1. The 2016 Economic Outlook for the U.S. and Issues Facing Illinois Rick Mattoon Senior Economist and Economic Advisor Federal Reserve Bank of Chicago JLL Commercial Real Estate Summit April 14, 2016

2. Themes Still struggling to get faster growth. While the U.S. economy is arguably the strongest in the world, it sure doesn’t feel that way. Latest estimates suggest U.S. GDP growth in 2016 will be around 2.0 to 2.5%. Pockets of strength and pockets of weakness…Good news for 2-handed economists. Big question is where will aggregate demand come from? Consumer, business, international, government? Need to answer this question to determine where faster growth might occur. Clashing world monetary policy…U.S. tightens (?) while much of the rest of the world is moving into QE First the good news…

3. The argument for why the economy will grow faster in 2016 Employment. Job gains have been strong (200K+)and the job mix is improving. Tighter employment is finally lifting wages. Higher wages coupled with a sustained decline in energy prices will lift household income and consumer spending. A Mastercard report found that holiday retail sales grew 7.9% vs 5.5% last year. However, December retail sales were not good even when factoring in low gas prices. Even after an essentially flat year for stocks, US household wealth is near record levels ($83 trillion). Household debt levels are down, balance sheets are better. Evidence….

4. Employment up, unemployment down to 5.0% 2016 has seen monthly net gains of 200,000+

5. Wages and salary cost increases, finally showing some life, but is the labor market all the way back?

6. Is the consumer back? Low energy prices give a $500 to $700 boost plus wage gains, car sales are up sharply and Christmas retail sales were up almost 6%

7. Labor market participation—some of the reason for 4.9% unemployment rate. Also underemployment is still high—the U-6 is 9.7%

8. The argument for why the economy will disappoint in 2016 Very weak foreign markets…both developed and emerging economies. Europe is either pushing QE or negative interest rates to spur consumption and there is still little lift. China is slowing to under 7% growth (probably even less than what is said publically) as it shifts away from a high investment/construction model to a more consumer economy. Emerging markets often dependent on commodity prices are getting hammered. Who is going to buy our stuff? Continued strong dollar makes exporting harder. Rising interest rates will cut into consumer purchases for items like cars or anything that was benefiting from cheap financing. The previously strong parts of the U.S. economy, manufacturing and agriculture are under serious pressure. Unlikely to get much lift here. Continued fiscal stress and policy uncertainty.

9. In addition to headwinds for manufacturing, all is not well on the farm

10. Manufacturing index went negative for 4 months, but turned positive in March (the future order index was up to 58.3)

11. What might tip the balance? Housing. Case-Schiller index showed some life as prices have begun to improve. Last Case-Schiller index saw prices up 5.7% (20 city composite) over previous year. However, gains are uneven…Denver, Seattle and SF up 10%, Chicago at 2.1% was the worst of the 20 city index. In aggregate, prices are still 11 to 13% below peak. Infrastructure investment. State and local governments started increasing construction toward the end of last year after sitting on the sidelines Business spending. Do they do more than just stock buy- backs, dividend increases and mergers? Does the service sector, particularly business and professional services, take up the slack from manufacturing?

12. Better Public Construction Numbers? (% change year over year)

13. The Current Forecast Last FOMC (March, 2016) central tendency projection for GDP growth in 2016 is 2.1 to 2.3%. Long-run 1.8% to 2.1%. More plodding growth in 2017 at 2.0 to 2.3% inflation is running well below target. CPI and core have seen either declines or minimal growth, although gas/food prices might cause a blip. FOMC forecast has PCE at 1.0% to 1.6% in 2016. Long-run estimate is at 2%, with 2017 projected at 1.7% to 2.0%. FOMC forecast has unemployment 4.6% to 4.8% (2016). Long- run—4.8% to 5.0% Fed policy. December was the first quarter point increase since 2008. Big issue will be the pace of potential future increases to get to “normalization” (3 to 3.5%). Inflation rising to 2% was a significant justification in the statement. Latest meeting suggests slower pace of rate hikes in 2016 than originally projected. 13

