A Perspective on Monetary Policy

March 23, 2017 David Oppedahl Senior Business Economist Bloomington, IL 312-322-6122 [email protected] The path of this recovery has been below past deep recession recovery cycles

Business cycle recovery path index- business cycle trough = 100 140 140 1981-82 135 135 130 average annualized growth: 5.4% 130 125 125 average annualized growth: 5.3% 120 120 115 average annualized growth: 2.4% 1974-75 115 2008-09 110 110 105 105 100 100 95 95 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 quarters before trough quarters after trough Confidence rising as uncertainty persists

Economic Policy Uncertainty Index Consumer Confidence (Conf. Board)

250 150

200

100

150

50 100

50 0

'01 '03 '05 '07 '09 '11 '13 '15 '17 '01 '03 '05 '07 '09 '11 '13 '15 '17 1999 1999 Record stock markets

Real S&P 500 stock index Index: 1990 = 100 400

350

300

250

200

150

100

50 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 System How does the Fed affect agriculture?

• Interest rates

• Price level (inflation)

• National income (GDP)

• Exchange rates (indirectly) What is the Federal Reserve System? • Twelve District Banks • Board of Governors • Federal Open Market Committee (FOMC)

• Functions of the Fed – Monetary policy – Regulator of financial institutions – Provides banking services for U.S. government – Electronic funds transfer & financial services – Protect credit rights of consumers Board of Governors of the Federal Reserve System

1 2

Janet L. Yellen Stanley Fischer Chair Vice Chair

3 4 5? 6? 7?

Daniel K. Tarullo Vacant Vacant Presidents of the Federal Reserve Banks

1 2 3 4

Eric S. Rosengren William C. Dudley Patrick T. Harker Loretta J. Mester First District - Boston Second District - New York Third District - Philadelphia Fourth District - Cleveland 5 6 7 8

Jeffrey M. Lacker Interim President Charles L. Evans James B. Bullard Fifth District - Richmond Sixth District - Atlanta Seventh District - Chicago Eighth District - St. Louis 9 10 11 12

Neel Kashkari Esther George Robert S. Kaplan John C. Williams Ninth District - Minneapolis Tenth District - Kansas City Eleventh District - Dallas Twelfth District - San Francisco

Goals of Monetary Policy

• Price stability -- low and stable inflation

• Low unemployment

• Economic growth

• Moderate interest rates Chicago Fed National Activity Index shows hesitant growth since 2009 2 (standard deviation from trend growth, Above 3-month moving average) Trend 1 Growth

0

Below -1 Trend Growth -2

-3

-4

-5 1999 '01 '03 '05 '07 '09 '11 '13 '15 '17 Chicago Fed National Financial Conditions Index

3

2

1

Tighter Conditions 0

-1 Looser Conditions -2 2001 '03 '05 '07 '09 '11 '13 '15 '17 Quantitative easing was necessary

Assets of the Federal Reserve Billions of dollars 4,500 4,000 3,500

3,000Maiden Lane II & III Term Asset-Backed Securities 2,500 Loan Facility AIG Support 2,000 Central Bank Swaps 1,500 Commercial Paper Facility 1,000 Maiden Lane Securities Held Outright 500 Term Auction Credit 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 Recent Monetary Policy Actions

• Tapering of asset purchases began in December 2013

• No additional asset purchases after November 2014, while continuing to reinvest assets as they mature

• In December of 2015 & 2016 and March 2017, raised the range of the Fed Funds Rate by 0.25% points

• The FOMC will monitor economic conditions to tailor future actions to meet objectives of maximum employment and 2% inflation In March 2017, the FOMC raised the Fed Funds rate target to a range from 0.75% to 1.00%

7 Rate (effective), Yields in percent per annum 6 5 4 3 2 1 0 1999 '01 '03 '05 '07 '09 '11 '13 '15 '17 Contributions to real GDP growth of 1.9% in the 4th quarter of 2016

• Consumption 2.0% • Residential Investment 0.4% • Business Investment 0.2% • Inventories 0.9% • Government 0.1% • Net Exports -1.7% The FOMC consensus outlook has output rising at about its trend over the next few years

Real gross domestic product percent change from a yearearlier 6 5 4 3 FOMC 2 1 0 -1 -2 -3 -4 -5 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19 Food price changes now well below core inflation (less food and energy)

