STRICTLY CONFIDENTIAL (FR)CLASS I-FOMC

Material for

Staff Presentation to the Federal Open Market Committee
Februaq 4, 1997

chart 1

Forecast Overview
Real Gross Domestic Product

BEA

Percent change, annual rate

-I6

r
"
I

1995 1996 1997 1998 1.3

Q4/W Percent Change

3.4 (3.1 GB)
2.3 2.1

1995

1996

1997

1998

Unemployment Rate

Q4 Average

Consumer Price Index Fourquarler percent change

L
1996

1995

5.6

5.3

1997

5.1

1998

5.0

-

1995 2.7 3.1 2.6

W/Q4 Percent Change

1996 1997
1998

3.0

I

I

I

I

I

I

I

I

I

I

1

1

1

985

1QW

1993

1997

Chart 2

PolicyAssumptions
Monetary Policy: Federal funds rate remains at 5-1/4 percent. Probably implies small decline in real short-term rate. Fiscal Policy:
No balanced budget amendment.

Agreement on a plan to balance federal budget by FY2002. Implies on-going, moderate fiscal restraint. Why budget deal this year, after last year’s failure? Two sides were not far apart when negotiations broke down last year. Task smaller now, given revised budget outlook. CBO Budget Deficit Projections
7

Billions of dollars

t

Current policy, including fiscal dividend December 1995 January 1997

-4
I

200

-

103

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I

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I

I

0

But it is not a sure thing

Partisan tensions have not disappeared. COLA adjustment is politically scary. Discretionary spending already cut deeply.

Risks
Even if accomplished on paper, could involve heavy use of gimmicks. Risks clearly biased toward less fiscal restraint than we have assumed.

Chart 3

Financial Market Euphoria
Price-Earnings Ratio S&P 500

-

r

T T

T

T

T T

T

30

10 2o

n "
1950 1965 1980 *Source: Goldman Sack T=Trough in earnings 1995

pP-E Ratio NASDAQ

-

60

Jandl 0

40

20

n

1986

1996

-

Inflation and P-E Ratios'

-

rsaP
500

Analysts' Expectations for Three-to-Five Year Earnings Growth Percent

CPI

Average S&P 500 P-E

Less than 3 5 .% 3.5% 4 5 .% 4 5 - 5.5% .% .% 55 -65 .% .% 6.5% - 7 5 Greater than 7 5 .%

18.3 14.8 14.8 13.9 9.9 8.9

12.5

-

11.5

10.5
*

For the period 1950-1996 source: 1113~s. Rate Spreads on Business Net percent tigMening bans at Banks

Risk Premia on xporate Bonds

-

Percent

Relative to Treasuries

1

-

Senior Loan Officer Sulvey

l2

1 -

loo 50

0

I86

I

I

I

I

I

I

I

1990

1994

990

1993

1996

I 100

Chart 4

Sectoral Summary
Consumption and Disposable Income
Four-Quarter Dercent chanae

r

. .-ar-term i6 pluses:
Income growth has been strong. Wealth up sharply. Sentiment high.

On-going and future minuses:
Forecast anticipates only modest further rise in stock prices this year. WealtMncome declines in1998. Debt burdens and tighter credit card lending.

I

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19 91

1994

1997

Business Fixed Investment Financial market conditions favorable. Internal cash flow growth slackening. Declining prices, technological advances will continue to drive gains in computers, communications equipment. Other PDE flat. Commercial real estate market firming; office vacanies down.

Residential Investment

r

Four-quarter percent change

1

Housing Starts (millions) Singles Multis Total '96 '97 '98 1 0 1.16 1.09 1.06 .8 .28 .31 .29 .28 1.35 1.47 1.38 1.34 '95

30

Mortgage rates in '97-'98 expected to be about the same on average as in '95-'96 Projected starts possibly high relative to demographic trends but affordability also high for singles

I
19 91

I

I

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I

I

I

I

1994

1997

Chart 5

Sectoral Summary, continued
Government Consumption and Gross Investment Four-quarter percent change

In the federal sector, shutdowns and erratic procurement have caused gyrations.
But trend lower.

State and local finances good overall.

