STRICTLY CONFIDENTIAL (FR) CLASS 1;FOMC

._

-

Material for

Staff Presentation to the Federal Open Market Committee
July 1,1997

Chart 1

Forecast Summary
Real GDP
Four-quarter percent change

WQ4percent change
1994 1995 1996 1997 1998 3.5 1.3 3.1 3.4 2.1

I
1994

I

I

I

r

1995

1996

1997

1998

Civilian Unemployment Rate

r

Percent

i 7 Percent
1994 1995

5.6
5.6

(fourth quarter)

1996
1997 1998

5.3 4.7 4.6

I
1994

I

I

I

I

1996

1998

Blue Chip
, 0

- 4

- 3.6
32 . 28 .
0--

: i m.
\ -, L./

r I
I

-

QdQ4 percent change Ex. food & energy Total Actual Adi.'
2.7 2.6 2.8 3.0 2.6 2.7 3.0 2.8 3.1 2.8 3.0 3.4

/

/

,. --

-

- \0 1
Staff
I

/

- 2.4
- 2

1994 1995 1996 1997 1998

3.2
22 2.8

'Adjusted for technical changes
I
I
I

1.6

Note: "Consensus' forecast, Blue Chip Economic Indicators. June 10,1997.

Chart 2

Background Factors in the Staff Forecast
_.

.. .

-

Financial environment
Federal funds rate remains at current level this year and then moves up moderately in 1998. Long-term rates begin to firm later this year reflecting inflation concerns, and rise a bit further next year as the System tightens. Stock prices climb further in the next few months; but disappointing profits, coupled with higher interest rates, lead to an appreciable correction next year.

Fiscal policy
The deficit widens slightly. Revenue growth slows in FY98, while outlays increase at about the pace of recent years. The macroeconomic consequences should be negligible.

Federal Fiscal Indicators
1995 1996 107.2 1997 59.1 -.2 1998
84.7

Unified deficit ($billions, fiscal year)
Fiscal impetus (calendar year)’
~ ~~

163.9 -.4

-.1

-. 1

* Percent of GDP; negative values indicate redraint.

chart 3

Forecast Summary: External Sector
Percent
. .

1

..

Billions of Dollars

-

50

0

-50

-1

-2

-3
-4

t
I I I

Current AcwuntVGDP I
I
I I I

7 -250 I I I

I

I

I

I
1992

1980

1982

1984

1986

1988

1990

1994

I I 1996

I -300 1998

* Excludescash gmnis received lor !ha Gun War.

U.S. Real Net Exports o Goods and Services f

r

Fourquarter percent change

Contribution to Real GDP Growth'
Percentage Points
1995H1 1995H2

-

-0.5 1.1
-0.9 0.5

lmH1 1997-H1 1997-H2 1998Hl

iwaw

1994

1996

1998

* F m end of previous pemd.

Issues in the Outlook

1. Exchange Rates 2. Foreign Outlook 3. Imports

Chart 4

Exchange Rates and Interest Rates
he Dollar and Real Interest Rates
1 ercentage Points G-10 nominal dollar . . 199301 = 100

Influences on the Dollar

-

0

G-10 price-adjusted dollar*

-

...-..._ 1liO ....... .......
90

1. External Balances 2. Inflation
3.

-1

Interest Rates

-2

4. European Monetary

Union
-3
1994
'Wid mnsumer prices. by

1996

1998

Dollar Exchange Rates

I

c

199401 = 1 2 120 yerddollar

I

Non-G-10 Exchange Rates'

-

199401 = 100 G-10
7

105

--.
-90

1994

I

I

I

I

85 1998

1996

'Adjusted by mnsumer prices.

Chart 5

Foreign Outlook and U.S. Exports
Real GDP'
Fwr-quarter percent change

.

...

Percent change, 04 to Q4
1996 1997 1998 ---

I

Japan Canada United Kingdom Euro Area" Mexico Other Latin Am. Other Asia Total'
Memo: United States

3.0 2.3 2.8 2.2 7.6 4.2 6.9 4.0 3.1

2.6 3.5 3.1 2.8 4.7 3.9 6.6 4.0 3.4

2.4 3.2 2.2 2.7 4.3 4.0 7.0 3.9 2.1

.
Consumer Prices Percent change, Q4 to Q4

Eum Area is EU-15 less Denmark. Graece. Sweden. U.K.

