# Profile of the Economy

\[Source: Office of Macroeconomic Analysis\]

As of February 6, 2009

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### Introduction

In early December 2008, the National Bureau of Economic Research (NBER)
announced its determination that the U.S. economy had been in recession
since December 2007, notwithstanding the positive growth in real gross
domestic product (GDP) registered during the first two quarters of 2008.
The December 2007 business cycle peak marked the end of a 73-month
expansion that began in November 2001. The previous expansion, which
began in March 1991 and peaked in March 2001, had lasted 120 months.

Growth in the U.S. economy had been on a slower path since late 2007,
but turned slightly negative in the third quarter of 2008, and steeply
negative in the fourth quarter. Labor market conditions, consumer
spending, and business investment have all declined sharply, and export
growth, once a bright spot in the economy, has also slowed dramatically
with falling demand in global markets. Headline inflation, which peaked
in July 2008 on the back of rising energy and other commodity prices,
retreated sharply during the latter half of last year, and most
recently, the headline consumer price level has fallen sharply. Core
inflation (a measure excluding food and energy) has remained relatively
contained, falling to the lower end of recent ranges last December.
Conditions in housing and financial markets continued to deteriorate,
but very late in 2008 and in early 2009, credit conditions showed some
signs of improvement. Stock market indexes dropped significantly in 2008
and have continued to trend downwards early this year. Private analysts
predict that the economy will remain very weak in the first half of
2009, but start to pick up in the third and fourth quarters.

### Growth

Growth in the U.S. economy stalled in the fourth quarter of 2007, the
quarter in which the NBER dated the start of the current recession.
Still, the economy grew by a quarterly average of nearly 1.9 percent
during the first two quarters of 2008, fueled in part by a significant
improvement in net exports as well as fiscal stimulus-supported personal
consumption. It contracted in the final two quarters, and edged down 0.2
percent over the whole year, the first four-quarter decline since 1991.
In the third quarter of 2008, real GDP fell by 0.5 percent at an annual
rate, due to a drop in consumer spending. In the fourth quarter of last
year, real GDP fell by 3.8 percent--the largest quarterly decline since
1982. In that quarter, consumer spending declined and residential
investment fell for the 12th straight quarter, while business investment
fell sharply. Net exports declined slightly, and government spending
grew modestly. The only sizeable offset to widespread weakening came
from a large inventory build in the fourth quarter.

Growth of consumer spending--which accounts for about 70 percent of
GDP--began to slow in the spring of 2007. Spending growth averaged about
1 percent at an annual rate in the first half of 2008, but turned
sharply negative in the latter half of last year, declining by 3.8
percent in the third quarter and by 3.5 percent in the fourth
quarter--these were the first declines in consumer spending since the
1990-91 recession. The decline in consumer spending subtracted 2.5
percentage points from real GDP growth in the fourth quarter. Over the
entire year, consumption fell 1.3 percent, marking the largest
four-quarter drop since 1974.

Residential investment--mostly residential homebuilding--accounts for
only about 3-1/2 percent of GDP, but the ongoing decline in this sector
has been a significant drag on real GDP growth since early 2006. In the
fourth quarter of 2008, residential investment plunged 23.6 percent, the
12^th^ straight quarterly decline, and subtracted 0.8 percentage point
from real GDP growth, roughly matching the average quarterly subtraction
from this component since the start of 2006. In 2009, the housing market
is expected to weigh further on real GDP growth. Home sales remain
sluggish, and inventories of unsold homes are at historically high
levels. Housing starts and building permits are down sharply.
Single-family starts and permits plunged to record lows in December
2008. The level of permits remained below starts for the 23^rd^ straight
month, suggesting further declines in new residential construction lie
ahead. Homebuilder optimism is at an all-time low.

House prices continued to fall, weighed down by the elevated inventory
of homes on the market. According to the Federal Housing Financing
Authority, prices for purchased homes fell 8.7 percent over the year
ending in November 2008. Other measures, such as the Standard & Poor's
(S&P)/Case-Shiller indexes, indicate that home prices are declining in
most major U.S. cities. The Case-Shiller 20-city index is down 18
percent over the year through November 2008, and is 25 percent below its
mid-2006 peak.

Mortgage delinquencies rose to an all-time high in the third quarter,
although the nationwide foreclosure rate flattened out at a record level
of 1.2 percent. Subprime adjustable rate mortgages remain largely
responsible for the record foreclosure rate; however, foreclosure starts
on prime loans have continued to rise as credit difficulties have
spilled over to high-quality loans.

