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US Federal Reserve: 950706StaffState1 | Baseline (Budgeting) | Economic Growth
US Federal Reserve: 950706StaffState1
BRIEFING JULY
Chairman: Since your last meeting, rates there has been more volatility in than
short-term were
and less volatility months both
in the dollar of the year. to reflect
experienced different risk
the previous movements
somewhat decreased of market
Within forth
the continued in June futures
the back-andrates and of by
movements rate
-- particularly
-- reflected
the shifting interpretations uncertainty course
implications of comments about both
and the alternating With increasing
Committee direction policy, with
of the economy market
and the likely have traded
of the Committee's rate markets The market's back-up in
participants anxiety
the interest conviction.
and decreasing reflected
skittishness rates
in the abrupt sales.
Because too fine market. dollar
of the market's on what
I am reluctant priced into
a point While
has or has not been of Fed Funds
and Europoint
by the end of the month of such a move
50 percent caution
probability against Indeed, July
at this meeting, estimate
extracting I think
expectations. now in the between
the 14 basis contract
of easing a clearing
Fed Funds majority an ease
a wide expect
who do not, number
in fact, who have an ease in
at this meeting that
convinced policy
With conviction concerted
consequences, markets.
the same Following
is present intervention in narrow
on May 31st, ranges
the dollar the mark ranges.
traded and the yen,
uneventfully albeit
Many can find cannot German Japanese state, much
market little
participants to justify will cause
see the dollar decline.
as undervalued, But they also While
a further the dollar appear system
and European economy uncertainty and
economies financial
to be slowing,_ and the appear to be in a dismal it hard day-by-day bonds to see market and and
for the dollar. see continued dollar selling banks
In the short-run, higher yields
participants persistent European
and Asian upward
as capping
and defining and 86 yen.
1.42 marks
Last week toward around
and closed and
end of its ranges, yen.
1.38 marks
84 and a half German
of higher-than-expected saw a decreasing The dollar moved up, and
preliminary likelihood following then moved leave this rates
of a Bundesbank the announced down after
of the auto-trade announced sales
dispute to
the Bundesbank's and the new homes
In my view, reflected on the part
the thinness of market
and the lack of conviction
In foreign 1 billion divided sold
operations, worth
the Desk 31st,
sold evenly we
and yen on May
the System dollars
and the ESF of both
-- so for the System, marks and yen. This
at the initiative the April
of the Treasury which
for sought With
the purpose an "orderly
of underscoring reversal" and that
G-7 communique rate
movements. G-10
our support banks market Halifax agreed
of the Bundesbank, the operation,
the other clearly
For value billion brings dollars
authorities Medium-Term
on the Treasury's dollars with
to 10.5 billion facility,
Medium-Term both
and the System's swaps
swaps. to
1st, when undertake System's
the short-term the second swap.
next mature,
of the agreed-three
In domestic were quite and
operations, from our
different large weaker
of a consistently turned out higher As a pass in on
reserve than were
to be much Treasury result, May
and the generally-expected than anticipated. dollar bill
4 and a half were
operations need.
Looking demand billion
the combination and the Treasury's to fund
of the weaker-than-expected monetization~ drawing, of 2.5 puts us in
for currency dollars
the posture July.
to be draining
Mr. ratify happy
of the Committee and I will be
the Desk's to answer
Michael J. Prell July 5. 1995
CHART We're afternoon. I'll going
SHOW PRESENTATION the tag-team approach this overview Tom some to the submitted
of the staff's Simpson, issues Larry
economic Slifman.
projection. and Karen might
The". my colleagues. Johnson. will address
I’ ll wrap
Committee. for inclusion
by unveiling
in the Board's 1 starts about
report. some of the recently. among quarter, oneAs
Chart key things we noted analysts
off by summarizing the economy there's has been
a consensus the second
activity has marked we've
a lot during down
not everyone half percent
as low as the minus for the period vigorously
estimated. so we could Be that the
The data not argue
far from complete, optimistic view. was
for our less swayed us in
as it may, what ultimately in labor market worker hours
our assessment notably left. right, with
indicators--most May. at the at the
the drop Although have not
in production initial risen claims
through benefits, think
to a level that we would in employment, any more
declines slide
we hesitated heavily highlight
the reported The expenditure
than we did. the sectors of
for which left,
we have two months
of datt.
