Economic reports from late 2011 and early 2012 indicate a recovery that is solidifying. While many were concerned about a possible double dip late last summer, increasing optimism seems to be taking hold as more jobs are created and the unemployment rate declines. As discussed elsewhere, some of these reports are probably a little misleading. Nevertheless, the economy is on more solid footing than it was six months ago. What could go wrong? One concern mentioned in the post regarding the outlook for the new year was rising oil prices. Less than two months later and more people are becoming concerned that we can see a repear of last year or worse. Recall that the economy appeared to be strengthening as 2010 ended and 2011 began, but than a series of shocks hit the economy including a spike in oil prices. As a result, economic growth was anemic in the first half of 2011. Could it happen again? Unfortunately yes. The average price of gas is at a record high for the month of February and some forecasts suggest it could hit $5 by summer. Barring a blow up in the Middle East, this seems unlikely (note that the record high average price is $4.13 reached in the summer of 2008 while it rose to $3.97 in May 2011).
Why are oil and gas prices rising? There are many reasons that are beyond control in the short term. One reason not discussed much is the "risk-on" trade. Investors were quite nervous in Fall 2011, depressing prices of many assets including stocks and oil. As investors became more confident and were willing to take on more risk, asset prices rose, including both stocks and oil. Since reaching a low in October, the S&P has risen by almost 24%. Over the same time, gas wholesale gas prices have risen by about 25% while Brent North Sea crude prices have risen by about 20% thus, part of the reason for the recent run-up in oil prices is renewed willingness by investors to take on risk. Of course there have been reasons for the willingness of investors to take on more risk including perceptions of a stronger US economy and less fear of a European meltdown, both of which led to rising stock and oil prices. In addition, speculation has played a significant role in the behavior of oil prices in the last decade, driving it up to $157 per barrel in 2008 and back down later that year as the global economy collapsed. Events in the Middle East, including the after effects of the Arab Spring and concerns about rising tensions over Iran's nuclear program are beginning to have an impact.
Though not much can be done about it in the short term, I suspect oil price may become a critical issue as the presidential campaign heats up this summer. The Obama administrations "delay" of the Keystone oil pipeline will be at the center of the debate. For details about the merits of the pipeline, I'll defer to a respected economist that specializes in energy, Jim Hamilton, who tends to be objective without an ideological agenda. Here are some of his recent posts in favor of the pipeline:
Tuesday, February 21, 2012
Friday, February 3, 2012
Did seasonal adjustments distort the January Job Report?
This post is not designed to be cynical or pessimistic, but to explore possible reasons that the report overestimated the strength of the job market. Most economic data, including employment data, are seasonally adjusted. As part of a recent analysis of the job market relative to GDP, Mark Vitner of Wells Fargo examined how seasonal adjustments may be misleading. It should be noted that this was not written as a way to explain away this morning's job report, but was released on January 31. Here are a few of his key points:
"The 2007-2009 recession was the deepest recession since the Great Depression, when considering peak-to-trough declines in real GDP. Moreover, some of the largest declines in employment, as well as the largest increases in the unemployment rate, occurred during the fall and early winter months of 2009-2010, with nonfarm payrolls reaching a bottom in February 2010... This occurrence has likely set the bar very low for employment gains during the winter months in such a way that even normal hiring gains related to the holiday shopping season are showing up as seasonally adjusted employment gains, leading to exaggerated estimates of employment growth.
The seasonal factors used to adjust the unemployment rate were also impacted by the severity of the 2007-2009 recession. The result of this amplitude change is that the seasonal adjustment process has tended to exacerbate downward movements in the unemployment rate during the fall and winter months, while exerting upward pressure on the unemployment rate in the spring and summer months."
In essence, hiring patterns in recent years are used to estimate seasonal adjustments. Given that some of the worst job losses during the Great Recession took place in the winter (Dec 2008-March 2009), the seasonal adjustments for those months may be biased, resulting in an overestimate of seasonally-adjusted employment growth for those months. How much of a difference did this make? If one seasonally adjusts last month's data using the average seasonal adjustment for January for the five years prior to the Great Recession, there would have been 40,000 fewer jobs reported (resulting in an increase of 203,000 jobs as opposed to 243,000). Thus, a significant portion of the upward surprise appears to be linked to seasonal adjustments that may be biased.
