Economic Outlook. William Strauss Senior Economist and Economic Advisor Federal Reserve Bank of Chicago

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1 Economic Outlook Illinois Public Pension Fund Association Hoffman Estates, IL February 16, 217 William Strauss Senior Economist and Economic Advisor Federal Reserve Bank of Chicago

2 GDP expanded by 1.9% over the past year Real gross domestic product percent Percent change from a year earlier Quarterly change (saar) 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16

3 The Midwest economy has been growing close to trend, a bit better than the national economy Midwest Economy Index 2 1 Relative MEI Midwest Economy Index (MEI) 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16

4 The real value of the stock market has reached new highs Index: 199 = Real S&P 5 stock index 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17

5 The Federal Open Market Committee (FOMC) expects GDP to grow around trend over the next three years Real gross domestic product percent change from a yearearlier FOMC Central Tendency (December 216) Longer run FOMC 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 '18 '19

6 The Blue Chip Forecast has GDP rising somewhat above trend this year and next year Real gross domestic product percent Quarterly change (saar) Blue Chip GDP Forecast Actual Forecast Percent change from a year earlier Q '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 '18

7 The path of the current recovery is restrained compared with past deep recession recovery cycles index- business cycle trough = Business cycle recovery path average annualized growth: 4.3% average annualized growth: 4.4% average annualized growth: 2.1% quarters before trough quarters after trough

8 Employment increased by over 2.3 million jobs over the past 12 months Total employment percent Percent change from a year earlier Monthly change (saar) 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17

9 Wisconsin s employment growth is around the middle of most Midwest states Total employment percent change from a year earlier IN US -2 IL IA WI '91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 MI

10 The unemployment rate has fallen to 4.8% percent Unemployment rate 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17

11 Wisconsin s unemployment rate is well below the nation s Unemployment rate percent MI IL US WI 4 2 IN IA 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16

12 The labor force participation rate fell to a level last seen in 1977 percent Labor force participation rate 195 '55 '6 '65 '7 '75 '8 '85 '9 '95 ' '5 '1 '15

13 Civilian Labor Force Participation Rate and Population Share 16 and Older by Age Category, United States, 27 and 216 Labor Force Participation Rate (%) Population Share (%) Change Change Population 16 and older to to to to to plus

14 Wages and benefit costs continue to increase at a very slow pace Employment cost index percent change from year ago 8 7 benefit costs wages and salaries 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16

15 The FOMC forecasts that the unemployment rate will be just below the natural rate through Unemployment rate percent 11 FOMC Central Tendency (December 216) Longer run FOMC '91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 '18 '19

16 Slow productivity growth helps explain why relatively strong employment growth has not translated into higher wages percent change (2-qtr rate) Productivty 195 '55 '6 '65 '7 '75 '8 '85 '9 '95 ' '5 '1 '15

17 A large part of the weakness in productivity growth has been the weak pace of investment 2 Real private nonresidential fixed investment percent Percent change from a year earlier Quarterly change (saar) 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16

18 Inflation is low, but moving higher Personal consumption expenditure - chain price index percent change from a year earlier '91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16

19 In large part inflation has been kept low due to the collapse of energy prices dol lars per barrel, 216 dollars Real West Texas Intermediate oil price 197 '75 '8 '85 '9 '95 ' '5 '1 '15

20 Natural gas prices have also declined and remains low dollars per mmbtu, 216 dollars Real natural gas price 1994'95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17

21 Expenditures on energy are well below the historical average Energy goods and services expenditures as a share of total consumption percent s 7s 8s s s 1s '65 '7 '75 '8 '85 '9 '95 ' '5 '1 '15

22 Removing the volatile food and energy components from the PCE, core inflation remains low Personal consumption expenditure - less food and energy - percent change from a year earlier chain price index '91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16

