisis levels exactly for those same reasons you want to use it gauge deflationary expectations: it's a better hedge against significant medium-term inflation uncertainty.

Posted by: Dan | October 08, 2010 at 01:39 AM

I don't know who is included in the survey of economists, but I would put the probability that we will have deflation in 2011 at substantially above 2%.

Posted by: don | October 12, 2010 at 10:30 PM

I wonder if there's some reason that you don't simply calculate the value of the embedded floors in TIPS, and then use the delta of that option? It's not easy, as you can't use black-scholes and you have to first strip out seasonalities and such...but it's actually a market price rather than a strange economist view of a market price.

For that matter, why not just compute the delta of 0% ZC floors, which are quoted and trade in the market?

Interesting shorthand approaches, but it seems to me that if economists really wanted the market's view on this, they ought to calculate an actual number.

Posted by: Michael Ashton | August 24, 2012 at 08:23 AM

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August 03, 2010

What makes forecasting tough

Bloomberg's Caroline Baum recounts her recent conversation with the Atlanta Fed's own Mike Bryan under the headline For Good Economic Forecasts, Try Flipping a Coin:

"How do economists fare when it comes to real forecasting, to predicting [gross domestic product] GDP growth and inflation one year out? About as good as a coin toss, according to Bryan's research. Less than half the economists did better than the naive forecast, which is based on no understanding of the economy and merely assumes next year's outcome will be the same as this year's. It's what you'd expect if the results were purely random."

A case in point could be found yesterday on Bloomberg, which featured a "chart of the day" that looked something like the one below (though I've updated the data for manufacturing inventories, given today's factory orders report):


The chart was accompanied by this commentary:

"U.S. business inventories are so low relative to demand that any increase may act as a catalyst for larger companies to add workers, according to Nicholas Colas, chief market strategist at BNY ConvergEx Group."

A few days back, in The Wall Street Journal, you could find this:

"Until recently, businesses had helped supercharge economic growth by restocking inventories. Now the oomph from inventories is waning.

"In the second quarter, the change in private inventories added slightly more than one percentage point to the 2.4% increase in gross domestic product from the first quarter, measured at a seasonally adjusted annual rate, the Commerce Department said Friday.

"That is a big change from the first quarter, when inventory-building contributed 2.6 percentage points to GDP growth of 3.7%, and the fourth quarter of last year, when it contributed 2.8 percentage points to GDP growth of 5%....

"But Friday's report suggests companies are nearly done restocking their shelves.

" 'Our sense is current inventories are about where they need to be globally, both in industrial distribution and with the large North American retailers,' John Lundgren, chief executive of Stanley Black & Decker Inc., said in a July 21 call with analysts discussing the tool and hardware maker's second-quarter results."

But, on the same topic, Seeking Alpha opined:

"Inventory increases added 1.05% to second quarter GDP. Based on the annual revision, they added 2.64% to first quarter GDP or 71% of the total increase. Inventories were also responsible for approximately two-thirds of the GDP increase in the fourth quarter of 2009. The entire economic 'recovery' has essentially been an inventory adjustment [emphasis theirs]. This does not bode well for the future."

So one analysis suggests that the latest readings on inventories portend a boost to GDP, one foresees a drag on GDP, and yet another divines that inventories are basically played out as an economic story for the balance of the year.

Again from the Baum piece:

"Bryan said it's not just about getting the number right. 'It's about the narrative.' "


For comparison, it's also useful to take a longer look at what effect inventories have on GDP growth coming out of a recession; see the graph below. It charts the percentage point contributions of various components to real GDP growth in the first four quarters following the end of a recession (the current recession is assumed to have ended in second quarter of 2009). I've shown on the graph the percentage contribution of inventories to the last seven recoveries, beginning with the one in 1971.


Regarding the point made in Seeking Alpha, inventories have contributed around 70 percent to the economic recovery recently, but in the recovery that began in 2002 inventories contributed 75 percent in the first four quarters. So the last two recovery periods stand out for large inventory components. But looking across the data, it's hard to say what an ordinary inventory contribution would be. Regardless of whether inventories are an unusually large part of this recovery, in absolute levels the scale of the recent inventory cycle—the initial liquidation and the subsequent restocking—has been unprecedented.

By Andrew Flowers, senior economic research analyst in the Atlanta Fed's research department

August 3, 2010 in Business Cycles, Forecasts | Permalink


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I remember around December 2007, when economists gave something like a 20% chance of recession, there was a Bloomberg poll that showed the public felt we were already in one.