As you can see in May.
at the middle HOWeVer. large give"
real consumer start
rose smartly take
in April. more than
gain in June
PRESENTATION And. though well starts
Page 2 the May burst for future
5. 1995 sales, the
average shown
increase. right,
guarantees negative for and. and in
construction GDP.
will contribute left panel,
second-quarter nondefense while motor
In the lower goods have
new orders of late:
been very choppy other
shipments vehicles
are up substantially. suggest
data on aircraft gain
that the second-quarter
in overall in the
may be less than half that at the right.
nonresidential and appears rise. likely to we
off in the spectacular
latest month quarterly
Unfortunately. inventory of room for
have only net export surprise emphasize.
one month's components
full data of GDP.
for the volatile plenty
GDP picture.
again, Turning
the tentativeness now to the outlook and fiscal
of our current for coming
estimate. Chart As that 1996: point. 2
summarizes you know.
the monetary we based funds that
of our forecast. assumption into early
our forecast rate will
on the arbitrary
the federal we assumed given the ahead
be held at 6 percent
drift down a half percentage we expect to occur
in the period restraint on
and an allowance of the
real rate of interest we've predicted evidence higher
in the economy. that the assumed of a pickup in
In long-term failure activity and that during
of the Fed to ease and incoming will there push bond will yields
by year-endsback-up
be only a partial
PRESENTATION We believe that
Page 3 the economy has received
5. 1995 over
a boost credit
from a swing toward loan terms: cautious
availability that lenders
and more will so.
lenient more
we are anticipating quarters. but
Meanwhile. in response
in the near term we anticipate be little
to the projected exchange 1996. factor with that
rise in bond yields, of the dollar will
that the foreign changed through One developments fiscal
play a role in shaping rates is
and exchange budget
is highly the did a
uncertain. prospects few months to convert bills that
We share the oft-expressed for deficit ago. the the slashing
seem greater think
don't budget
be at all easy specific such broad that,
congressional President will
sign or that have will In the end. it seems
support if there
as to be veto-proof. is to be a budget.
will have to some panel,
serious our assumed are
compromising. fiscal smaller before spelled more '96 and than
As you can see in the bottom '97 deficit contained tacks reductions
of $30 and $25 billion, resolution--at
the Congress out.
on any tax cuts. which hand, our deficit
have yet to be is much We've it
On the other than that that
by President will
cuts in purchases and grants We've
be modes';. and that the bulk of the
be transfers
deficit-reduction. credit for children.
a tax cut, in the form
PRESENTATION Chart 3 describes, against
Page 4 in broad terms.
5. 1995 the
how we think GDP growth,
this backdrop. final
the red as seems to
line in the top panel, inventory investment this
last year. pattern
be reversing
year. rates of l-3/4 percent in 1995 and and assumed to be the 2-l/2
The GDP growth 2-l/4 trend percent rate
in 1996 are both below what we've of potential pressures output.
of expansion Consequently, panels
As the middle unemployment of factory average
we are projecting 6 percent.
that the while the rate
inch back above
use is expected
to drop to below
its longer-term
of 81.3 percent. With this decline should that in resource utilization. consumer this be
price year. edging
inflation We expect south
both the overall
and core CPIs will
of 3 percent 4 sketches of GDP.
again by 1996. out the projected I perhaps should movements of the
Chart major components these
note that we haven't in the firstchanges were that and stocks
updated quarter small.
but those panel.
As you can see in the upper-left investment further probably slowed
we believe quarter summer.
inventory will slow
in the third. alignment
By the end of the with sales.
be in reasonable accumulation fourth This
and the resumption of
of moderate GDP in the
to an acceleration
quarter. of course. here on the vitality of final to
all hinges,
SHOW PRESENTATION decline that
Page 5 has occurred figure in mortgage sales
July rates.