1991

1994

1997

Net Exports Billions of 1992 dollars, saar 50

0 50
100

+

Contribution of Net Exports to GDP Growth, in percentage points
Q4lQ4

Annual
0 -.l -.4 -.3

1995 1996 1997 1998

+.3

-3
-.7 -.2

150

-.2 in BEA advance

200 1991 1994 1997

Inventory investment

r
I
1991

Billions 1992 dollars, saar

1
50

loo

Inventoty-sales ratio currently low. Inventories expected to grow about same pace as sales - no GDP growth effect.

+

0

I
50 1994 1997 Note: All data chained (1992) dollars, based on Greenbook.

Chart 6

Labor Market
Helpwanted Advertising' Job Availability Index, 1990=100

Conference Board

Conference Board

Percent O hOUS?hOldS f

60

40

20

Plentiful
1
I I I

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..

1

1

1

1

1

V
1 1 1 1

1

1

1

0

I985 1990 1995 ' Adjusted for newspaper consolidation and use of temps.

1965

1990

1995

Labor Force Participation Rate'

r

Percent

Labor Productivity r N o n f a m business

Chained (1992) dollars per hour

1 32

* Pre-1994 data adjusted for change in CPS.

~ o t e 96:

estimate based o BEA advance. n

Employment Cost Indexes Four-quarter percent change industry
6 1995
4

Total Compensation

2.6

1996

31 .

1997
2

35 .
37 .

1998

0 1985 1989 1993 1997 Note: Shading indicates unemployment rate below NAlRU (6 percent in 198Os, 5.6 percent In 1990s).

Chart 7

Prices
CaDacitv Utilization in Manufacturino Percent

-

Vendor Deliverv Performance

1

NAPM

Diffusion index

1 0 4

J

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1

I

I

I

I

I

174

J

I

I

I

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I

I

120

.1985

1990

1995

1985

1990

1995

Non-oil Import Prices Four-quarter percent change 1 9

CPI Food and Energy Four-quarter percent change

1985

1991

1997

Consumer Price Inflation

-

Four-quarter percent change

Q4/Q4 Percent Change

adj.

(3.3)

(2.8) (3.1) 3.2 (3.6)

1997
adj. 1998 adj.
1985

2.6
(2.9) 3.0 (3.4)

1989

1993

1997

Note: Shading indicates unemployment rate below NAIRU (6 percent in 198Os, 5.6 percent 1990s).

Note: Numbers in parentheses adjusted for technical changes in indexes since 1994.

Chart 8

Forecast Summary
External Balances
Billions o dollars, saar f 1 0

- External Sector

r

Real net exports of goods and services

I 1993

I

I

....... .... -180 ............ ..... . . .. . .... I
1997

-. Current account

-

-60

-120

:b;
-15

.._.. .... ... .
**.

-

-1.0

-2.0

--

-2.5

1995

-240

I

I

I

I

I

-. 30

Major Factors in the Outlook

r
1. Pickup in forei n growth insufficient to outweigh U.S. growth, income elastic1 ies, and starting point.

9

2. Strength of dollar damps inflation and aggregate demand in the near term.

3. Oil price declines $5 a barrel from its recent peak.

-

Issues i the O t o k n ulo

.

1. Projection for growth abroad.

2. Risks to the dollar and in internationalfinancial markets.

3. Inflation and import prices.

4. Consequences if oil prices remain elevated.
5. Projection of weak net exports.

Chart 9

Foreign Outlook
Fiscal Policy: Change in Structural Balances Percent of GDP
Chan e Chan e 1995 8 8996 1997 8 ?99E

G-10 Real Interest Rates
Percent
1

United Kingdom France Germany Italy Japan Canada

2 114 1 314 0 1 3/4 -2 3 112

314 314 1 5 1 314 1 114
0

I+
-1993

rl

late

4 6

Avg. 1981-1996

I
1995 1997

Real GDP Percent change, 0 4 to 0 4

r
2.4 3.2 2.3 4.3 4.0 7.0

Percent change

W. Europe Canada Japan Mexico Other Latin Am. Other Asia

2.2 2.1 2.7 4.8 4.1 6.2

2.5 3.4 1.9 4.7 3.9 7.0

Forecast Comparison Percent change, annual
1997
ConStaff sensus'

.
1998
con-

Forecast Errors
I

1
4

3
2

1

0

Average absolute error in global growth (1980 - 1995):

0.5 percent

Staff sensus.