1996
Japan 0.1 2.0 Canada 3.2 United Kingdom 1.9 Euro Area' 28.1 Mexico Other Developing' 4.2 4.1 Total' Memo: United States
3.2

1997 1998 1.5 1.4 2.6 1.7 19.0 4.0 3.5 2.1 0.6 1.6 2.7 1.8 12.5 4.4 2.9 2.8

1

-

Percent of Potential
1996Q4 199804
-0.5 -0.8

Japan Canada United Kingdom Euro Area' Germany France

-1.5 -2.6 -0.4 -2.0 -1.o -2.2 -3.1

Italy

0.2 -1.3 -0.5 -0.9 -3.0

I

* US. n d l impcil Whts; h a m i z e d indexesfwEum

Contribution to Growth in Real Exports of G

0
l6 12

Total Export Growth
OtherGoads*

a Agriculture

Services

I:
1993
1994

Computers 8 .%miconductors Statistical Residual Percent change, Q4 to Q4

8
4

a
4

0
-4

0
-4

1995

1996

1997

1998

Chart 6

US. Imports
Prices of U.S. Imports
1994Ql = 100 Manufactures @IS) Fwrquarter percent change

1 112

-

Contribution of Exchange Rates

I
Quantities of U.S. Imports'

I I 1996 1997 1998 * Excludig oil, mmpnen, and semimndmtm;d e W lrwn NlPk

I

I

1994

1995

r
* Excludii oil, m

Fwrquarter percent change

12o 15

c

Fourquarter percent change

I:
10
5

4

0
Contribution of Relative Prices Contributionof U.S. GDP

e n . and micMducLors.

Contribution to Growth of Real Imports of Goods and Services
Total Import Growth

= 0

OtherGoods'

rn Computers 8 Semiconductors
Statistical Residual Percent change, Q4 to Q4

r

1l6

Chart 7

Consumption
Sales of Light. Vehicles . Millions of units PCE Ex. Motor Vehicles FouFquatter percent change
_.

1989

1992

1995

1998

r
I

Consumer Sentiment Michigan SRC Survey

Unemployment Expectations
Index, 1966=100 120

Michigan SRC survey

Index

180

160
100

140

80 120

I

I

I

I

I

I

I

I

I

60

I
~

I

I

I

1

I

I

I

- 1

100

1989

1992

1995

19

1989

1992

1995

1<

~ o t e .Percent expecting unemployment to rise over next 12 months less those expecting unemployment lo fall plus 100.

Chart 8

Price-Earnings Ratio - S&P 500
Ratio

T

__

T

T

T

T

T

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1962

1968

1974

1980

1986

1992

1998

*Source: GOldman Sachs

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

-

Before-Tax Economic Profits Annual average, percent change 1994 1995 1996 1997p 199813
D =Stafforoiection

S&P 500

Jun.

14

12.6 9.1 10.8 8.4 -.4

Ratio to income Consumption rate

Percent

1

loo

5 -

45 .

Household net worth

- 92
I

4

I

I

I

I

I

I

I

I

I

1

I

I

I

I

I

I

I

88

1980

1986 1989 ~ o t eConsumption rate equals 100 minus me saving rate. :

1983

1992

1995

1998

Chart 9

Business Investment

Producer's durable equipment Computers Aircraft Other Nonresidentialstructures

BFI Forecast
(Percent chanae. Q4 to Q41
1996 9.7 37.2 9.2 2.1 1997 12.6 26.0 1998 6.9

-

18.5
3.2

50.5
6.4 4.5

.a
4.3

9.0

U.S. PC Unit Shipments

-

Percent change

Aircraft Deliveries at BOeing 40

1 r
30

Units per month

1
6o

20

10

n "
1992 1995 1998 Source: InformationTechnology lndusby Council 1989 1993 1997 Note. Historical data are plotted as six-monm moving average; forecast is Boelng's sdeduled deliveries.

."

r
I-

New Orders for Nondefense Capital Goods

Office Vacancy Rates Billions of dollars

-

38

Excluding computers and aircraft
32

r

Percentage sq. ft. vacant
2 4

26

2 0

16

20

12

14

I

I

1

I

I

I

I

I

I

I

8

1989

1993

1997

1989

1993

1997

Chart 10

Other business equipment

- 16 12

-

-

- 8

- 4

+
0

1965-70

1970-75

1975-80

1980-85

1965-90

1990-94

1994-98

* Capital input (equipment and structures)per labor hour.

Chart 11

The Supply Side
Supply-side Components of Potential GDP
(Average annual growth rate) Long-term trends
1960-73
1. Potential GDP 4.1

Projection
1990-98
1.9 1.o .9 .O

1973-79

1979-90
2.7

2 .
3. 4.

Laborinput Labor productivity 1 Technical factors

12 .
3.0 -. 1

33 . 20 .
1.1

16 .
1.1 .O

. 2

1. Nonfarm budneSS sector. 2. Technical lactors include: me ratio of GDP to Me output ofthe nonfarm buslness sector; the ratio of nonfarm business employment to householdemployment: and rounding error.

Nonfarm Business Productiv'W

r

Chained 1992$Rlour 1 3

1977 1981 * Adjusted to reflect anticipated revision.