Interestingly, most people would say the recession has never ended, though economists confidently point to the turn to positive GDP one year ago. What if there is another downturn already starting, and the NBER committee decides it is really one large event?

Posted by: Bob_in_MA | August 03, 2010 at 05:14 PM

Regardless of whether inventories are an unusually large part of this recovery, in absolute levels the scale of the recent inventory cycle—the initial liquidation and the subsequent restocking—has been unprecedented.

Posted by: GHD Straighteners | August 04, 2010 at 02:39 AM

I remember around December 2007, when economists gave something like a 20% chance of recession, there was a Bloomberg poll that showed the public felt we were already in one.

Posted by: links of london | August 04, 2010 at 02:40 AM

If we can't forecast, surely this makes the case for analysis of effective design of automatic stabilisers into an interesting question?

Posted by: rjw | August 04, 2010 at 02:55 PM

My predcition for AAA corporate bond yields in 1981 was 15.48%. AAA corporate yields hit 15.49%. I was off by .01%.

It is a scientific fact that economic forecasts are mathematically infallible. All you need is the G.6 debit and deposit turnover release.

Posted by: flow5 | August 05, 2010 at 12:56 AM

The transactions concept of money velocity (Vt) has its roots in Irving Fischer’s equation of exchange (PT = MV), where (1) M equals the volume of means-of-payment money; (2) V, the transactions rate of turnover of this money; (3) T, the volume of transactions units; and (4) P, the average price of all transactions units.

The “econometric” people don’t like the equation because it is impossible to calculate P and T. Presumably therefore the equation lacks validity. Actually the equation is a truism – to sell 100 bushels of wheat (T) at $4 a bushel (P) requires the exchange of $400 (M) once (V), or $200 twice, etc.

The real impact of monetary demand on the prices of goods and serves requires the analysis of “monetary flows”, and the only valid velocity figure in calculating monetary flows is Vt. Income velocity (Vi) is a contrived figure (Vi = Nominal GDP/M).

The product of MVI is obviously nominal GDP. So where does that leave us? In an economic sea without a rudder or an anchor. A rise in nominal GDP can be the result of (1) an increased rate of monetary flows (MVt) (which by definition the Keynesians have excluded from their analysis), (2) an increase in real GDP, (3) an increasing number of housewives selling their labor in the marketplace, etc. The income velocity approach obviously provides no tool by which we can dissect and explain the inflation process.

To the Keynesians, aggregate demand is nominal GDP, the demand for services (human) and final goods. This concept excludes the common sense conclusion that the inflation process begins at the beginning (with raw material prices and processing costs at all stages of production) and continues through to the end.

The Fed first calculated deposit turnover in 1919. It reported weekly until 1941 (like M3, the series was also discontinued, in Sept. 1996). The figure “other banks’’ was used until 1996. Prior to this revision Vt included all banks located in 232 SMSA’s excluding N.Y. City. This was the best that could be done to eliminate the influence on prices of purely financial and speculative transactions. Obviously funds used for short selling do not contribute to a rise in prices.

The Fed calculates these velocity figures by dividing the aggregate volume of debits of these banks against their demand deposits.

We do know that to ignore the aggregate effect of money flows on prices is to ignore the inflation process. And to dismiss the concept of Vt by saying it is meaningless (that people can only spend their income once) is to ignore the fact that Vt is a function of three factors: (1) the number of transactions; (2) the prices of goods and services; (3) the volume of M.
Inflation analysis cannot be limited to the volume of wages and salaries spent.

To do so is to overlook the principal "engine" of inflation - which is of course, the volume of credit (new money) created by the Reserve and the commercial banks, plus the expenditure rate (velocity) of these funds. Also overlooked is the effect of the expenditure of the savings of the non-bank public on prices.

The (MVt) figure encompasses the total effect of all these monetary flows (MVt).

Posted by: flow5 | August 05, 2010 at 01:02 AM

Economist still try to conjure up learned interpretations. Now its the yield curve and its associated long term contractions and expansions of business activity, prices, etc.

“Double-Dippers Are All Wet Ignoring Yield Curve” Caroline Baum - Bloomberg – July 12 2010:

“It’s just that the yield curve, or what it represents, is possibly the best leading indicator of the business cycle”

Everyone on the FED's technical staff that thinks the money supply can be managed by using interest rates should lose their job and their pension.