5, 1995 Even
the large discounting
last week's appear investment With
considerably, the upturn in
the prospects residential
for achieving is graphed
at the right. sector. to firm. we would But. as
an improvement for furnishings
in the housing and appliances panel.
you can see in the middle-left income hiring, growth growth is now slowing, looking
of disposable pace of
and so we're of personal We expect
for only a limited expenditures
consumption that there
quarters. of
will be a further
business that that
half of this year--one red bars--but A moderate year. as firms demand
is most also
for producers' nonresidential spending lags,
durables--the structures.
step-up respond,
in equipment with
the usual level
to the firming costs.
of capital purchases
Government assumptions. federal grants Not
will be sluggish.
our fiscal push in to
only will down
the deficit-reduction rare. but the on states
at a faster the pressures outlays
trim the growth
for goods and services. of foreign growth should already seen
Finally, combine with
the depreciation rapid
of the dollar of exports sucked
to produce period.
over the forecast
inro the U.S. at a rise only marginally. to GDP than few years.
substantial Still,
be a far more
the sizable
seen cover the past
PRESENTATION I've obviously given
Page 6 only a broad-brush admittedly
5. 1995 to
our projection--and
what you've to add out
read in the Greenbook. some value in this
start by fleshing
some of our thoughts Larry will focus
for the economy; questions
on .some of the more for private some issues
interesting spending
relating and Karen
to the outlook will address
and for inflation: to the prospects of our key trading
pertaining of some
for the dollar partners.
and for the economies
7 Thomas D. Simpson July 5. 1995
In my comments economic forecast, front: I will
on the financial focus on: gains
for the staff on the credit thus far in and the
developments in stock
the healthy represents rates
1995 and whether level fiscal of real
of a "bubble;" a period
restraint. Charts 5 and 6 address credit availability. positions The upper quite a
that bank capital of recent
good bit from the period 1980s and early banks 1990s. have
of the late capital the center
In the context become willing of banks
positions. panel shows
thar: the margin
more willing sizable
ro make over the first this greater
and co~~sumer loans has remained year. seems standards confirmed Consistent
In the case of business to importantly imposed reflect years
willingness stringent generally
a relaxarion
ago. an observation
by examiners. with loans. rhe willing represented loans. years. posture of loan officers. Ln the
spreads bottom
on business panel
by the red line have Auto
for small the past
business couple months
been on a mild loan spreads have
downtrend widened
in recent have
but from unusually typical levels fashion
low le.\-els.as lagged rn2.lbet rate
auto loan declines,
in fairly below
and they Spreads
of the early debt,
199Cs. a? the ro?
on open market have
risen some of late as the bond market:
PRESENTATION larger volumes while
Page 8 the paper market pressures.
5. 1995 has though.
has absorbed been they affected remain
by some quarter-end fairly tight. the dramatic
Meanwhile, in the end. consumer
seems to have shows that
come to a" consumer loan in
delinquencies keeping line. with
to be turning upturn
up from very
low levels. burdens. that
in debt-service forecast
the black household line, in
debt-service and thus
as shown by the broken further increases
delinquencies. The bottom nonfinancial panel shows net interest in relation to cash payments flow. of with began
the delinquency rising last year they
rate on business but remain
Interest low and.
relatively midyear.
in the staff while higher the in
forecast, delinquency coming
edge down after on business the increase these
Accordingly. will move
loans likely should
quarters, 0" net.
prove modest. suggest rhat lenders will
be turning However, staff
will become rates unfold will
less available. in line with be mild. the
forecast, only
to stringency
drag on spending. run-up in stock prices about whether this year to eve" a "bubble" might at i
The tremendous higher records has raised
co"cer"
be developing this time illustrates
in this market foster share
and whether speculative
an easing behavior.
of policy Chart
have rise" about
17 perce":
PRESENTATION half been that of this year. on
Page a period the upside
9 in which by
July analysts
generally Spikes although they shows were have that up of
surprised magnitude typically been
reports. for long. and panel of late.
typically have not of
immediately The center out two
harbingers profits,
recession. sane
leveling from
25 percent the broken of
earlier. for
shows growth the that
staff year.
a resumption In the
later red the
panel. shows
S&P yield I will of months, a is
dividend very be low
dividend which side
historically. shortly, norms. might
MOreOVer, may be
rates, high
historical iactor dividend unusually earnings it was were that
despite call for number for these oi
sizable higher iirms
declines dividend have been have
yields. exrremely fa\;ored back
HOWeVer, low, retained shares when as an
pay-outs large to
corporations investment
finance that
or to buy on
potential as the
returns black
internal illustrates. on
investments rhe
Indeed, ratio. rising
earnings-price basis, has been
using this is,
earnings year, the P-E and
a trailing is not
particularly high. On that. in near in the
low--that
balance, context are be
believe recent 7dins
forecast. a' th_ risks
prices may appear
unsustainable. on the
However. downside, than
111 th:-
since abour rhe
PRESENTATION and we have
Page 10 interest
July rate.s going
up. which
into the market. rates, the upper panel funds of and the of this
Turning chart 8 plots
to real interest of the note
measures Treasury
real rate on federal 1960.
