John C. Williams, executive vice president and director of research
Looking at the outlook from a year ago, our forecasts for economic growth and inflation proved to be reasonably on target, but the unemployment rate rose far more than we had expected. According to currently available data, real GDP growth was close to zero last year, with a sharp contraction in the first half of the year offsetting strong positive growth in the second half. Based on past experience, zero real GDP growth implies an increase in the unemployment rate of between 1 and 1-1/2 percentage points, consistent with our forecast from a year ago. In fact, the unemployment rate rose 3 percentage points from the fourth quarter of 2008 to the fourth quarter of 2009. The main factor driving this unusual rise in unemployment was very rapid productivity growth that allowed businesses to cut back sharply on labor while maintaining output levels.
Both overall and core measures of inflation were a touch higher than we had forecast a year ago, reflecting the effects of unexpected increases in oil and other import prices. In addition, methodological changes in the definition of core inflation boosted this measure of inflation a bit, explaining part of the change in our forecast.
Consumers relaxed their grips on their wallets during the holiday shopping season. Retail sales increased strongly over the final three months of 2009. Motor vehicle sales continued to trend upward, after dropping back following the expiration of the cash-for-clunkers program.
The manufacturing sector has likewise started to rebound from last summer’s depressed level. Leading indicators of business spending have moved up in recent months. The Institute for Supply Management’s new orders index rose to a very high level in December, and orders and shipments of nondefense capital goods, excluding aircraft, recorded robust increases in November.
Various signs indicate that the economic recovery is broad based. Increases in consumer spending, residential investment, and government purchases all contributed to real GDP growth in the third quarter of 2009. We expect that this pattern has continued in the fourth quarter and into this year. In addition, swings in inventory accumulation have added significantly to growth in the fourth quarter. Our forecast is for real GDP to increase by about 5-1/2 percent (annual rate) in the fourth quarter of 2009 and by about 3 percent in the first quarter of this year.
Ebbing financial headwinds, greater consumer and business confidence, and substantial support from monetary and fiscal policy should propel the economy to grow about 3-1/2 percent this year and about 4-1/2 percent in 2011. A key risk to this forecast is whether household and business spending will improve sufficiently to offset waning fiscal stimulus over the next two years.
Although the economy’s output expanded during the second half of last year, the labor market has yet to turn upward. Nonfarm payrolls declined by 85,000 jobs in December. Other labor market indicators, such as the rates of hiring, job openings, and quits, were at very low levels in November. The labor market’s lagged response to turning points in spending is typical of the early stages of recoveries from recessions. Given our forecast of solid output growth this year, the labor market soon should start to revive. However, in view of the depth of the recession, substantial labor market slack will likely persist for the next few years.
The prolonged, deep recession has contributed to a decline in the inflation rate that is likely to continue for some time. Stable inflation expectations and rising prices of oil and other imports have partially offset the downward pressure on prices from slack in labor and goods markets.
Improvements in the economic outlook and an increased appetite for risk have pushed yields on Treasury securities higher. However, mortgage rates remain low. Yield spreads on corporate bonds relative to Treasury securities have continued to decline. Based on futures contracts, financial market participants expect the Federal Reserve and central banks in other major industrial economies to start raising short-term interest rates sometime later this year and to steadily increase rates in 2011.
The views expressed are those of the author, with input from the forecasting staff of the Federal Reserve Bank of San Francisco. They are not intended to represent the views of others within the Bank or within the Federal Reserve System. FedViews generally appears around the middle of the month. Please send editorial comments to Research Library.