Update (Saturday):
"The 2007-2009 recession was the deepest recession since the Great Depression, when considering peak-to-trough declines in real GDP. Moreover, some of the largest declines in employment, as well as the largest increases in the unemployment rate, occurred during the fall and early winter months of 2009-2010, with nonfarm payrolls reaching a bottom in February 2010... This occurrence has likely set the bar very low for employment gains during the winter months in such a way that even normal hiring gains related to the holiday shopping season are showing up as seasonally adjusted employment gains, leading to exaggerated estimates of employment growth.
The seasonal factors used to adjust the unemployment rate were also impacted by the severity of the 2007-2009 recession. The result of this amplitude change is that the seasonal adjustment process has tended to exacerbate downward movements in the unemployment rate during the fall and winter months, while exerting upward pressure on the unemployment rate in the spring and summer months."
In essence, hiring patterns in recent years are used to estimate seasonal adjustments. Given that some of the worst job losses during the Great Recession took place in the winter (Dec 2008-March 2009), the seasonal adjustments for those months may be biased, resulting in an overestimate of seasonally-adjusted employment growth for those months. How much of a difference did this make? If one seasonally adjusts last month's data using the average seasonal adjustment for January for the five years prior to the Great Recession, there would have been 40,000 fewer jobs reported (resulting in an increase of 203,000 jobs as opposed to 243,000). Thus, a significant portion of the upward surprise appears to be linked to seasonal adjustments that may be biased.
Update (Saturday):
Here’s the math underlying the analysis. The average seasonal adjustment for January data between Jan 2002 and Jan 2009 was about 1.583% (these adjustments were not affected by the financial crisis). That is, non-seasonally adjusted data are adjusted upward by 1.58% to get the seasonally-adjusted numbers). Meanwhile, the January 2012 was adjusted upward by about 1.65%. What difference does that make?
Non-seasonally adjusted employment for January 2012 was 130.263 million and the seasonally-adjusted number was 132.409 million. If one applies the average adjustment from 200522009 (1.58%), the seasonally-adjusted number for January 2012 is 132.321 million, 40,000 less than the official figures. Thus, it's still a strong report, but probably reflects some bias from the new seasonal adjustment factors (note: this does not account for issues related to warmer than normal temperatures in Jan 2012, etc.).
January Jobs Report
This morning's job report far exceeded expectations, indicating that the economy added 243,000 jobs in January (257,000 in the private sector) and the unemployment rate declined to 8.3%. Jobs gains were widespread, evidence of a strengthening economy. Does this mean that the economic recovery is beginning to shift into high gear? Though this was a good report, there are some reasons to think that it overestimated the strength of the economy (to be discussed in another post). Let's take a quick look at some of the key numbers:
- The participation rate was 63.7%, setting a new low for this period and is the lowest since March 1983. If it declines a little more (63.5%), it'll reach a rate not seen since the late 1970s.
- The employment-population ratio remained at 58.5%, slightly above the recent low of 58.2% (last time it was this low was 1983).
- The broad measure of unemployment (U6) declined to 15.1% (from 15.2%).
- The household survey showed a surge in jobs, most of which were part time. Full-time employment rose by 80,000 while part time rose by about 700,000.