key ten-year long period,
By the standards funds
real federal experience.
rate is a
bit on the high real rate has above decade longer
side of historical
The longer-term remains
a good bit this year but it. too. averages. both By the standards real short whether and long
of the past rates are
moderate. restrictive other
or not at any point acting
in time depends
on the economy. rates and foreign interest measures proposals
such as private output.
propensities policy.
and fiscal time are
Of particular impending President a balanced deficit-cutting have embraced
as both the Congress that they claim will
and the result scaled in by
The middle perspective.
puts the deficit
GDP in historical appreciably the 1980s standards. action,
Even though levels
is down much of
from the swollen and early As shown 1990s.
that characterized large
by historical absent bold fiscal
in the inset would
to the left, some
the deficit ahead,
tend to widen
in the years labeled "baseline" In contrast, translation balance
by the red line "currenr
is based line
on the CBO's labeled recent
law" baseline. is a staff
"balanced
of Congress's in the year
CHART SHOW PRESENTATION
July 5. 1995
One way to assess this and other developments bearing on equilibrium real interest rates is through an econometric Such an exercise is shown in the bottom
model like the staff's. panel.
In essence. the experiment performed involves selecting
the real federal funds rate path that results in output moving in line with potential and stable inflation. A word of caution at
this point is that exercises of this sort should be regarded as illustrative and not read too literally: uncertainties Apart from all the
about behavioral relations in the model. the
particular results depend on various assumptions. The red line. labeled "baseline." corresponds to the baseline deficit shown in the center panel and should not be confused with baseline strategies shown in the Greenbook and Bluebook. Under this baseline, the real federal funds rate would
remain in the 3 percent area. buoyed by continued large fiscal deficits. The solid black lirie illustrates the path of the
federal funds rate required under the balanced budget scenario. based on the assumption that the bond rate, which plays a critical role in this model. responds primarily to current and past levels of short-term rates--that is, the process determining the bond rate is adaptive or backward looking. circumstances. In these
the funds rate would need to drop promptly, given
lags. by about 3/4 percentage point or so to avoid a weaker economy once spending cuts begin to kick in larer this year. This new lower level would need to be held for a couple years before it would have to drift down about another 112 percentage point to counter the mounting drag from ongoing deficit reduction.
CHART SHOW PRESENTATION Of looking. a factor recent on the cour.se. it the has bond
Page market built the
12 might in bond be more
forward reduction. over effects black would line need
Indeed. that months. economy the in were the fully accurately needed
already to act to
some deficit market the rally
contributed will
cushion cuts. federal if
impending that of
budget the real model, to market the the
The broken funds rate
illustrates to take,
path eyes
a balanced and current
budget bond funds
participants future path of
reflected achieve
federal other real the two
simulations federal turn of funds the
circumstances. be necessary prompt.
no reduction for some time,
the until rate
rate century,
would as
forward-looking to
declines offset real level
provide weakness
sufficient coming would from need
stimulus fiscal to
rate-sensitive Eventually. toward
sectors the the
restraint. converging
decline, case
expec~atlons. Clearly, looking paths both the backward-looking In any market and fully event. implies the need the that for forwardsomewhat recent aggressive
represent nature are, in to the
extremes. of the bond
forward-looking rate policy declines measures
a degree. quarters
reducing ahead.
13 Lawrence Slifman July 5. 1995
inventory first,
To give you the bottom inventory to autos items, overhangs
line of our analysis are widespread:
we do not think they are confined
and some suppliers Producers
such as steel. in these showing have sectors signs of
housing-related have been prompt
to cut output. the process
and with demand should
firming, course
pretty much quarter.