(Consumer Price Index, percent change from year ago) 8

6

4

2

0

-2 1991 1996 2001 2006 2011 2016

CPI Less Food and Energy CPI for Food Real Cash Crop Prices

($/bushel, adjusted by CPI-U for January 2010) 40

30

20

10

0 1976 1981 1986 1991 1996 2001 2006 2011 2016 Corn Soybeans Real USDA Livestock Prices

($/hundredweight, adjusted by CPI-U for January 2010) 250

200

150

100

50

0 1976 1981 1986 1991 1996 2001 2006 2011 2016 Hogs Cattle Oil prices plummeted and lower gas prices boosted consumer saving/spending (2010 $/barrel)

150

100

50

0 1971 1976 1981 1986 1991 1996 2001 2006 2011 2016 Natural gas prices have moderated

Real Natural Gas Price {2010 $/mmbtu} 15

10

5

0 1997 2002 2007 2012 2017 Even including the volatile food and energy components, inflation remains contained

Personal consumption expenditure - chain price index percent change from a year earlier 6 5 4 3 FOMC 2 1 0 -1 -2 1990 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16 '18 Employment fell by over 8.7 million jobs between December 2007 and February 2010, and finally recovered all the lost jobs in May 2014

Total employment percent 6

4

2

0

-2

-4 Percent change from a year earlier -6 Monthly change (saar) -8 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 Alternative measures of unemployment Still high including discouraged workers and part-time employment for economic reasons

Unemploymentrate percent 18 16 U-6 14 12 U-5 10 8 U-4 6 U-3 4 2 0 1994 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16 The share of those unemployed more than 6 months remains significantly high

Unemployed for 27 weeks or more percent 50 45 40 35 30 25 20 15 10 5 0 1950 '55 '60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 '15 The FOMC forecasts that the unemployment rate will be under the natural rate through 2019

Unemployment rate percent 11 10 9 8 7 6 5 FOMC 4 3 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19 Wages and benefit cost increases remain low

Employment cost index percent change from year ago 8 benefit costs 7 6 5 4 3 2 wages and salaries 1 0 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 Stronger productivity after the recession, but weak results recently Productivty percent change (20-qtr rate) 5

4

3

2

1

0

-1 1950 '55 '60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 '15 Poor business investment explains much of the lower productivity levels

Real private nonresidential fixed investment percent 20

10

0

-10 Percent change from a year earlier

-20 Quarterly change (saar) -30 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 Manufacturing is growing again; orders for capital goods moving up

ISM purchasing managers index Nondefense capital goods ex. aircraft (net percent reporting increase) (orders in millions of dollars, 3-month moving average)

65 75

60 70

55 65 50 60 45

55 40

50 35

30 45

'01 '03 '05 '07 '09 '11 '13 '15 '17 '01 '03 '05 '07 '09 '11 '13 '15 '17 1999 1999 Industrial production is forecast to improve, yet remain below its historic rate of growth

Total industrial production percent 10 Percent change from a year earlier 5

0 Q4-2016 -5

-10 Blue Chip IP Forecast Actual Forecast -15 2016 2017 2018 -0.1 2.3 2.3 -20 Quarterly change (saar) -25 2000 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 Vehicle sales are anticipated to edge lower

Vehicle sales millions of units 18 17 16 15 14 13 Blue Chip Light-Vehicle Sales Forecast 12 Actual Forecast 2016 2017 2018 11 17.5 17.4 17.3 10 1980 '85 '90 '95 '00 '05 '10 '15 Housing market tanked, moving up slowly

Housing starts Home mortgage rate (millions of units, 3-month moving average, SAAR) (percent, effective rate for all loans closed)

2.5 9

8 2.0 7

1.5 6

5 1.0 4

0.5 3

'01 '03 '05 '07 '09 '11 '13 '15 '17 '01 '03 '05 '07 '09 '11 '13 '15 '17 1999 1999 House Price Indexes (expanded data from the Federal Housing Finance Agency)

250 U.S. 200

Illinois 150

100

50 1991 1994 1997 2000 2003 2006 2009 2012 2015 The burden of mortgages has been receding

Mortgage debt as a percentage of disposable income percent 100

90

80

70

60

50

40

30 1960 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 '15 Although improving, delinquencies on mortgages remain elevated

