Quarterly Economic Review
As of December 31, 2012
The state of the general economy can help or hinder a business’ 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 December 11-12, 2012, meeting of the Federal Open Market Committee (the “Committee”) of the Federal Reserve, the Committee issued a statement that economic activity has continued to expand at a moderate pace and consumer spending and the housing sector have continued to improve, but the unemployment rate, despite declining somewhat since the summer, remains elevated and business fixed investment has slowed.
Gross Domestic Product
The U.S. Bureau of Economic Analysis (BEA) estimates that real gross domestic product (GDP) — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 3.1 percent in the third 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. In the 25 consecutive months from February 2008 to February 2010, 8.8 million non-farm jobs (net) were lost. In the 34 consecutive months from March 2010 to December 2012, 4.8 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 7.8 percent as of December 2012.2 Such a high level of unemployment places severe strain on the economy as consumers are unable or reluctant 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 appropritae policies to fulfill its dual mandate of fostering maximum employment and price stability. At its December 11-12, 2012, meeting the Committee kept the target federal funds rate at zero to 0.25 percent and anticipated that an exceptionally low federal funds rate is likely to be warranted as long as unemployment is greater than 6.5 percent and inflation expectations remain close to the Committee’s goal of 2.0 percent. The Committee also announced that it would continue its policy accommodation by purchasing mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury bonds at a pace of $45 billion per month, with no specific end date. The Committee will continue extending the average maturity of the Treasury securities it holds and reinvesting proceeds from maturing bonds. 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 year-end 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 five of seventeen euro area countries: Greece (April 2010), Ireland (November 2010), Portugal (May 2011), Spain (June 2012), and Cyprus (June 2012). Other nations appear vulnerable, as France’s credit rating has been downgraded from Aaa, Italy’s bond yields have spiked upward, and Spain’s banks needed recapitalization. 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 after the November 2012 elections resulted in both parties retaining control of their respective branches of government. The sudden and simultaneous combination of tax increases and spending cuts, a so-called “fiscal cliff,” scheduled to take effect in 2013 was narrowly averted, albeit temporarily. A last minute deal was reached to delay scheduled cuts to discretionary spending until March 2013, permanently increase tax rates on high income workers, and restore the payroll tax to its pre-2010 level. These measures are not enough to meaningfully reduce annual deficits or stabilize debt as a percent of GDP, and uncertainty regarding the impending budget cuts and raising the nation’s borrowing authority continue to weigh on consumer and business confidence.
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 December, the Federal Reserve lowered its projected range of near-term GDP growth from its September forecast but maintained its projected range of longer-term GDP growth. This data is presented in the following figure.
U.S. GDP GROWTH ESTIMATES
Source: Federal Reserve.
The Congressional Budget Office’s (CBO) August 2012 report estimated that the federal budget deficit for fiscal 2012, which ends September 30, will be $1.1 trillion, the fourth year in a row with a deficit of more than $1 trillion. The CBO projects that the sharp increases in federal taxes and reductions in federal spending that are scheduled under current law to begin in calendar year 2013 are likely to lead to a recession in 2013.”3 The CBO estimates that real GDP will grow 2.1 percent in 2012 and contract 0.5 percent in 2013, with growth averaging 4.3 percent from 2014-2017. GDP is expected to remain below the economy’s potential until 2018.4
Inflation, as measured by the Core Consumer Price Index, which excludes the effects of food and oil, is forecast to be 1.5 percent in 2013, eventually increasing to an average of 2.0 percent per year in the 2018 to 2022 period.5 On September 11, 2012, Moody’s Investor Service warned that the United States’ credit rating was at risk of being downgraded from Aaa if budget negotiations do not result in a stabilization of the country’s ratio of debt to GDP.
1 Source: Bureau of Labor Statistics. “Employment, Hours, and Earnings from the Current Employment Statistics survey (National).” <http://data.bls.gov/timeseries/CES0000000001?output_view=net_1mth>.
2 Ibid. Unemployment rates reported on a seasonally adjusted basis.
3 U.S. CBO. “An Update to the Budget and Economic Outlook: Fiscal Years 2012-2022.” August 2012. <http://www.cbo.gov/sites/default/files/cbofiles/attachments/08-22-2012-Update_to_Outlook.pdf>