Turning the sharp run-up
to the specifics, in dealer
the upper year
left panel this
shows year. in the in
As you know. second
responded picked
up in May--bolstered
part by manufacturers' climb
incentives--
and if. as we expecr, the current level
they of norm
a bit fur-ther during should bring
close TO the 60~day
by September. Outside overhangs economy. monthly somerimes appear
inventory of the because that That reports to and
to be limited the phrase data
to only a few sectors to be". in part.
are subject alter
to sizable analytical panel--and
conclusions,. anecdotal
said, the dara--shown suggest that stocks
in the middle are most
out of kilter market:
the softness home goods
in rhe housing as appliances are
In addition. The stockred line.
to be excessive. is shown by the
for rhese
PRESENTATION as shown up much that by the black less relative
Elsewhere, have edged
line. stocks to sales.
in the aggregate lower left panel
illustrates goods,
manufacturers responded
of construction promptly
to the recent nearly
accumulation, January. sectors
We expect will
that the inventory during
in these through a
the next few months adjustments
combination strengthening strengthening
of some further of demand. was
One tentative
sign of that received by these
the May rise in new orders lower noted. right panel.
manufacturers--the As Mike containing
in our forecast.
the size and scope firming In making
of the current demand--the
is a projected next chart. ourselves noted
in consumer this
projectio".
we first had to ask months. Among an We them,
why PCE has been so siuggisi-!in recent a variety of possibilities. doubrless
in the Greenbook
the exhaustion important role.
of pent up demand
of chart goods
10. during rapidly: It is the first
1992. 93. and 94. real outlays indeed. probably
grew pace.
lcnger-r::!l average of spending
the case year
half of this consumer to above begin
reflected, that
ai least follows
<n part, the Typical a period of rapid spending
"breather" trend
often If this
analysis limited.
is correct. in co"sumer
we should spending.
to see a pick up, albeit For motor vehicles.
age of the nation's trending up
auto fleet,
irl tne upper
right ~c::el. hzs been
15 the late replacement
July 1940s. demand
5. 1995 In light to IIi
and now is at its highest of the aging continue addition, consumer of the stock, sales
over the next year picks
if housing spending
up as we are projecting. also should
strengthen. In the Greenbook fundamental favorable black useful other only half. which line determinants levels. Among we noted that several activity of the are still at the to be a and and
of consumption them
is unemployment which
expectations. seems
indicator durable
of consumers' Given
to purchase of sustained
autos growth
goods. rise
in the jobless much
rate over the next in these
we don't suggests
deterioration should
expectations. as a share of
income. several line Over
In addition. hundred
the recent dollars
stock market to household much
has added the black dip. as
in the bottom the long would
of the previous are inversely run the flat
run, net worth predict,
related. relationship
theory is much
less tighT. bond during
Nonetheless. prices
stock market influence in the pushing on
and declining consumption projection. the saving
may have been a damping half of this year. rise in securities
we see the recent rate a bit lower Another important in equipment
prices be.
than it otherwise
issue in the forecast spending
is how much next
longer chart.
can be sustained--your durable
real outlays
for producers' annual
to grow at more
a 5 percenr
rate over the nexr
CHART SHOW PRESENTATION and a half.
Coming on top of the double-digit growth rates for
equipment spending during the past three years. one would think the current investment boom should be off the charts compared with previous cyclical expansions, and that a major contraction may be imminent. But. as shown in the upper panel, using a
quantity index that is less distorted by the relative decline in computer prices over time, the current cycle is well within the range of previous long-expansion experience. One problem with this cyclical comparison is that, over the years. equipment investment has switched toward capital goods that depreciate more rapidly, such as computers and communications equipment. Because of the higher depreciation To
rate. firms have to "run faster" just to stay in place. adjust for this, the middle panels look at m
ir?vestment
relative fo the net capital stock--that is. the growth rate of the net capital stock. Because of rhe dramatically different
investment rates for computers and other PDE, they are shown separately. In both cases, the capital stock is growing rapidly,
but not out of bounds by historical standards. One negative factor in the outlook for equipment spending is our projected decline in capacity utilization--the lower left panel. Clearly. if firms find that they have too much
idle equipment. they will re-think their plans to replace or upgrade. let alone expand. rxisting capacity. This has led us to
keep the level of spending for equipment other than computers essentially flat over the projection period. In contrast. the
cost of capital relative to the cost of labor-~the lower right panel--continues to fall rapidly, primarily reflecting further On balance, we expect
declines in computer prices.
