Quarterly Economic Review as of June 30, 2012
The state of the general economy can help or hinder a business’s prospects and therefore has a direct impact on the value of a business. The economic recovery following the recession of 2007-2009 continues, but modestly. Following the June 19-20, 2012, meeting of the Federal Open Market Committee (the “Committee”) of the Federal Reserve, the Committee issued a statement that, “the economy has been expanding moderately this year, but growth in employment has slowed… and the unemployment rate remains elevated. Despite some signs of improvement, the housing sector remians depressed. Inflation has declined, mainly reflecting lower prices of crude oil and gasoline. Longer-term inflation expectations have remained stable.”
Gross Domestic Product
The U.S. Bureau of Economic Analysis (BEA) estimates that real gross domestic product (GDP) increased at an annual rate of 1.9 percent in the first quarter of 2012. Quarterly GDP data for the preceding ten years is shown in the following figure.
QUARTERLY U.S. GDP GROWTH
Seasonally Adjusted Annualized Rates; Shaded Bar Indicates Recession
Sources: U.S. Bureau of Economic Analysis and National Bureau of Economic Research. GDP percent change is based on chained 2005 dollars.
The employment situation in the United States remains weak. Over the 25 consecutive months from February 2008 to February 2010, 8.8 million non-farm jobs (net) were lost. In the 26 consecutive months from March 2010, 3.5 million non-farm jobs (net) were created.1 The unemployment rate peaked at 10.0 percent in October 2009 and has abated somewhat to a still-elevated 8.2 percent as of June 2012.2 Such a high level of unemployment places severe strain on the economy as consumers are unable or unwilling to spend. The past ten years of employment data are presented in the following figure.
MEASURES OF STRESS IN THE LABOR MARKET
Shaded Bar Indicates Recession
Sources: Department of Labor, Bureau of Labor Statistics, and National Bureau of Economic Research. Data represents non-farm payrolls.
The Committee meets periodically to assess economic conditions and determine appropriate policies to fulfill its dual mandate of fostering maximum employment and price stability. At its June 19-20, 2012, meeting the Committee kept the target federal funds rate at zero to 0.25 percent and cited various factors for maintaining monetary policy that is very loose by historical standards, including low rates of resource utilization and a subdued outlook for inflation. Additionally, the Committee voted to continue through the end of the year its existing program to extend the average maturity of the Treasury securities it holds. Specifically, the Committee will purchase Treasuries with maturities of 6 years to 30 years and sell Treasuries with maturities of 3 years or less. Sometimes referred to as “Operation Twist,” the goal is to apply downward pressure to longer term interest rates, thereby “twisting” the yield curve to make financial conditions more accommodative. The Committee expects that economic conditions will warrant keeping the federal funds rate at its current level at least through the end of 2014. Ten years of historical interest rate data are shown in the following figure.
SELECTED INTEREST RATES
Shaded Bar Indicates Recession
Source: Federal Reserve Statistical Release H.15 (519) Selected Interest Rates.
The European sovereign debt crisis that began in earnest with Greece in 2010 continues to spread at a slow pace and shows no signs of resolution as of mid-2012. Although the proximate cause was the 2007-2009 financial crisis, a combination of persistent structural deficits, trade imbalances, and real estate bubbles in the decade prior have resulted in a series of European nations requiring substantial financial bailouts. A “troika” of international lenders consisting of the European Union, the European Central Bank, and the International Monetary Fund has provided extraordinary financial support to Greece (April 2010), Ireland (November 2010), Portugal (May 2011), and Spain (June 2012). Other nations appear vulnerable, as France’s credit rating has been downgraded from AAA and Italy’s bond yields have spiked upward. Global stock markets and consumer confidence have been rattled by unemployment and social unrest as nations attempt to stabilize debt levels and avert insolvency in an attempt to prevent a cascade of defaults that could spread through the global financial system. There is speculation some countries may exit the European Union.
In the United States, fiscal policy remains gridlocked as the November 2012 presidential and congressional elections approach. The George W. Bush-era tax cuts of 2001 and 2003 that temporarily lowered tax rates were due to expire at the end of 2010, but were extended through 2012. The failure of a “supercommittee” of congressional Democrats and Republicans in 2011 to agree on measures to reduce the national deficit will trigger automatic cuts of $1.2 trillion over a decade, allocated equally between defense and domestic spending. These cuts are scheduled to commence on January 1, 2013. The sudden and simultaneous combination of tax increases and spending cuts, a so-called “fiscal cliff,” is projected by many economists to have adverse short-term effects and may push the still recovering U.S. economy back into recession. Both Democrats and Republicans agree that these contractionary fiscal measures would be undesirable, but Congress remains at odds over how to avoid them.
In recent months various statistical reporting agencies have revised the U.S. economy’s projected growth rate downward as the strength of the economic recovery has moderated and substantial uncertainty remains about the ability of American and European governments to enact policies that will stabilize debt levels while supporting economic growth. In June, the Federal Reserve lowered its projected range of near-term GDP growth from its April forecast. This data is presented in the following figure.
U.S. GDP GROWTH ESTIMATES
Source: Federal Reserve.
The Congressional Budget Office’s (CBO) January 2012 report stated that, “the pace of economic expansion will remain quite modest over the next two years because of the lingering effects of the financial crisis and the recession as well as the path of federal fiscal policy under current law.”3 The CBO estimates that real GDP will grow 2.0 percent in 2012 and 1.1 percent in 2013, with growth averaging 4.1 percent from 2014-2017. GDP is expected to remain below the economy’s potential until 2018.4
On June 26, 2012, Standard & Poor’s said it estimated a 20 percent probability of the United States entering a new recession in the near term, although the most likely scenario is a continuation of slow recovery. Inflation, as measured by the Core Consumer Price Index, which excludes the effects of food and oil, is forecast to be 1.2 percent in 2012, eventually increasing to an average of 2.0 percent per year in the 2018 to 2022 period.5
1 Source: Bureau of Labor Statistics. “Employment, Hours, and Earnings from the Current Employment Statistics survey (National).”
2 Ibid. Unemployment rates reported on a seasonally adjusted basis.
3 U.S. Congressional Budget Office. “The Budget and Economic Outlook: Fiscal Years 2012-2022.” January 2012.