1985

1989

1993

1997

Labor Force Participation Rate
Percent

Labor Force and Employment*
69

L
Percent change, 04 to Q4

67

U
1995 1996 .5

Labor

Emnlovment
.6

1.8
1.7

65

1997 1998

2.0 2.3
1.4

1.2

63

1980

1988 NOWAdiusted for CPS revidon.

1996

Chart 12

The Labor Market
Unemployment Rate Percent Conference Board Survey

r

Index

Jobs hard to get

1:
-6
- 5
- 4

1985

1988

1991

1994

1997

Health Insurance Premiums'

r

Percent change
10

Michigan SRC survey m da .one year ahead e in

8
6

-

4

- 3

* KPMG survey

Employment Cost Indexes

-

Fourqwrter percent change
- 8

Q4/Wpercent change

-6

sQ@ul?kules
2.6 28 .
3.4 3.1

c-.

- 4

/-/&-

1997
1998
I

3.3

37 . 38 .

- 2

3.4

I

I

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I

I

I

I

I

I

I

I

I

I

1986

1989

1992

1995

~0 1998

Chart 13

Product Markets and Price Inflation
Non-oil Import Prices Percent change, saar

F

. .

r

ManufacturingCapacity Utilization Percent

1959-1996 average 1 9 5

1992

1995

1998

Trend Markup o Prices over Unit Labor Costs f
Ratio

11.52

Nonfarm business sector

\

- 1.5
\
\

\

.~ - 1.48
1.46

19731996 average
I

I

I

1

I

I

I

I

I

I

I

I

I

I

I

I

I

I

1980

1983

1986

1969

1992

1995

1998

- Chain-weighted

PCE

Q4/Q4 percent change

-6

w m
- 4

1995

2.5 2.1

2.1 2.5 2.1 2.6

*//s 2 I
I I I

1997 1998

2.2 2.5

I

I

I

I

I

I

I

I

I

0

Chart 14

The Effects of Faster Productivity Growth
Nonfinancial Corporate Productivity
Chained $92/hr. ratio scale

1

1

1

1

1

1

1

1

I

I

I

I

1

1

1

1

1

1

I

I

I

I

I

II,,
1997

1977

1981

1985

1989

1993

The Supply-side Effects Initially, business profitability increases. Price inflation is reduced. Real wages rise more quickly through a combination of lower price inflation and some pickup in nominal wage inflation.

The Demand-side Effects Investment demand strengthens as firms expand capital spending to exploit enhanced profit opportunities. Consumer spending accelerates as households respond to higher permanent income.

Chart 15

Alternative Scenarios with Faster Productivijr Growth
(0.5 percentage point per year faster productivity growth;

deviations from baseline)
. .

Percentage point lent targeting

PCE Inflation

Unemployment Rate Percentage point Unemployment targeting Inflation targeting

r
-

1 :
- 1.6

Unemployment targeting Inflation targeting

- 1.-6 .
1.g

Unemploymenttargeting Inflation targeting

-

12 .
0.8

03

- 0.4
- 0 -

- 03
- 0
1 1 1 1 1 1 1 1 1 I

+

+

04 .

-

1

1

1

1

1

1

1

1

1

1

0.4

1996
PCE Inflation (Q4to 04 percent change) 25 . Baseline Unemployment targeting 25 . Inflation targeting 2.5
Unemployment Rate (annual averages) 54 . Baseline Unemployment targeting 54 . Inflation targeting 54 .

1997

1998

1999

2001

2006

r

21 . 19 . 20 . 49 . 49 . 4.9

26 . 21 . 2.3 46 . 46 . 4.5

29 . 24 . 27 . 48 . 48 . 46 .

3.2 2.8 31 . 56 . 5.6 5.4

3.2 28 . 32 . 5.6 5.6 56 .

Chart 16

ECONOMIC PROJECTIONS FOR 1997 FOMC
. .

-

Ranae

Central Tendencv

Staff
U 5.4
4.6

Percent change, Q4 to Q Nominal GDP
previous estimate

5 to 6
4’14 to 5’14

5 to 5112 4’12 to 4314 3 to 31 ’4
2 to 2114

Real GDP
previous estimate

3 to 3l/2 2 to 2 1 12 2 to 2% 2 to 23/4 2 3 1 10 3112 ~

3.4
2.3

GDP Price Index CPI
previous estimate

2 to 2’14 2’14 t0 Z1/2 23/4 t0 3

2.2 2.2
2.6

Average level, Q4, percent

I
I

Unemployment rate
previous estimate

43/4 to 5
5’14 t05l/2

t0 5
5’/4 tO5’/2

4.7
5.1

ECONOMIC PROJECTIONS FOR 1998 FOMC Range Central Tendency Staff

Percent change, Q4 to- Q Nominal GDP Real GDP GDP Price Index CPI
4 ’14 to 53/4 1 1 to 3 34 2114 to $ 4 1 2112 to 3 4112 to 5 2 to 2112 2lI2 to 23/4 2112 to 3 4.3 2.1 2.5 2.8

Average level, Q4, percent Unemployment rate
4‘12 to 5’14 43/4 to 5 4.6

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

rounding to nearest quarter percent.