23 The FOMC anticipates that PCE inflation will be around their two percent target over the next three years Personal consumption expenditure - chain price index percent change from a year earlier 6 5 FOMC Central Tendency (December 216) Longer run FOMC '92 '94 '96 '98 ' '2 '4 '6 '8 '1 '12 '14 '16 '18

24 The FOMC anticipates that core PCE inflation will reach two percent by 218 Personal consumption expenditure - less food and energy - percent change from a year earlier chain price index 5 FOMC Central Tendency (December 216) FOMC '92 '94 '96 '98 ' '2 '4 '6 '8 '1 '12 '14 '16 '18

25 Blue Chip International Consensus Forecasts Inflation Exchange Rate Real GDP % change Against Interest Rates % change Annual US Dollar 3-Month Annual Consumer Prices End of Year End of Year United States Canada Mexico Japan South Korea ,23 1, United Kingdom Germany France Euro Zone Brazil Russia China India Blue Chip Economic Indicators Forecast February 1, 217

26 Manufacturers Purchasing Managers Indexes Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Global United States Canada Mexico Eurozone Germany France Italy Spain UK Russia Japan China India Brazil

27 Over the past couple of years, the real trade-weighted dollar increased by 22% i ndex: Ma rch 1973= Trade-weighted exchange value of the U.S. dollar (real) 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17

28 Manufacturing output is flat compared with a year earlier percent Industrial production - manufacturing Monthly change (saar) Percent change from a year earlier 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17

29 Capacity utilization has been edging lower Capacity utilization - manufacturing percent '91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17

30 Manufacturing has lost jobs over the past year Manufacturing employment percent Percent change from a year earlier Monthly change (saar) 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17

31 Manufacturing jobs were added in Michigan and Wisconsin and lost in Indiana, Illinois and Iowa percent change from a year earlier Manufacturing employment WI US IA IN IL MI 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16

32 The Midwest Economy Indexes manufacturing component is near its trend and doing relatively better than the nation Midwest Economy Index: Manufacturing 1..5 Relative MEI Midwest Economy Index (MEI) 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16

33 Light vehicles sales set a record in 216 edging up.4% from 215 Light vehicle sales millions of units (saar) '91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17

34 216 light truck sales were 7.3% higher while passenger car sales were 7.9% lower millions of units (saar) Passenger car and light truck sales light trucks passenger cars 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17

35 Alternative powered vehicles (including hybrids) are a very small fraction of total vehicle sales percent of total sales Power-Type Gasoline and Diesel Alternative 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17

36 Alternative powered vehicles (including hybrids) market share barely exceeded 4% and have been declining over the past two years Alternative Powered Vehicles percent of total sales '91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17

37 Vehicle sales are anticipated to edge lower over the next two years Vehicle sales millions of units Blue Chip Light-Vehicle Sales Forecast Actual Forecast '85 '9 '95 ' '5 '1 '15

38 Industrial production is forecast to improve but expand at a pace below its historical rate Total industrial production percent 1 5 Percent change from a year earlier Quarterly change (saar) Q4-216 Blue Chip IP Forecast Actual Forecast '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 '18

39 The forecast calls for a very gradual recovery in housing Housing starts thousands 2,5 Blue Chip Housing Starts Forecast (thousands) Actual Forecast ,168 1,263 1,348 2, 1,5 1, '85 '9 '95 ' '5 '1 '15

40 Monetary policy has been very aggressive, keeping the Fed Funds near zero since December 28 percent Fed Funds rate 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17

41 The Federal Funds Rate is expected to reach the neutral rate at the end of 219 percent Target Federal Funds Rate FOMC Central Tendency (December 216) Longer run FOMC 199'91 '92 '93 '94 '95 '96 '97 '98 '99 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 '18 '19

42 Summary The outlook is for the U.S. economy to expand at a pace around trend through 219 Employment growth is expected to slow with the unemployment rate remaining below the natural rate Disappearing slack in the economy will lead to a gradual rising inflation rate Manufacturing output is expected to increase at a rate below its trend in 217 and 218 The housing market is expected to continue improving through 218

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