Posted by: flow5 | August 05, 2010 at 11:43 AM

yes forecasting is tought. But that is why we are willing to pay lots of money for them. Trouble is, we (ie everyone) pays lots of money for those which are wrong.

Posted by: chris | August 11, 2010 at 08:27 AM

People are just people. Sometimes they are right in their forecasts, sometimes not. The most important point is to be able to acknowledge mistakes that we make. Perfection comes with practice.

Posted by: Monklet | August 16, 2010 at 08:09 AM

there are two papers one has to mention when discussing inflation forecasts.
The naive approach was first tested by Atkeson and Ohanian.
Stock and Watson published results of a comprehensive quantitative comparison of existing models.

Atkeson, A., Ohanian, L.E., (2001). “Are Phillips curves useful for forecasting inflation?”, Federal Reserve Bank of Minneapolis Quarterly Review 25, 2-11.
Bureau of Labor Statistics, (2003). “Revisions in the CPS effective January 2003”,

Stock, J., Watson, M. (2007). Why Has Inflation Become Harder to Forecast? Journal of Money, Credit and Banking, 39(3), 3-33.

Posted by: kio | August 19, 2010 at 02:41 AM

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June 30, 2010

Keeping an eye on Europe

In June, a third of the economists in the Blue Chip panel of economic forecasters indicated that they had lowered their growth forecast over the next 18 months as a consequence of Europe's debt crisis. When pushed a little further, 31 percent said that weaker exports would be the channel through which this problem would hinder growth, while 69 percent thought that "tighter financial conditions" would be the channel through which debt problems in Europe could hit U.S. shores.

Tighter financial conditions also were mentioned by the Federal Open Market Committee in its last statement, where the committee noted, "Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad."

In his speech today, Atlanta Fed President Dennis Lockhart identified the European sovereign debt crisis as one of the sources of uncertainty for the U.S. economy that he believes "have clouded the outlook." President Lockhart explicitly expressed his concern that Europe's "continuing and possibly escalating financial market pressures will be transmitted through interconnected banking and capital markets to our economy."

Negative effects from the European sovereign debt crisis can be transmitted to the U.S. economy through a number of financial channels, including higher risk premiums on private securities, a considerable rise in uncertainty, and sharply increased risk aversion. Another important channel is the direct exposure of the U.S. banking sector—both through holdings of troubled European assets and counterparty exposure to European banks, which not only have a substantial exposure to the debt-laden European countries but have also been facing higher funding costs. The LIBOR-OIS spread has widened notably (see the chart below), liquidity is now concentrated in tenors of one week and shorter, and the market has become notably tiered.


Banks in the most affected countries (Greece, Portugal, Ireland, Spain, and Italy) and other European banks perceived as having a sizeable exposure to those countries have to pay higher rates and borrow at shorter tenors. Although for now U.S. banks can raise funds more cheaply than many European financial institutions, some analysts believe that there's a risk that the short-term offshore dollar market may become increasingly strained, leading to funding shortages and, conceivably, forced asset sales.

Bank for International Settlements data through the end of December of last year show that the U.S. banking system's risk exposure to the most vulnerable EU countries appears to be manageable. U.S. banks' on-balance sheet financial claims vis-á-vis those countries, adjusted for guarantees and collateral, look substantial in absolute terms but are rather small relative to the size of U.S. banks' total financial assets (see the chart below). The exposure to Spain is the biggest, closely followed by Ireland and Italy. Overall, the five countries account for less than 2 percent of U.S. banks' assets.


U.S. exposure to developed Europe as a whole, however, is much higher at $1.2 trillion, so U.S. financial institutions may feel some pain if the European economy slows down markedly. How likely is a marked slowdown? It's difficult to determine, of course, but when asked about the largest risks facing the U.S. economy over the next year, the Blue Chip forecasters put "spillover effects of Europe's debt crisis" at the top of their list.

By Galina Alexeenko, economic policy analyst at the Atlanta Fed

June 30, 2010 in Banking, Europe, Forecasts | Permalink


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I honestly think we have reached the end of the road for monetary policy. How cheap can money get? the banks are still in bad shape.

If there is a stimulus to come, it must be from fiscal policy-and not spending.

Tax cuts. Only way to get out of the morass.

Posted by: Jeff | July 05, 2010 at 10:55 PM

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