Friday, January 27, 2012
One more update on Black Friday, Holiday Sales, and Consumer Spending
In late November, I commented on the historical relationship between Black Friday and different measures of consumer spending (holiday sales and fourth quarter consumption). Many commentators were optimistic about economic growth for the quarter, given the strong performance of Black Friday sales. With the release of today's GDP report, we can now consider that relationship for 2011. With the exception of 2006, Black Friday sales have been a poor predictor of overall consumer spending for the quarter (sometimes too high, while other times too low). This time, Black Friday sales proved to lead to too much optimism about the consumer. It appears that Black Friday led to an early burst in consumer spending that disappeared in December, resulting in modest gains in holiday sales and consumer spending. See the updated chart below for more information (numbers in parentheses are adjusted for inflation; consumption is already adjusted for inflation):
| Year | Black Friday | Holiday Sales | Consumption Q4 |
| 2011 | +6.6% (+4.0%) | | |
| 2010 | +0.3% (-1.0%) | +5.2% (+3.9%) | +3.6% |
| 2009 | +0.5% (-1.0%) | -0.4% (-1.9%) | +0.4% |
| 2008 | +3% (+1.3%) | -2.8% (-4.5%) | -5.1% |
| 2007 | +8% (+4.5%) | +2.4% (-1.1%) | +1.2% |
| 2006 | +6% (+4.1%) | +4.6% (+2.7%) | +3.8% |
Fourth Quarter GDP
This morning's report on fourth quarter GDP was a little disappointing, showing economic growth of 2.8%, which was below expectations. Growth in personal consumption, the largest portion of the economy, grew at a 2% annual rate, which was in line with recent trends and didn't reflect the burst that some were expecting. Spending on motor vehicles did surge, but spending on services was relatively flat. Federal spending subtracted from GDP, led by a significant decline in defense spending (mainly reflecting the timing of purchases). On a cautionary note for future economic growth, inventories were responsible for just under 2% of economic growth; thus final sales to domestic producers rose by only 0.9%. In other words, when one removes the effect of a build-up of inventories, economic growth was under 1%. The build-up in inventories suggests that future production will be constrained.
After rising to above 6% during the recession, the savings rate has declined to 3.7%, the lowest since 2007. One reason is that real disposable income per capita was flat for the quarter and down for the year. This raises concerns about consumer spending as we move into 2012. On a more positive note, inflation as measured by the PCE deflator rose only 0.7%, the lowest since Spring 2010, reflecting a slowdown in inflation.
Overall, a weaker than expected report that continues to confirm a modest economic recovery without evidence of speeding up any time soon.
After rising to above 6% during the recession, the savings rate has declined to 3.7%, the lowest since 2007. One reason is that real disposable income per capita was flat for the quarter and down for the year. This raises concerns about consumer spending as we move into 2012. On a more positive note, inflation as measured by the PCE deflator rose only 0.7%, the lowest since Spring 2010, reflecting a slowdown in inflation.
Overall, a weaker than expected report that continues to confirm a modest economic recovery without evidence of speeding up any time soon.
Wednesday, January 25, 2012
More on the Fed and Monetary Policy
Besides announcing that it has adopted a policy of inflation targeting, there was other interesting news from the Fed today. In a continuation of the increased transparency introduced since Ben Bernanke became chair, the Fed released the forecasts of the expected future target for the federal funds rate. Believe it or not, back in the early 1990s, the Fed didn't even inform the public of the current federal funds rate (financial markets had to figure it out on their own). Alan Greenspan increased information somewhat, but Bernanke came in with a goal of increasing transparency so both the public and financial markets can better understand the Fed's policy. Of course he didn't expect to have to deal with the worst financial crisis since the 1930s, which required a nontraditional, complex response.
The Fed also released the consensus forecasts of the Federal Reserve District Banks (click here). In the past, the Fed was overly optimistic about the future state of the economy. This time, it lower its forecasts, indicating a modest recovery for years to come. Inflation is expected to be at or below its target for the next several years while unemployment is expected to decline only slowly due to moderate economic growth. Given this forecast, the Fed indicated that it expects to keep the federal funds rate exceptionally low through late 2014 (emphasizing this was conditional on their forecast; that is, if the economy turns out to be stronger than expected, interest rates would increase sooner).
Of course the Fed continues to be criticized from both sides. Some complain that it should be doing more given the relatively weak economic recovery while others think it's doing too much. Personally, I enjoy being able to comment on the policy instead of being the one responsible for implementing the best policy, given all that's going on in the global economy! As mentioned in previous posts, the biggest unknown is the severity of the European Debt Crisis. If it leads to financial contagion, expect the Fed to loosen policy even further in an attempt to cushion the US economy from the financl fallout.
