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Nation Sees Moderate Recovery and Accompanying Price Pressures

May 4, 2011

Though the economy is growing at a moderate pace, recent data have tempered the near-term outlook. The Federal Open Market Committee (FOMC) lowered its 2011 real gross domestic product (GDP) growth forecast to between 3.1 and 3.3 percent from 3.4 to 3.9 percent in January. The revision was mainly attributed to weak construction activity and high gasoline prices—both viewed as relatively transitory hindrances.

Many economists expect greater GDP expansion in coming quarters as weather-related drags dissipate and job creation contributes to real household income growth and spending. Additionally, geopolitical issues in oil-exporting countries may ease along with Japan-related supply-chain disruptions.

Financial Conditions Improve, Recovery Under Way  
In August 2010, Federal Reserve Chairman Ben Bernanke indicated the FOMC was considering further monetary easing.[1] What became known as the second round of quantitative easing, or QE2, aided the recovery by providing the economy with additional liquidity. It left many financial intermediaries and corporations flush with cash but also with little incentive to park capital in low-yielding, conservative investments.

As recently as last summer, many economists and policymakers pondered the uncomfortable possibility of what we had referred to as economic “stall speed”—insufficient growth to escape the economic ditch the nation entered in December 2007. Now, talk of inflation has overtaken notions of disinflation or deflation. Equities have reached multiyear highs, nominal gold prices are at record levels, other commodity prices are soaring and the U.S. dollar has retraced its crisis low against the euro (Table 1). Even with still-present labor market slack, a low-interest-rate environment has helped diminish unemployment and strengthen corporate and household balance sheets.

Table 1
Financial Conditions, August to April

 
August 2010
April 2011
(or most recent)
Change
Aug. '10– Apr. '11
Percent change
CPI inflation (%, yr/yr)
1.2
2.7
1.5
Core PCE inflation (%, yr/yr)
1.2
0.9
–0.4
Trimmed mean PCE inflation (%, yr/yr)
1.0
1.1
0.1
Federal funds effective rate (%)
0.19
0.10
–0.09
–47.4
3-month Libor (based on U.S. $, %)
0.36
0.27
–0.09
–24.7
High–yield corporate bond yield (%)
8.33
6.91
–1.42
–17.0
Nominal trade-weighted value of the U.S. $¹
76.18
68.82
–7.36
–9.7
Total number of unemployed (thousands)
14,849
13,542
–1,307
–8.8
Unemployment rate (%)
9.60
8.80
–0.80
–8.3
Underutilization rate (%)²
16.70
15.70
–1.00
–6.0
Average real weekly earnings ('82–'84 $/wk)
355.54
351.00
–4.54
–1.3
Total nonfarm payrolls (thousands)
129,873
130,738
865
0.7
Real disposable income per capita³
33,149
33,377
228
0.7
Real spending (real PCE)³
9,334
9,512
178
1.9
Nominal spending (PCE)³
10,373
10,756
383
3.7
Standard & Poor's 500 Composite Index
1,087
1,352
265
24.4
10-year Treasury benchmark yield
2.70
3.36
0.66
24.4
Gold: London cash price ($/troy oz.)
1,215
1,540
325
26.8
CRB spot price index: all commodities
449
570
121
26.8
West Texas Intermediate crude oil ($/barrel)
76.8
111.1
34.2
44.6
U.S. retail regular gasoline price ($/gal.)
2.73
3.96
1.23
45.2

NOTES:

  1. Nominal trade-weighted exchange value of the U.S. dollar versus major currencies (e.g., euro area, Canada, Japan, U.K., Switzerland).
  2. Includes total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons.
  3. Seasonally adjusted, annualized percent change.

SOURCES: Bureau of Labor Statistics; Bureau of Economic Analysis; Federal Reserve Bank of Dallas; Federal Reserve Board; U.S. Treasury; Freddie Mac; Bank of America Merrill Lynch; Financial Times; Wall Street Journal; Reuters-Commodity Research Bureau; Department of Energy; author's calculations.

Effects of Higher Relative Prices

Relative price changes involve macroeconomic factors, such as rising or falling living standards and changes in manufacturing output both here and abroad. Other shifts, such as the relative price of energy, may reflect oil producers’ conscious decision to restrict production (circa 1970s) or major disruptions in geographically and geopolitically important oil-production countries. Chart 1 depicts a pair of ratios: rising headline consumer prices relative to core prices (excluding food, fuel), and higher prices for what we purchase relative to what we produce. Such movements affect household and business decisionmaking. They also carry labor market implications—jobs shifting between industries and regions.