Delinquencies on Mortgages percent of loans 90 or more days past due or in foreclosure 10 9 8 7 6 5 4 3 2 1 0 1980 '83 '86 '89 '92 '95 '98 '01 '04 '07 '10 '13 '16 Lending standards for mortgages have been easing recently

Senior Loan Officer Opinion Survey netpercentage of domestic respondents tightening mortgage loan s tandards 80

60

40

20

0

-20 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 The dollar’s exchange value peaked in 2002, before falling below earlier range and rallying

(Real Broad Trade-Weighted Exchange Value of the US$) {March 1973=100} 120

110

100

90

80 1991 1996 2001 2006 2011 2016 U.S. exports and imports decreased in 2016

3.0 Imports 2.5

2.0 Exports 1.5 trillion $ trillion 1.0

0.5

0.0 1992 1995 1998 2001 2004 2007 2010 2013 2016 Value of agricultural exports expected to slide in 2016 and rebound in 2017

160 140 2017* 120 Exports 100 80 Imports billion $ 60 40 20 Surplus 0 FY1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

(*USDA projection) Survey results for January 2017 Annual change in farmland values in Seventh Federal Reserve District

30

20

10

0 Percent -10

-20

-30 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Index of Seventh District farmland values (1981=100)

500

400 Nominal 300

200

100 Inflation Adjusted 0 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Supporting factors for farmland values?

1. Long-term stream of farm income 2. Productivity and yield trends 3. Mix of investors has broadened (more diversifiers; recreational buyers returning) 4. Off-farm income growth is important 5. Government payments are lower and insurance programs provide less protection 6. Relatively low interest rates for agriculture 7. Limited availability of farmland 8. Opportunism Index of Seventh District Cash Rents Nominal vs. Inflation Adjusted (1981=100)

300

250 Nominal 200

150

100

50 Inflation Adjusted 0 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 7th District Earnings to Price Ratio (left axis, 1981=1.0) vs. Real Return on 10 Year Treasury Bonds

Percent 1.4 10

8

1.2 E/P Ratio 6

1.0 4

10 year 2

0.8 bond rate

0

0.6 -2 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 Real farm sector assets and equity still at levels above prior peak

3,000

2,500 2017* Assets 2,000

1,500 Equity billion 2009$ 1,000

500 Debt 0 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

*USDA forecast

Index of agricultural loan demand for the Seventh Federal Reserve District (excluding real estate)

160

140

120

100

80

60

40 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 Index of agricultural loan repayment rates for the Seventh Federal Reserve District

160 140 120 100 80 60 40 20 1980 1985 1990 1995 2000 2005 2010 2015 Farm loan volume with “major” or “severe” repayment problems in Seventh Federal Reserve District (fourth quarter of year)

10

8

6

percent 4

2

0 1998 2001 2004 2007 2010 2013 2016 Real Net Farm Income

150

100

Billion 2009$ Billion 50

0

1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009 2014

7G U.S.

Interest Expenses as Share of Agricultural Value of Production (% of total) 20%

15%

10%

5%

0% 1949 1959 1969 1979 1989 1999 2009 7G U.S. Interest rates charged on new farm loans in the Seventh Federal Reserve District

20

15

Farm operating 10 percent Farm real estate 5

0 1975 1980 1985 1990 1995 2000 2005 2010 2015 The is forecast to move up

Target Federal Funds Rate percent 9 8 7 6 5 4 3 FOMC 2 1 0 1990'91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19 The Federal Funds Rate is anticipated to reach the neutral rate by the end of 2019 Summary

•The outlook is for the U.S. economy to expand at a pace around trend through 2019 •Employment growth is expected to slow with the unemployment rate edging lower •Shrinking slack in the economy will help the inflation rate gradually rise toward 2% •Growth in manufacturing sector should continue •Housing turned the corner, but still has far to go •Net exports remain a wild card given world conditions Impacts on Agriculture

•U.S. economic growth boosting demand at restaurants and for animal products •Subpar world economic growth and stronger value of the dollar holding back U.S. agricultural exports •Plentiful grain and oilseed supplies pushing down prices and feed costs for animal agriculture, but livestock prices down too •Some give on input costs but rising interest rates (still low) •Lower levels of farm income; farmland values adjusting •Strong past decade for agriculture tempers downturn www.chicagofed.org