The Fed also released the consensus forecasts of the Federal Reserve District Banks (click here). In the past, the Fed was overly optimistic about the future state of the economy. This time, it lower its forecasts, indicating a modest recovery for years to come. Inflation is expected to be at or below its target for the next several years while unemployment is expected to decline only slowly due to moderate economic growth. Given this forecast, the Fed indicated that it expects to keep the federal funds rate exceptionally low through late 2014 (emphasizing this was conditional on their forecast; that is, if the economy turns out to be stronger than expected, interest rates would increase sooner).
Of course the Fed continues to be criticized from both sides. Some complain that it should be doing more given the relatively weak economic recovery while others think it's doing too much. Personally, I enjoy being able to comment on the policy instead of being the one responsible for implementing the best policy, given all that's going on in the global economy! As mentioned in previous posts, the biggest unknown is the severity of the European Debt Crisis. If it leads to financial contagion, expect the Fed to loosen policy even further in an attempt to cushion the US economy from the financl fallout.
Inflation Targeting
Following today's meeting, the Fed annoinced that it adopted a policy of inflation targeting, with a long-term goal of 2% inflation. This formalizes the informal target already employed by the Fed and follows the pattern of many other central banks around the world (Australia, Canada, New Zealand, United Kingdom, Euro area, etc.). In most cases, their goal is also 2% inflation (or close to 2%).
Some may ask - why not 0%? There are several reasons, but perhaps the biggest is the fear of deflation. Once it takes root, deflation is hard to stop and tends to lead to a cycle of economic weakness (think Japan or the US' last bout with deflation - the Great Depression). Most central banks in developed countries have chosen to target a rate of 2% to provide a cushion against possible deflation while maintaining a low and stable inflation rate. Unlike most other central banks that target inflation, the Fed continues to have a dual mandate of maintaining full employment; something only Congress can change.
There are several ways to estimate inflation. The one chosen by the Fed is the personal consumption expenditure (PCE) index, which has been recognized by most economists as the best gauge of consumer inflation since, among other reasons, it reflects recent spending patterns as opposed to an old survey (like the consumer price index). It's important to note that this policy does not mean the Fed will seek to keep inflation at 2% all the time, but instead will seek to keep inflation close to 2% per year over time. For example, if energy prices experience a temporary spike, causing inflation to temporarily rise above 2%, the Fed may not respond if it anticipates inflation will return to its target.
By the way, one of the leading proponents of inflation targeting has been Ben Bernanke (link to article by Bernanke from 1997). Despite what many in the blogosphere think, Ben Bernanke has been a long-term advocate of low and stable inflation. That doesn't mean his policies are perfect, but he is not seeking to implement policies that result in high inflation.
Some may ask - why not 0%? There are several reasons, but perhaps the biggest is the fear of deflation. Once it takes root, deflation is hard to stop and tends to lead to a cycle of economic weakness (think Japan or the US' last bout with deflation - the Great Depression). Most central banks in developed countries have chosen to target a rate of 2% to provide a cushion against possible deflation while maintaining a low and stable inflation rate. Unlike most other central banks that target inflation, the Fed continues to have a dual mandate of maintaining full employment; something only Congress can change.
There are several ways to estimate inflation. The one chosen by the Fed is the personal consumption expenditure (PCE) index, which has been recognized by most economists as the best gauge of consumer inflation since, among other reasons, it reflects recent spending patterns as opposed to an old survey (like the consumer price index). It's important to note that this policy does not mean the Fed will seek to keep inflation at 2% all the time, but instead will seek to keep inflation close to 2% per year over time. For example, if energy prices experience a temporary spike, causing inflation to temporarily rise above 2%, the Fed may not respond if it anticipates inflation will return to its target.
By the way, one of the leading proponents of inflation targeting has been Ben Bernanke (link to article by Bernanke from 1997). Despite what many in the blogosphere think, Ben Bernanke has been a long-term advocate of low and stable inflation. That doesn't mean his policies are perfect, but he is not seeking to implement policies that result in high inflation.
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