W. Europe Germany Canada Mexico Other Latin Am. Japan Other Asia Total"

2.4 2.3 3.2 4.9 4.4 1.9 6.5

2.5 2.2 3.2 4.2 4.5 1.4 6.8

2.5 2.3 3.2 4.4 4.0 2.1 7.0

2.6 2.5 2.9 4.2 5.2 2.3 7.2

Risk to 1997 US. Forecast Real GDP growth (Q4lQ4): Current Account (Q4):

0.05 percent
$6.5 billion

38 .

38 .

39 40 . .

Chan 1 0

International Financial Markets
The Dollar and Real Interest Differential
Percentage Points Index. January 1993 = 100

Equity-Market Indexes

d 1 0-%ear

, * a A, a m n t , ~ l ' ,

.......-..

1

r
120
110

January, 1992 = 100

lm

100

90

I

I

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I

I

I,
Price-to-Book Value Ratios

1993

1995
h

1997

'Adirrsted by msurrmr p

Price-to-Earnings Ratios

1975

1
r

Europe
I

I

I

I

1980

1985

1990

1995

0 0

1975 -

1980

1985

1990

1995

Bond Yields
W i n e f r o m 10- ar l995Peak Spain Sweden Canada France

International Bond Issues by Developin Countries

&
71 .7 6.73
6.65
6.48

r

Billions o Dollars

B

~

~

1

6.57 59 .5 49 .9 31 .7 28 . 22 .3 20 .3 14 .5 1.42

Japan
Gennany United Kingdom United States

55 .8 24 .2 57 .2 73 .4 64 .7

Chart 1 1

U.S. Inflation and Import Prices
(Four-quarter percent change) Japan
c

uropean Union

1

* Dollars per unit of local currency.

Canada

r-

1 992

I

1994

1996

-25

I

I
1994

I

-25 1996

1992

1 U.S. import prices

15

5

Exchange rate'

1996

-5

-5

Exchange rate'
-15

1-15
1 992

1994

-25

1992

1994

1996

-25

** Hong Kong, Singapore, S. Korea Taiwan
L

- 2

Dollar Stays at Recent High

r

1
2

CPI goods ex. food & energy

- 0

Non-oil import price
4

-2

1996

1997

1998

.*..

- ....

0

-2

Non-oil import price
1998

1996

1997

-4

Chad 1 2

World Oil Markets
Oil Prices
Dollars per barrel

80

Percent change in price'

Dollars per barrel

60

40

20

1990

1992

1994

1996

1998

0

Alternative Oil Price Scenario

Baseline: Alternatives: Policy Assumption:

Greenbwk forecast extended. Oil prices remain at 1996424 level. Federal funds rate unchanged; foreign G-7 follow Taylor-rule type of policy.

Percent change, Q4 to Q4

1997
U.S. PCE Inflation Baseline Alternative U.S. Real GDP Baseline Alternative Foreign 6 7 Inflation" Baseline Alternative Foreign 6 7 Real GDPBaseline Alternative
2.2 2.6 2.3 2.3 1.6 2.0 2.8 2.3

19 98
2.6 2.8 2.1 2.2
1.I 1.4

1999
3.1 3.2 1.4 1.3 1.3 1.5 2.5 2.5

2.7 2.9

U.S. Current Account Baseline Alternative
* US. non-oil import weights.

Billions of dollars, Q4
-194 -210 -210 -215 -214 -213

** US. nonagriculturalexport weights.

Chatt 13

Prospects for Net Exports
15

-

.... .*. .. .- ............ .......---. .. ... ............... .......... ._.*-..,..-

15

10

-

-

10

5-

-5

0

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I

0

Real Exports of Goods and Services Actual or Forecast Income

Billions of 1992 dollars, Q4 to Q4 70 ’ 0

Residual
60

-I60
40
20

40

20

0

1993

1994

1995

1996

1997

1998

0

Real Non-Oil Imports of
100

Goods and Services

Billions of 1992 dollars, Q4 to Q4

Actual or Form
80

-

1M)

80

60

60

40

40
20

20

0

0

Chart 14

ECONOMIC PROJECTIONS FOR 1997
FOMC Range Central Tendency Percent change, Q4 to Jominal GDP
previous estimate

4 t0 5’14
4 t0 5lI2

4’12 to 4314
4114 to 5

Staff
4.6

qeal GDP
previous estimate

2.3

>PI
previous estimate

Jnemployment rate
previous estimate

NOTE: Central tendencies constructed by dropping top and bottom three from distribution.