Outlook for the U.S. Economy

1. Outlook for the U.S. Economy Joe Kennedy

2. Is there a Trade-off Between Inflation and Unemployment?

3. Growth is Moderate Growth in the 1stQuarter of 2012 slipped to 2.2 percent. This ended a streak of three straight quarters of accelerating growth and indicated that strong growth may not be just around the corner.

4. The Economy has Finally Started Adding Jobs The economy added only 115,000 jobs in April 2011. After three strong months at the turn of the year, job creation may be slowing. Economists believe that the economy needs add approximately 125,000 each month just to accommodate new entrants into the workforce.

5. The degree of long-term unemployment remains high The unemployment rate fell to 8.1 percent in April although much of the recent improvement has been due to people leaving the workforce rather than finding jobs. A broader measure of unemployment that includes marginally attached workers, discouraged workers and part-time workers who seek full-time work is much higher. The average duration of unemployment is 39.1 weeks. 41.3 percent of the unemployed have been jobless for 27 weeks or longer. An interesting question is whether the expiration of extended unemployment benefits helped create a sudden fall in unemployment that is now petering out. Labor market participation has declined over 2 percentage points from its high going into the recession.

6. Education matters Less than high school The unemployment rate for those without a high-school degree is much higher than for those with a college degree or more. Age and race also matter. The unemployment rate for teenagers is 24.9 percent, for those age 25-54 it is 6.9percent. The unemployment rate of blacks is usually double that for whites, currently 13.0 percent to 7.4 percent. College or more

7. The Economy is Still Driven by Consumer Spending Consumption has risen to over 70 percent of GDP, while private investment has fallen to just over 13 percent. A persistent criticism is that America does not invest enough in infrastructure, education, and research and development.

8. And Consumers are Still Over-Leveraged Much of the reduction in household debt has been due to write-offs as consumers and homeowners defaulted on outstanding loans. Only a portion has been due to a shift away from consumption and into savings.

9. Rising Gas Prices Could Depress Consumer Spending Crude oil accounts for 65 percent of the cost of gasoline. Taxes add another 13 percent.

10. Business Fixed Investment Continues to Rebound

11. But the Financial Sector Still Accounts for a High Percent of Total Profits This is a dangerous sign. The financial sector is a service industry that should follow business activity in the rest of the economy, not lead it. High profits may mean that financial institutions are building leverage and expanding risk again.

12. The Dollar Has Fallen Most recently the dollar has been trending up after a long decline The weak American economy has caused the dollar to depreciate against major currencies. But this has been offset by the dollar’s position as the world’s reserve currency and the tendency of investors to flock to Treasuries in times of high risk. The European and Japanese markets also have economic difficulties.

13. Exports have Increased but so have Imports Imports Changes in the currency rate usually take about two years to fully affect trade patterns Exports

14. Inflation Expectations Remain Low

15. Inflation Remains Low Despite Rising Food and Gas Prices Motor fuel accounts for 5.1 percent of all consumer purchases Household energy accounts for another 4 percent of purchases Food accounts for only 14.8 percent of all purchases

16. The Federal Deficit Has Expanded Rapidly The automatic rise in spending and fall in taxes accounted for much of the deterioration between 2008 and 2011. Policy changes, in particular the ARRA accounted for a smaller portion. Future deficits are driven largely by entitlement programs driven by the growing number of retirees and, especially, the expected rise in medical costs.

17. The Current Deficit is due to Both Rising Spending and Falling Revenues Outlays But even without additional taxes, revenues are expected to surpass the recent average of around 18 percent of GDP once the economy recovers. Revenues

18. Total Federal Debt is on Pace to Exceed World War II Highs

19. Housing Remains Weak Housing prices appear to have stabilized A large number of foreclosures remain in the system. Uncertainty over how these foreclosures will be handled and how quickly will continue to depress prices. Approximately 25 percent of homes remain underwater. It is unclear whether financial institutions have adequately marked down these assets.

20. Equity Markets have Rebounded

21. Volatility is Down Although far down from its extraordinary highs during the financial crisis, the VIX index, is still subject to sudden swings.

22. But Markets Still Appear to be Overvalued When prices are divided by a ten-year average of real earnings, they appear to be much higher than their long-run average.

23. Main Risks Going Forward International Domestic Fears of Inflation Inevitable Fed Unwinding Government Deficits Continued Foreclosures Policy Uncertainty • European Sovereign Debt • Unrest in the Middle East (including Pakistan and Afghanistan) • Overheating and Political Instability in China