PRESENTATION equipment should remain
July trend,
computing slower
on a rising keeping
although PDE growing
its recent rate.
at a respectable Your greater many detail.
next chart Basically,
our inflation is: why.
forecast in contrast
do we think percent next
is likely so far this
to year. of to
subside a shade consumer higher middle
from the 3-l/2 under 3 percent
rate observed
In part the acceleration of this year
in the opening costs
materials panels.
prices--the be in the The PPI for 0.2 spot
Some additional those
may still soon.
pipeline. intermediate percent prices fallen changed price
But we expect materials
food and energy activity have
rose only contracting,
in May for many recently.
and. with industrial
manufacturing commodities the dollar period,
OI even
is expected and this
to be little keep import
durirlg the projection in check,
should surge.
increases Labor
recently. in the
quarters sector
increased 3 percent.
hourly lower panel,
compensation much
was up only
of the moderation from
in compensation slowing
over the past rwo_years costs--much premiums of it rose
has come related only
in benefit insurance while
to health percent
care costs. over
the past year. which
the posts related
for to medical
workers' inflation,
compensation actually slowed
plans. fell.
employer- pension Some of
in the firsr quarrer.
CHART SHOW PRESENTATION these improvements
in benefit-cost
inflation reflect one-time
savings and we expect some bounce-back in the growth of benefits next year. In addition, with resource utilization rates expected
to remain fairly high, we are projecting some upward pressure on the growth of wages and salaries. On balance, we are forecasting hourly compensation to rise at a 3-l/4 percent rate through the end of next year--only a quarter of a percentage point faster than during the past year.
Karen will now continue our presentation.
19 Karen Johnson July 5. 1995
As Mike has explained,
I will consider issues underlying
our thinking on the dollar
and some elements in our outlook for key U.S. trading partners. Chart 13 shows recent developments currencies of the other G-10 countries, in dollar exchange rates. In terms of the during the first
the dollar has generally been declining
half of this year in both nominal terms, not shown, and price-adjusted the top panel--continuing Economic developments a longer trend of dollar depreciation
terms, the red line in
that began in early 1994.
during much of 1995 have worked to lower jointly the real long-term value of the dollar. With respect to
interest differential, the individual
the black line, and the price-adjusted
G-10 currencies--the
lower left panel--movements
of the dollar to date this year
have differed substantially, bilateral dollar rates. States--and
the differing factors that lie behind the changes in the persistent trade dispute between Japan and the United on the yen/dollar December. rate, and it is against Of the European The
trade imbalances--weighed most--l5
the yen that the dollar has depreciated G-10 currencies, dollar fluctuated
percent--since
the dollar has fallen least against the Italian lira and the British pound.
in terms of the Canadian currency during the past half year, often moving in from its change with respect to the other G-10 currencies, but on
balance, there is now little change from December In contrast to its movement
in the bilateral Canadian dollar rate. the dollar has appreciated
against G-10 currencies,
strongly in terms of the Mexican peso, shown in the lower right, since the eruption of the
crisis in Mexico last December.
At first, the dollar’ sharp appreciation in nominal terms, s
the black line, resulted in real dollar appreciation, the red line, as well. Subsequently, as Mexican consumer price inflation rose in response to the exchange rate shock, the real
appreciation in the peso/dollar rate began to retreat.
We expect the nominal peso/dollar rate
high, though slowing,
to move up a bit further over the forecast period, but continued Mexican inflation should result in less real appreciation balance, by the end of 1995 than we see now. developments in Mexico for the U.S. economy
of the dollar in terms of the peso, on of
I shall return to the implications shortly.
Chart 14 contains one development
common this year to almost all the G-10 countries, long-term interest rates,
including the United States: lower nominal interest rates, particularly shown on the right. U.S. short-term those abroad.
The numbers in the tables in the middle panel show that on average
rates, on the left, are above foreign rates and have not fallen as much as Just the opposite is the case, however, for long-term rates, on the right.
rates have come down the most, but the decline in U.S. rates noticeably Our forecast is for long-term rates abroad to
exceeds that of foreign rates on average.
change little from current levels over the rest of this year and next.
In that event, the dollar U.S. long-term
can be expected to retrace some of its decline, as somewhat higher projected rates move the interest differential dollar would subsequently
over the next few months in favor of dollar assets; the
remain little changed over the rest of the forecast period.