Business activity outside of homebuilding also slowed in 2008 compared
with 2007. After growing by 6.4 percent in 2007 and by roughly 2.5
percent at an annual rate in the first half of 2008, nonresidential
fixed investment--about 10 percent of GDP--declined by 1.7 percent in
the third quarter and then dropped by about 19 percent in the fourth
quarter. The fourth quarter plunge was the largest since the mid-1970s,
and reflected the first decline in outlays for business structures in
almost 3 years, and the largest decline in spending on equipment and
software since 1958. Inventory investment contributed 0.8 percentage
point to the third quarter real GDP growth and a more substantial 1.3
percent in the fourth quarter. Nonetheless, the fourth quarter inventory
build may have reflected an unintended accumulation due to falling
consumption and investment, which would point to lower growth or a
steeper decline in the first quarter of this year.

Export growth had been a key driver of growth for the six quarters prior
to the final quarter of last year, when the contribution of this
component declined significantly. The latter trend is expected to
continue this year, given slowing growth and recession in overseas
markets. Exports account for about 12 percent of GDP, while imports,
which are subtracted from GDP, account for about 17 percent. Real
exports fell nearly 20 percent in the fourth quarter of 2008,
year-over-year, after growing 3.0 percent in the third quarter and 10 to
11 percent in the first two quarters of the year. Real imports declined
nearly 16 percent over the last four quarters, the largest decline in
imports since mid-1980. As a result, net exports contributed only 0.1
percentage points to fourth quarter growth in real GDP--far less than
the boosts of roughly 1 to 3 percent in the previous three quarters.

Public sector purchases--which account for roughly 20 percent of
GDP--grew 1.9 percent at an annual rate in the fourth quarter, slowing
from the third quarter's 5.8 percent rate and contributing only 0.4
percent to real GDP growth. Federal spending grew 5.8 percent in the
fourth quarter, slowing considerably from the 13.8 percent pace of the
previous quarter. State and local government finances continued to
deteriorate, with spending down 0.5 percent in the final quarter of last
year, after growing by an average of nearly 2 percent in the previous
two quarters.

### Labor Markets

Labor market conditions have weakened noticeably since late 2007--since
the recession began in December 2007, a total of 3.6 million jobs have
been lost. On a percentage basis, the 13-month decline is the largest
since 1982. Nonfarm payrolls fell by an average of 180,000 per month
during the first three quarters of 2008, then plunged by an average of
518,000 per month in the final quarter. Job losses have been spread
broadly across most sectors. Manufacturing has lost two million jobs
since December 2007, and construction has cut 781,000 jobs. However, a
few sectors have continued to see job growth, including health care and
education, which together added about 573,000 jobs to payrolls between
December 2007 and January 2009. The unemployment rate has trended
higher, with more noticeable increases over the past 6 months:
unemployment jumped to 7.6 percent in January 2009, the highest rate
since September 1992, and was 3.2 percentage points above the March 2007
low of 4.4 percent. Payroll employment fell by 598,000 in January 2009,
the largest 1-month decline since December 1974.

###  {#section .unnumbered}

### ![](media/image2.wmf){width="3.8854330708661418in" height="4.260236220472441in"}![](media/image3.wmf){width="3.6354330708661418in" height="3.427165354330709in"}Inflation

![](media/image4.wmf){width="3.3645833333333335in"
height="3.3125in"}Rising food prices and the energy price surge through
the middle of last year boosted headline inflation, which peaked at 5.6
percent in the 12 months through July 2008 and has since retreated
sharply. Headline consumer prices rose 0.1 percent in the year ending
December 2008, plummeting from the 4.1 percent year-earlier pace and
representing the smallest yearly rise since 1955. Fluctuations in
headline consumer prices have mainly reflected changes in energy and
food prices, which are volatile, and more recently, slowing consumer and
business spending as well. In fact, for the 3 months ending in December
2008, headline consumer prices fell by 12.7 percent at an annual rate.
Core consumer prices (excluding food and energy) rose by 1.8 percent in
the latest year, slowing from the 2.4 percent pace in 2007. This was the
smallest increase in the core measure since 2003. In the 3 months ending
in December 2008, core prices declined by 0.3 percent. The personal
consumption expenditures (PCE) price deflator rose 0.6 percent in the
year ending in December 2008, down significantly from the 3.5 percent
rate posted a year earlier. The core PCE price deflator also slowed,
rising 1.7 percent in the 12 months through December 2008, below its
year-earlier increase of 2.3 percent.

