# Profile of the Economy

\[Source: Office of Macroeconomic Analysis\]

As of November 12, 2008

### ![](media/image1.wmf){width="3.3958333333333335in" height="3.0520833333333335in"}Introduction

The U.S. economy has remained on a path of slower growth since late
2007, although quarterly performance has fluctuated notably. The housing
market has continued to decline and financial and credit markets have
undergone unprecedented volatility. Labor market conditions continue to
deteriorate and both consumer spending and business investment have
declined dramatically. However, exports have been a bright spot,
supporting growth in recent quarters. Although rising energy and other
commodity prices boosted headline inflation particularly through the
first half of the year, these prices have retreated sharply in recent
months. Core inflation (a measure excluding food and energy) has
remained relatively contained. Private analysts have reduced their
forecasts for growth in the final quarter of 2008 as well as the first
few quarters of 2009. Analysts now expect the economy to contract in the
final quarter of 2008 and remain weak into 2009. In response to
deteriorating conditions in housing and financial markets, U.S.
policymakers have taken a variety of measures to boost liquidity and
confidence. These measures have helped to prevent a further
intensification of financial market turmoil, and credit markets are
showing some tentative signs of improvement.

### Growth

Growth in the U.S. economy stalled in the fourth quarter of 2007 and
although the economy accelerated during the first half of 2008, growth
stalled again in the third quarter. Real gross domestic product (GDP)
grew by 2.8 percent at an annual rate in the second quarter, led
primarily by a significant improvement in net exports and personal
consumption expenditures, the latter supported by fiscal stimulus
payments. However, real GDP declined 0.3 percent in the third quarter,
due in large part to a drop in consumer spending. Residential investment
fell for the 11th straight quarter and business investment slipped.
Weakness in these sectors was partly offset by continued growth of net
exports, a surge in government spending, and a positive contribution
from inventory investment.

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. In the second
quarter, spending was boosted by the nearly \$80 billion in stimulus
payments to households. In the third quarter, however, consumer spending
fell for the first time since 1991: spending dropped 3.1 percent at an
annual rate--the largest quarterly drop since 1980--and subtracted 2-1/4
percentage points from real GDP growth.

Residential investment--mostly residential homebuilding-- accounts for
only about 5 percent of GDP, but the ongoing decline in this sector has
been a significant drag on real GDP growth since early 2006. In the
third quarter of 2008, residential investment plunged 19 percent, the
11th straight quarterly decline, and subtracted 0.7 percentage point
from real GDP growth. Going forward, the housing market will likely
weigh on real GDP growth in 2009. 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 fell
to a 26-year low in September. The level of permits remains below
starts, suggesting further declines in new residential construction are
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 6.0 percent over the year
ending in August. Other measures, such as the Case-Shiller indices,
indicate that home prices are declining in most major U.S. cities. The
Case-Shiller 20-city index is down 16.6 percent over the past year, and
is 20 percent below its mid-2006 peak.

Mortgage delinquencies and foreclosures rose to new highs in the second
quarter--the nationwide foreclosure start rate rose to a record 1.2
percent. Subprime adjustable rate mortgages are largely responsible for
the upward trend, but foreclosure starts on prime loans have continued
to rise as credit difficulties have spilled over to high-quality loans.

Business activity outside of homebuilding has 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 1.0 percent in
the third quarter. This was the first quarterly decline in business
investment since late 2006. Outlays for business structures slowed
dramatically, but still grew by about 8 percent in the third quarter.
This helped to offset a 5.5 percent decline in investment in equipment
and software. Inventory investment contributed 0.6 percentage point to
the third quarter real GDP growth.

Export growth has been a key driver of growth in recent quarters but
slowing growth in overseas markets suggest that trade may make a smaller
contribution to growth in real GDP going forward. Exports account for
about 12 percent of GDP, while imports, which are subtracted from GDP,
account for about 17 percent. In the third quarter, year-over-year
growth of real exports moderated to 6.9 percent, from gains of 10 to 11
percent in the first two quarters of this year. Real imports fell by 3.1
percent over the last four quarters, the largest decline in imports
since early 2002. As a result, net exports contributed 1.1 percentage
points to third quarter growth in real GDP--less than the 2.9 percentage
point boost from net exports in the second quarter, but still quite
substantial.

Public sector purchases--which account for roughly 20 percent of
GDP--grew 5.8 percent at an annual rate in the third quarter,
contributing 1.2 percentage points to real GDP growth. The third
quarter's growth, the fastest since 2003, jumped up from the already
brisk 3.9 percent pace in the second quarter and the 0.8 percent pace in
the first quarter of 2008. Federal spending grew 13.8 percent in the
third quarter, as defense outlays accelerated sharply, whereas state and
local government spending slowed to 1.4 percent from the 2.5 percent
pace of the previous quarter.