14. Turning to Illinois State has had a slow recovery…underperformed both US and the Midwest. Recent evidence shows a shift in growth. Chicago and the metro area has accelerated while downstate is slumping. The big story is still fiscal conditions. Both Illinois and Chicago have been running structural budget deficits since before the Great Recession. The recession only exposed the depth of the problem. Common to both has been borrowing from the future to pay for current services. Mostly this has come in the form of underfunding pension liabilities. This has not gone unnoticed. Illinois and Chicago bond ratings are rock bottom. Both governments have to pay a significant premium to issue debt. Moody’s has lowered Chicago to Ba1 in May which represents junk status. Soon after CPS status was also reduced.

15. Employment growth by MSA (11/2015 to 11/2016 IGPA) MSAGrowth RateNumber of jobs Sector with highest growth rate Sector with lowest growth rate Bloomington- Normal 0.17 to 0.22160 to 210GOV (3.85%)Information (-14.02%) Champaign/ Urbana 0.51 to 0.59600 to 650Education (3.09%)Leisure (-1.33%) Chicago1.51 to 1.6260,600 to 65,000Construct (4.21%)Manuf ( -1.37%) Davenport/ Rock Island 0.00 to 0.640 to 1,200Leisure (1.65%)Information (-4.19) Decatur-1.61 to -1.08-800 to -500Prof/bus (1.41%)Information (-7.01%) Kankakee-0.28-to 0.48%-100 to 100Construct (2.58%)Leisure (-1.92%) Peoria0.12%-0.32%200 to 600Transport, trade, utilities (2.21%) Leisure (-5.50%) Rockford-0.11 to 0.26-200 to 400Education (2.78%)Construct (-6.67%) Springfield-0.25 to -0.10%-300 to -100Education (2.33%)Information (- 10.69%)

16. Illinois Job Recovery By Sector (University of Illinois, IGPA, Illinois Economic Review) Job changes during the recession (12/2007-12/2009) Job changes 1/2010 to 12/2015 Recovery rateForecasted job changes 1/2010 to 12/2016 Forecasted recovery rate Construction-63,80011,10017.4014,40022.57 Manufacturing-114,60012,20010.6510,6009.25 Trade, transportation and utilities -97,70049,70050.8717,00017.40 Information-11,300-8,700-76.99-13,200-116.81 Financial-33,0004,20012.733,30010.00 Professional and business services -92,200148,200160.74134,900146.31 Education and Health 32,60078,400--91,400-- Leisure, hospitality -22,30051,200229.6055,000249.33 Other service-5,900-1,700-28.81-1,900-32.20 Government6,000-25,700---30,000--

17. Illinois Fiscal Climate Illinois Fiscal Climate On paper, Illinois has not been a particularly high tax state. Measures of taxes to GDP are better than most of our neighboring states However, keep rates down has come at a cost. Illinois borrows from the future to keep rates low and services available. 2 big issues—uncertainty and paying for services already consumed Issue for all municipalities is contagion. Credit agencies are worried about the level of future state transfers and shifting costs to local governments.

18. Average tax rates by neighboring states—all were within.5 % pt. of U.S. average except Wisconsin 18

19. How big is the gap? U of I Fiscal Futures project o Estimates all funds spending and revenues o Forecasts future absent any policy changes

20. Illinois ran deficits since 2000 “Legacy Costs” in their projections: Liability = $159 billion 20

21. Impact of adjusting taxes to close the gap Scenario 1, current law: Filling the annual budget gap with new tax revenue 21

22. Scenario 2: Additional taxes to meet “recognized” unfunded obligations on a 30–year basis 22

23. Can Illinois be fixed? Issue 1—we are not a fast growth state. Demographics are against us so we won’t grow our way out of the problem. Issue 2—adjustment will take many years. We need a multi-year plan and it needs to be binding. Issue 3—expenditures and revenue changes are likely necessary, but they should be done in the context of what is economically the least disruptive. Issue 4—who pays? Revenue hills, capacity vs willingness. How to prevent this from happening? Better fiscal rules including all funds reporting, multi-year budgeting, identifying one-time revenues, adequate reserves. Move to more rules based approach.