Energy prices reached record highs in mid-summer, but have fallen
sharply since then. The retail price of regular gasoline--which hit a
record of \$4.11 per gallon in early July--stood at \$1.84 per gallon in
the week ended January 26--a level not seen since early 1994. The
front-month futures price for West Texas Intermediate crude oil traded
to a record \$147 per barrel in mid-July, but has since dropped by more
than \$100 to roughly \$42 per barrel in late January. Compared with 1
year ago, oil prices are now about \$45 per barrel lower.

Food prices began rising much more rapidly in early 2007 and continued
to accelerate in 2008, remaining above the overall inflation rate.
Consumer food prices rose by 5.9 percent in the 12 months through
December, above the 4.9 percent increase of a year-earlier, which itself
was markedly above the 2.1 percent increase for the year ending December
2006. Most recently, however, food prices edged down 0.1 percent in
December 2008, the first decline since April 2006.

### Federal Budget

The federal budget deficit widened to \$455 billion in fiscal year 2008
(3.2 percent of GDP), following 3 years of improvement that had trimmed
the deficit to \$162 billion (1.2 percent of GDP) in fiscal year 2007.
Stimulus payments associated with the Economic Stimulus Act of 2008 as
well as the weak economy were partly responsible for the increase in the
fiscal year 2008 deficit.

The budget deficit will continue to grow in fiscal year 2009 as
expenditures rise sharply and receipts are depressed by falling
employment and income as well as declining asset values. The increase in
federal spending due to the Troubled Assets Relief Program (TARP)
outlays, and expenditures associated with a new stimulus package, are
expected to push the federal deficit to a record level in fiscal year
2009, both in absolute terms and as a share of GDP. In early January
2009, the Congressional Budget Office estimated that the fiscal year
2009 deficit will exceed \$1.2 trillion, equivalent to more than 8
percent of GDP.

### Financial Markets

Financial markets came under unprecedented stress last fall, but a wide
range of measures have been taken as part of the Emergency Economic
Stabilization Act of 2008, enacted in early October. For example, the
Capital Purchase Program has allocated nearly \$195 billion in funds
from the TARP to a broad array of financial institutions. Several
additional programs have been put in place to help normalize credit
markets and prevent disruption in financial markets and the broader
economy.

Partly in response to rising financial market stress as well as signs of
more slowing in the broader economy, the Federal Reserve began easing
monetary policy in August 2007, and has since cut the federal funds rate
target by 525 basis points. That amount represents the lower bound of
the range of 0 percent to 0.25 percent set at the December 2008 Federal
Open Market Committee (FOMC) meeting, which brought the target to its
lowest level in history. The target range was maintained at the FOMC's
most recent meeting in late January, when the Committee observed
downside risks to inflation as well as growth. In addition, the Federal
Reserve has greatly expanded its tools to increase liquidity in credit
markets and ease lending terms to sectors that need a temporary
injection. These include the Asset-Backed Commercial Paper Monetary
Market Mutual Fund Liquidity Facility, the Commercial Paper Funding
Facility, the Money Market Investor Funding Facility, the Primary Dealer
Credit Facility, and the Term Securities Lending Facility. Although
these facilities were set to expire this Spring, the Federal Reserve
extended the programs through October 30, 2009. The expiration date of
the Term Asset-Backed Securities Loan Facility remains until December
31, 2009, and other liquidity facilities, such as the Term Auction
Facility, do not have a fixed expiration date. Finally, last October,
the Federal Reserve announced that it would pay interest on member
banks' required reserves.

Equity market indexes fell very sharply last year, and volatility rose
to record levels. The S&P 500 index declined 38.5 percent last year,
compared with a 3.5 percent gain in 2007. The loss was the largest since
1931, when an earlier version of the index (containing only 90 stocks)
dropped 47 percent. As of early February, the S&P was down another 5
percent. The Dow Jones Industrial Average (DJIA) declined 33.8 percent
in 2008, after rising by 6.4 percent in 2007. So far this year, the DJIA
has declined by about 8 percent. The S&P stock market volatility index
(VIX), often used as a measure of financial market uncertainty, surged
to an all-time high of 80 percent in late October, after hovering in a
range of 20 to 30 percent for most of 2008. The VIX remains elevated,
but has since retreated to about 43 percent as of early February.