Of course, other factors can influence exchange rates as well. Two that are
relevant now are listed in the lower left: U.S. fiscal policy and the long-run As market participants associate less risk with the progress on the budget
outlook for our current account balance.
long-term outlook for fiscal policy, perhaps in response to perceived in Congress and with the Administration,
they may in the near term also have a more Over a somewhat longer perspective,
favorable view of the dollar, causing it to rise. adjustment within the economy
to a sustained lower fiscal deficit is likely to be associated value that would
with lower real interest rates and some decline in the dollar’ spot exchange s induce some of the resources goods sector. Continued current account deficits also pose a risk to the dollar. no longer consumed
in the public sector to move into the traded
Our econometric
models based on post-war experience over the medium
suggest that our external deficit would expand further If market participants came to see the
term at current exchange rates.
external deficit as implying ever higher U.S. net indebtedness share of GDP, they would put downward
to the rest of the world as a Arguing against widening at current exchange rates, are It may
deficitis is the fact that U.S. unit labor costs in manufacturing,
well below those of our major industrial trading partners, as can be seen on the right. be that our econometric production downward side. models do not incorporate sufficiently this competitive
A more favorable trade outcome would eliminate the hypothesized on the dollar. The exchange markets will bring forward into current developments. but to what extent is difficult
rates the expected
outcome of these longer-term
to anticipate--adding
to our outlook for the dollar. As you
Your next chart presents an overview of the foreign outlook for real growth. can see in the top left, we expect that growth in our trading partners, agricultural of 1994. exports, Through weighted
by U.S. non-
fell sharply during the first half of this year from the robust growth rate the end of 1996, we expect to see foreign growth recover somewhat and The top right box shows the critical role of in 1995.
continue to outpace growth of U.S. real GDP. the Asian developing countries
in sustaining growth of foreign output, particularly in the industrial and, especially,
We expect that 1996 will see improvement American countries. The middle left panel provides for U.S. exports and output.
an insight into the relative importance
of these regions
The industrial countries account for more than half of U.S. important. Latin American and Asian developing
exports, and Canada by itself is particularly countries each have a significant Mexico, and the Asian developing countries, the slowdown share.
Details of the forecast for the foreign G-7 countries, For the foreign G-7 in Canada and Japan.
countries are shown on the right.
in the first half of this year is concentrated weakness is most pronounced
Par the developing
in Mexico. in Mexico on Data
The lower panels summarize the U.S. economy
our estimate of the impact of developments
and our outlook for Mexico and the other Latin American countries.
already available confirm an extremely quarter that accounts
sharp drop in Mexican real output during the first 1995 decline shown in the chart on the left.
for much of the projected
decline in large part results from the policy measures
Mexican officials and the impact of the depreciation Mexican consumer and business confidence.
and rise in peso interest rates on
We expect that by the end of this year real Some
output will no longer be falling, and we look for Mexican growth to resume next year. slowing of output growth in other Latin American countries, particularly Argentina,
spillover effects of the Mexican crisis into asset markets and on macroeconomic On the right, our projection assumptions
for the U.S. trade balance with Mexico under current
for Mexican real growth, prices, and the exchange value of the peso is compared last December. We expect that the bilateral balance for goods and
with our projections services excluding
oil will fall from a small surplus last year to a deficit of $15 billion by the Data for merchandise trade through April, the line,
end of this year, a bit larger next year. suggest that such a substantial turnaround underway.
in the trade balance with Mexico is already well largely accounts for the of
The severe decline in Mexican output that has occurred
speed with which U.S. trade with Mexico has adjusted.
Looking ahead, real depreciation
the peso will help maintain a surplus for Mexico as positive real output growth returns in 1996. With the adjustment negative influence of our trade balance with Mexico largely behind us, an important
on the change in U.S. net exports and activity during the first half of the
year will have ended. Chart 16 addresses countries and Canada. in more detail our outlook for the major European industrial
rate movements are likely to affect the pattern of
growth in Europe, two countries
The top left panel groups Germany and compares
with relatively strong currencies, whose currencies
them with the United Kingdom in 1992 and then fell value of the mark, on
and Italy, two countries somewhat
further again this year.
the right panel, has appreciated
during this year to peak values for the floating rate period from the level it maintained in 1993-94. In both pairs
while the pound has fallen somewhat of countries, growth is expected
to slow noticeably this year from the robust pace last year.
We project some boost to growth this year for the United Kingdom and Italy from their external sectors while in Germany and France net exports will contribute despite the near-term slowing, little. However,
for all these countries growth is expected to average about 3 by the end of 1996 close
percent over the rest of the forecast period, moving these economies to our estimates of their respective levels of potential output.