### Labor Markets

Labor market conditions have weakened noticeably since late 2007.
Nonfarm payrolls fell by an average of 159,000 per month in the third
quarter, compared to 77,000 jobs lost per month on average in the first
half of 2008. Nonfarm payroll employment is down by nearly 1.2 million
jobs on net this year, with the pace of job decline accelerating towards
the end of the year. Job losses have been spread broadly across most
sectors. Manufacturing and construction have been particularly hard hit
with 492,000 and 396,000 job cuts, respectively, since December 2007.
However, a few sectors have continued to see job growth, including
health care and education, which together added about 435,000 jobs to
payrolls between December 2007 and October 2008. The unemployment rate
has trended higher, with more noticeable increases in recent months:
unemployment rose to 6.5 percent in October, the highest rate since
March 1994, and was 2.1 percentage points above the March 2007 low of
4.4 percent.

### ![](media/image2.wmf){width="3.6874015748031495in" height="3.25in"}![](media/image3.wmf){width="3.895669291338583in" height="3.572834645669291in"} {#section .unnumbered}

### Inflation

Rising food prices and the energy price surge through the middle of this
year have boosted headline inflation, although core inflation remains
relatively contained. Consumer prices were up 4.9 percent in the 12
months ending in September, much faster than the 2.8 percent pace of a
year earlier. Core consumer prices (excluding food and energy) rose just
2.5 percent over the latest 12 months, up only slightly from a year
earlier. In the year through September, the personal consumption
expenditures (PCE) price deflator rose by 4.2 percent, up sharply from
the 2.6 percent increase posted a year earlier. But the core PCE price
deflator was also relatively contained, rising 2.4 percent in the 12
months through September, a bit above its year-earlier increase of 2.0
percent, but remaining roughly within the narrow range that has
prevailed for the past four years.

![](media/image4.wmf){width="3.3958333333333335in"
height="3.3333333333333335in"}Energy prices reached record highs in
mid-summer, but have since started to come down. The retail price of
regular gasoline--which hit a record of \$4.11 per gallon in early
July--declined to \$2.40 per gallon in the week ended November 3, the
lowest price since early 2007. The front-month futures price for West
Texas Intermediate (WTI) crude oil traded to a record \$147 per barrel
in mid-July, but has since dropped by \$86 to roughly \$61 per barrel in
early November. Oil prices are now about \$35 per barrel lower than a
year ago.

Food prices began rising much more rapidly early last year, and have
continued to accelerate in 2008, remaining above the overall inflation
rate. Consumer food prices rose by 6.2 percent in the 12 months through
September, well above the 4.5 percent increase of a year-earlier, which
itself was markedly above the 2.6 percent increase for the year ending
September 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 (see
below) as well as the weak economy are partly responsible for the
increase in the fiscal year 2008 deficit. The slow economy has pushed up
outlays for some programs and reduced growth in tax receipts. Under the
Economic Stimulus Act of 2008--signed in mid-February--117 million
households received stimulus payments totaling \$95 billion. These
counted as tax refunds, leading to lower levels of tax receipts through
the summer. This expansionary fiscal policy, in combination with ongoing
measures to support the housing market, will help support economic
growth more broadly as adjustments continue in the housing sector and in
credit markets.

### Financial Markets

Financial markets have come under unprecedented stress in recent months.
While the roots of the crisis remain in the housing and mortgage
markets, concerns have spread beyond these sectors. Important parts of
credit markets have seized up and equity markets have posted steep
losses, triggered by uncertainty about the overall economy, and about
the performance and viability of a wide range of assets, as well as the
financial institutions holding or providing contingent guarantees for
those assets.

Recent measures undertaken by the Federal government are helping to
stabilize financial markets and put the economy back on a firmer
footing. The Emergency Economic Stabilization Act of 2008 (EESA), signed
into law on October 3, gives the Treasury the ability to design and
deploy a number of tools to restore the flow of credit to consumers and
businesses. Specifically, the EESA provides \$700 billion that can be
used in a variety of ways, such as to insure mortgage assets, inject
capital into financial institutions, and for other measures the Treasury
and the Federal Reserve deem necessary to promote financial market
stability.