Additionally, a country's purchasing power diminishes when it is a net importer of high-priced commodities. We can afford to buy less with what we produce as the prices we pay for our purchases rise faster than what we receive for our products. Chart 2 shows that the purchasing power of U.S. output is growing less than the nominal value of what we produce. Simply put, the economic recovery does not feel as strong as production data would suggest. From storefronts to the gas pump, relative price changes influence consumers and businesses. They also prompt policymakers to assess whether the relationship between trends in headline inflation and core inflation has changed.

Consumer Price Pressures Increase

The Consumer Price Index (CPI) surged 0.5 percent in March, lifting the year-over-year rate to 2.7 percent from 2.1 percent in February as food and energy costs continued accelerating. The core CPI measure, while slowing slightly from its January and February monthly pace, rose slightly to 1.2 percent on an annual basis. Another indicator of consumer prices, the personal consumption expenditures (PCE) price index, showed headline inflation rising 1.8 percent and the core rate increasing 0.9 percent from year-ago levels.

For both CPI and PCE, goods prices have risen much quicker than the less-volatile services component, largely due to a surge in prices for nondurable goods such as food and energy. Relatively subdued wage growth has passed limited pressure through to services inflation (Chart 3). So while consumer prices appear to be heading higher, monetary policy makers have suggested that price pressures should remain within ranges considered acceptable for staying the course in the Fed’s pursuit of its dual mandate of price stability and full employment.[2]

Prospects for greater wage growth—an important element of sustainable economic growth as well as higher inflation—increased with March’s personal income and spending report. Wage and salary income advanced 0.3 percent, an annualized 4.1 percent pace in the first three months of the year. However, measures of real wage growth (adjusted for inflation) remained subdued or negative, and other measures of compensation remained relatively weak. In line with still soft but improving underlying income growth, the University of Michigan survey component on employment expectations has been sluggish. Combined with a rise in near-term inflation expectations, higher gasoline prices seem to be eroding consumers’ consumption and expectations.

Laboring Forward

In its March labor market snapshot, the Bureau of Labor Statistics counted 230,000 more jobs on private employer payrolls than in February. Furthermore, the latest job count was not influenced by weather-related factors that pushed January figures higher while lowering February payroll reports. During the first quarter, net job gains averaged 159,000 per month, up from 137,000 in the fourth quarter. In the context of typical labor supply expansion, this pace would be consistent with a small unemployment rate decline. Indeed, the headline unemployment rate dipped 0.1 percent in March to 8.8 percent, a two-year low. However, the labor force grew only slightly and the participation rate failed to budge in March from a 27-year low, suggesting that discouraged jobseekers are remaining on the sidelines.

Since the recovery began, employers have relied upon productivity growth and the restoration of hours for existing staff. As those measures are exhausted, about 2.5 million workers may be added to payrolls this year and job growth may double the 2010 rate. This implies robust monthly gains of about 278,000 jobs through the rest of the year. It remains to be seen whether labor market slack is dissipating at a healthy enough pace to engender hearty economic expansion.

Moderate Growth Amid Uncertainty

Inconclusive data regarding confidence and employment expectations, as well as recent initial unemployment insurance claims, have tempered optimism about labor market improvement, near-term wage growth and sustained consumption in the face of commodity price surges. The outlook for stronger U.S. output, job and income growth remains clouded by still-unresolved and challenging events in the Middle East and North Africa, calamities in Japan, European sovereign-debt funding pressures and domestic drags to U.S. growth such as state and local government budget cuts and housing-market woes. Responding to extraordinary monetary policy measures taken during the depths of the financial crisis, commerce and economic engines of output are restored and slowly gaining steam. Inflation pressures are ramping up, though longer-term price expectations remain moored at acceptable levels for now.

The disconnects between medium-to-large and smaller businesses, creditworthy and still credit-lacking borrowers, as well as spenders and savers are heightened by divergent readings on inflation and the rising cost of many business inputs and consumer items. The modest pace of recovery and factors propelling higher relative prices bear monitoring as the economic expansion continues.

—David Luttrell

Note
  1. See speech by Federal Reserve Chairman Ben Bernanke at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyo., Aug. 27, 2010, www.federalreserve.gov/newsevents/speech/bernanke20100827a.htm.
  2. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents at the April 27, 2011, FOMC meeting were released to show the central tendency measure (a forecast excluding the three highest and three lowest projections) of overall PCE inflation ranging from 1.2 to 2 percent in 2012 and 1.4 to 2 percent in 2013, compared with a projected 2.1 percent to 2.8 percent this year.
About the Author

Luttrell is a senior research analyst and coordinator of economic and financial analysis in the Research Department of the Federal Reserve Bank of Dallas.

 

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