In contrast, and is expected last year’ rate. s
real output growth in Canada fell drastically in the first half of the year below
to revive only to about 2-112 percent over the next six quarters--well
The Canadian outlook in part reflects the slowing to date of output growth in for the current quarter. In addition, both monetary
the United States and the weak projection
and fiscal policy in Canada were tightened in 1994. The panel on the right shows the upward movement in the Canadian overnight rate of nearly 450 basis points, on balance, since the
beginning of 1994. remains quite high.
While the Bank of Canada has begun to ease that rate back down, it In addition, the Canadian government has injected greater fiscal restraint
The structural budget deficit over this time is estimated points of GDP. As a consequence
to have contracted
by about l-1/2 percentage
of the lags with which these
policy actions have their effects, we expect Canadian real output growth to remain subdued over the forecast period. of slowing that occurred annual rate. quarters, We were surprised, however, as were most analysts, by the extent
in the first quarter, when real output grew less than 1 percent at an may subsequently be revised away or reversed in later only
Some of this deceleration
but there is clearly some risk that such an abrupt drop, which was moderated accumulation, could be a harbinger--or could precipitate--even
by large inventory
growth than we are forecasting. Your next chart presents the elements of our thinking about the outlook for the Japanese economy. strengthen period. However, currencies As shown in the upper left, we look for real growth in Japan to begin to
during the second half of this year but to remain subdued through the forecast The strength of the yen is a major factor restraining expected Japanese growth for some of the other Asian countries, appreciation of the yen in terms of their countries is expected to
will boost exports so that growth in the Asian developing
continue strong, although
it will slow a bit from its very high rate in 1994.
As can be seen in the right panel, Japanese growth of around 2 percent per year is not sufficient to narrow the gap between actual and potential output, and we project a widening in that gap through the end of next year. the appreciation of the yen have contributed The low level of resource utilization to deflation in goods prices. in Japan and
panel shows the changes over the preceding consumer index.
twelve months for two major components
price index, services less rent and goods less food, and for the producers’ price in the price of services, which are domestically produced and for the most
part do not compete year. However,
directly with imports, has been between 1 and 2 percent over the past This deflation is
prices of goods have actually been falling for some time.
not limited to imported
final goods, but likely does reflect the influence of competing
imported goods and the falling prices of imported inputs. The panel on the right shows that critical asset prices--those are also falling in Japan--as they have been for some time. for stocks and for land-decline in land the already
prices has added to the woes of the Japanese banking system and risks increasing large burden of nonperforming loans.
Lower land prices reduce further the value of portion
collateral behind real estate loans on the books of the banks, already a much-troubled of banks’ portfolios. Further declines
in stock prices would lessen the market value of the
hidden reserves of the banks and so reduce the capacity of Japanese banks to finance additional loan loss from hidden reserves. progress While these problems have been acknowledged for
some time by Japanese authorities, been limited. crisis in Japan. particularly Continued
in terms of improving banks’ balance sheets has risk of a banking
declines in these asset prices add to the perceived
At the very least, it appears that Japanese banks are not in a position to be of the recovery of economic activity.
Without any foreseeable pressure on resource availability soon and with asset prices and goods prices falling, easing by the Bank of Japan would seem warranted. In our forecast
we have assumed a small further reduction in the call money rate, but no discrete easing move, such as a discount rate cut, by the Bank of Japan. While we are forecasting some recovery in real growth in Japan, without even greater impetus from monetary policy or additional fiscal stimulus, there is downside risk of a return to recession in Japan in our outlook. Indeed, Governor Matsushita, in his press conference today following the Bank of
Japan’ branch managers’ meeting, suggested that a discount rate cut is under consideration. s Mike Prell will now present the committee’ forecast. s
28 Michael J. Prell July 5. 1995
To wrap a moment submitted. growth staff dark this to the
let me just draw summarizes
last chart. lowered with
You've year,
for real GDP the in that
now bracketing silver lining
forecast, cloud
l-l/Z to 2 percenr. central tendency
is a tad lower
now. at 3 to 3-l/4 looking tendency for some
percent. pickup in growth 2-114 your to
You are generally next year, Z-3/4 price with the central to the high center
of forecasts staff
percent. forecasts
on 3 percent.
to our prediction.
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