The Capital Purchase Program announced by the Treasury allocates \$250
billion to injecting capital into a wide range of banks, which will help
shore up banks' capital positions and translate into increased lending
to consumers and businesses. The Federal Deposit Insurance Corporation
(FDIC) temporarily raised the deposit insurance limit from \$100,000 to
\$250,000 per depositor per bank, and, in addition, has temporarily
guaranteed the senior debt of all FDIC-insured institutions and their
holding companies, as well as deposits in non-interest bearing deposit
transaction accounts.

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 425 basis points. At the most recent Federal Open Market
Committee meeting in late October, the Committee cited concerns about
the downside risks to economic growth and cut the federal funds rate
target by 50 basis points to 1.0 percent, its lowest level since June
2004. The Federal Reserve has also greatly expanded its tools to
increase liquidity in credit markets and ease lending terms to sectors
that need a temporary injection. These include the Term Auction
Facility, the Term Securities Lending Facility, the Primary Dealer
Credit Facility, and the Money Market Investor Funding Facility. In
October, the Federal Reserve announced that it would pay interest on
member banks' required reserves, and also started up a Commercial Paper
Funding Facility.

Equity market indexes have fallen sharply this year, and volatility has
risen to record levels. This year, through the end of October, the
Standard & Poor's (S&P) 500 index had declined 34 percent, compared with
a 3.5 percent gain for all of 2007. The Dow Jones Industrial Average
declined roughly 30 percent through the end of October, after rising by
6.4 percent in 2007. 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 in late October, after hovering in a range of 20 to 30 for
most of 2008. The VIX remains elevated, but has since retreated to about
50 as of early November.

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.
Between May and July 2008, the 10-year Treasury note yield traded in a
fairly narrow range between 3.75 percent and 4.25 percent. The yield
then trended lower in August and September, reaching a 6-month low of
3.4 percent in mid-September. Since then, the 10-year note yield has
generally moved higher, reaching 4.0 percent at the end of October. The
3-month Treasury bill yield, by contrast, has generally trended lower
this year under the relatively steady influence of safe-haven demand for
short-term liquid assets. The yield was fluctuating around 3.3 percent
at the start of 2008, but generally declined through the year, reaching
an all-time low of about 0.2 percent in mid-October. Through the end of
October, the 3-month yield traded in a range of between 0.5 percent and
about 1.0 percent.

Key interest rates on private securities have risen sharply relative to
Treasury rates, reflecting an increase in financial risk, anticipation
of slower economic growth, and concerns of financial market participants
about short-term liquidity difficulties facing a number of institutions.
The spread between the 3-month London Inter-bank Offered Rate 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 nearly 450 basis points in early
October 2008. More recently, there has been some improvement in
perceptions of credit market risks, and although it remains elevated,
the TED spread narrowed to about 240 basis points in early November. 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 turmoil emerged. However, the
spread has generally trended upward since August 2007, and stood at 550
basis points as of late October 2008.

Rates for conforming mortgages as well as jumbo mortgages have generally
moved higher in recent months, and the spread between jumbo and
conforming mortgage rates has also fluctuated markedly, and in an
elevated range. The average interest rate for a 30-year conforming
fixed-rate mortgage fell from a recent high of 6.7 percent in July 2007
to a low of 5.5 percent in late January 2008, then climbed to as high as
6.5 percent in August. In late October the rate was averaging around 6.2
percent. The jumbo-conforming spread had widened late in 2007 to about
100 basis points, well up from the more typical 20 to 25 basis point
spread seen prior to the onset of the housing and credit market
problems. After stabilizing in the 100 basis point range early in 2008,
the spread widened to more than 150 basis points in April before
returning to roughly 100 basis points over June and July. Thereafter,
the spread widened again, reaching nearly 160 basis points in late
October before narrowing somewhat to about 130 basis points in early
November.

![](media/image5.wmf){width="3.541732283464567in"
height="3.333464566929134in"}![](media/image6.wmf){width="3.458267716535433in"
height="3.4062992125984253in"}

### Foreign Trade and Exchange Rates

Although the U.S. trade balance (which measures trade in goods and
services) and current account (which measures trade in goods and
services, as well as 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 8 months of 2008 suggest that
the merchandise trade deficit has widened, mainly reflecting the higher
value of oil imports. 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. In the first half of
2008, the current account deficit averaged \$718 billion at an annual
rate (equivalent to 5 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 October 2008, the exchange
value of the dollar compared to an index of these currencies fell by
about 28 percent. Over this period, the dollar depreciated by 25 percent
against the yen, and by 34 percent against the euro. The dollar has also
depreciated, but by a far lesser amount, against an index of currencies
of 19 other important trading partners (including China, India, and
Mexico). Between February 2002 and October 2008, the dollar depreciated
by about 2 percent against this basket of currencies.