Long-term Treasury interest rates have been buffeted by a variety of
factors, including flight-to-quality flows in response to financial
market pressures as well as concerns about the increase in supply that
will be necessary to fund the Treasury's emergency support programs. For
most of last year, the 10-year Treasury note yield traded in a fairly
narrow range of 3.5 to 4.5 percent. The yield then dropped off sharply
starting in mid-November, reaching 2.1 percent in late December. Since
then, the 10-year note yield has traded higher, reaching 3.0 percent as
of early February. The 3-month Treasury bill yield, by contrast,
generally trended lower throughout 2008 under the relatively steady
influence of safe-haven demand for short-term liquid assets. The yield
reached an all-time low of slightly above zero by the end of December,
but has risen relatively rapidly since, to about 0.3 percent as of early
February. The 2- to 10-year Treasury yield spread, one measure of the
steepness of the yield curve, has widened noticeably since mid-2007. A
steepening yield curve may suggest rising uncertainty about long-term
prospects. Key interest rates on private securities have risen sharply
relative to Treasury rates, reflecting an increase in financial risk and
concerns by financial market participants about short-term liquidity
difficulties facing a number of institutions. The spread between the
3-month London Inter-bank Offered Rate (LIBOR) and the 3-month Treasury
bill rate (the TED spread, a measure of inter-bank liquidity and credit
risk) had averaged less than 50 basis points in 2006 and much of 2007.
Starting in August 2007, however, this spread started to widen sharply,
reaching an all-time high of nearly 460 basis points in early October
2008. In very recent months, though, perceptions of credit market risks
have ![](media/image5.wmf){width="3.395669291338583in"
height="3.3125984251968505in"}![](media/image6.wmf){width="3.395669291338583in"
height="3.322834645669291in"}improved, and as of early February, while
remaining elevated, the TED spread had narrowed considerably to about
100 basis points. The spread between the Baa corporate bond yield and
the 10-year Treasury yield, another measure of investor risk appetite,
averaged 170 basis points through most of 2007, before the financial
market turmoil emerged. This spread also trended upward starting in
August 2007 and peaked at nearly 620 basis points last December. Since
then, this spread has narrowed only a bit, to about 530 basis points as
of early February--still very high by historical standards. Finally, the
spread between LIBOR and the 3-month overnight indexed swap rate
(OIS)--a measure of what banks perceive as the credit risk in lending to
one another--was roughly 9 basis points prior to mid-2007, but by
October 2008, had peaked at 365 basis points. As of early February, this
spread had narrowed substantially, to about 100 basis points, but
remains quite high relative to its pre-crisis range.

Rates for conventional mortgages have trended lower in recent months,
but jumbo mortgage rates have continued to rise. The interest rate for a
30-year conventional fixed-rate mortgage touched a 2008 high of 6.6
percent in July, but fell to an all-time low of 4.96 percent this year
in mid-January. The conventional rate is currently about 5.25 percent.
The jumbo-conventional spread had widened to 215 basis points by the end
of last year, well up from the more typical 20 to 25 basis point spread
seen prior to the onset of the housing and credit market problems. This
spread has since narrowed somewhat, to about 180 basis points as of
early February.

### Foreign Trade and Exchange Rates

Although the U.S. trade balance (which measures trade in goods and
services) and current account (which also includes investment income
flows and unilateral transfers) remain in deficit, both deficits have
narrowed appreciably in recent years, largely due to an improvement in
the trade balance. The merchandise trade deficit reached \$838 billion
in 2006, but declined to \$819 billion in 2007. Data for the first 11
months of 2008 show that the merchandise trade deficit has narrowed
further, mainly reflecting the lower value--and to a small extent, lower
volume--of oil imports in the latter half of the year. The current
account balance has been in deficit almost continuously since the early
1980s, and in 2006, reached a record \$788 billion, equivalent to 6.0
percent of GDP. In 2007, the deficit narrowed to \$731 billion, or 5.3
percent of GDP. Through the third quarter of 2008, the current account
deficit had narrowed to \$696.4 billion at an annual rate (equivalent to
4.8 percent of GDP).

The value of the U.S. dollar compared with the currencies of seven major
trading partners (the euro area countries, Japan, Canada, the United
Kingdom, Australia, Sweden, and Switzerland) has depreciated
significantly from its peak in February 2002, but most recently, has
begun to stabilize. Between February 2002 and January 2009, the exchange
value of the dollar compared to an index of these currencies fell by
about 28 percent. Between January 2007 and January 2009, however, the
dollar appreciated by 1.4 percent against these currencies. Over the
longer timeframe, the dollar depreciated by 33 percent against the yen,
and by 34 percent against the euro, but over the past 2 years, the
dollar has depreciated by about 25 percent against the yen and by
roughly 2 percent against the euro. The dollar has also begun to
stabilize against an index of currencies of 19 other important trading
partners (including China, India, and Mexico). Between February 2002 and
January 2009, the dollar appreciated by about 1 percent against this
basket of currencies, and over the past 2 years, firmed by nearly 5
percent.