1. The Economic Outlook for 2012 Presentation to the Financial Executives Network Group St. Louis, Missouri Kevin L. Kliesen Federal Reserve Bank of St. Louis March 14, 2012 Not an official document

2. The Big Picture Current Conditions: Steadily Improving Economic and Financial Conditions An Update on Economic Conditions in St. Louis and Missouri Outline of Today’s Talk

3. The views I will express are my own and do not necessarily reflect the positions of the Federal Reserve Bank of St. Louis or the Federal Reserve System. Disclaimer

4. The Big Picture The economy is improving and the unemployment rate has receded faster than expected; 2012 should be better than 2011. Threats to the economy and financial markets have receded noticeably over the past six months, although a further rise in oil prices could be damaging. Headline inflation has eased of late, but rising energy prices and strengthening economy could reverse that trend. The St. Louis economy generally appears weaker than the nation’s.

5. A deep recession, followed by an uneven recovery, and then a steady, slow return to “trend growth.” 5 The consensus forecast calls for weaker growth during the first half of 2012 with slightly faster growth during the second half.

6. Global financial strains pose a “significant downside risk.” As a result, uncertainty and volatility remain high. Negative wealth effects (mainly housing). Consumer and business confidence remains tepid. Few worries about accelerating inflation. Additional Fed actions may be needed. 6 One Narrative: The Worrywarts

7. Dynamic economies have strong self-corrective mechanisms. The recovery was derailed last year by bad luck and policies that elevated uncertainty among businesses. The former have, by and large, disappeared. The effects on the U.S. economy from Europe’s recession are likely less debilitating than many expect. Momentum swing... Strengthening economy, improving labor markets, and a modest housing upturn (yes, you read that right!). 7 An Alternative View

8. As the economy gathers steam, uncertainty begins to wane, consumer and business confidence builds. Corporate balance sheets are in excellent shape; firms begin to put cash to work. Money and credit growth accelerating. Supporting evidence: Global stock markets roar ahead thus far in 2012 and measures of financial market stress ebb. Under this scenario, inflation pressures could begin to build unless policymakers “normalize” policy quicker than most people expect. 8 An Alternative View

9. The nation’s unemployment rate remains stubbornly high—but we’re making progress. 9 In Feb. 2012, the unemployment rate was 8.3%.

10. Continued good news in the labor markets in Feb. 10 Over the past 6 months, private job gains have averaged 215,000 per month. Key Threshold Start of recession

11. Following a fourth-quarter lull, business capital spending is expected to be strong this year and next. 11

12. Homebuilder sentiment is improving at a healthy clip. Inventories of new homes at record lows. 12

13. Housing affordability is at a record high. 13

14. The end of the road for house price declines? 14

15. Forecasters expect housing construction to continue to increase this year and in 2013. 15 However, we are still far below the 2006 peak—and likely to remain so for several more years.

16. Financial Stresses on a Rollercoaster... But Returning to Normal The St. Louis Financial Stress Index is a barometer of U.S. and global financial markets. An index level of zero is “normal.”

17. Money and C&I loans are growing at a decent clip, consumer credit growth moderately less so. 17

18. Threats? 1. Rising energy prices 2. Slowing productivity growth

19. Rising energy prices: A looming threat? Oil and gasoline prices are up about 18% year- to-date

20. Rising Oil Prices: A Looming Threat? Higher oil prices increase inflation (actual and expected) and act as a tax on consumers and businesses. Research finding: Large increases in oil prices increase the probability of a recession. A mitigating factor: mild winter, natural gas prices are low

21. A permanent slowing in labor productivity growth would be exceedingly worrisome

22. Inflation remains uncomfortably high

23. But inflation expectations, while volatile, suggest consumers and financial markets remain sanguine.

24. Current Conditions: The St. Louis and Missouri Economy

25. On net, states and local governments continue to trim payrolls from year-earlier levels. 25 State and local payrolls tend to lag the private sector. Governments tend to respond to changes in tax receipts.

26. Missouri’s unemployment rate is trending below the nation’s; Illinois’ rate is still well above the nation’s. 26

27. St. Louis’ unemployment rate is about equal to the nation’s; still above K.C.’s rate, though. 27 Chicago’s unemployment rate than St. Louis’ or Kansas City’s rate. St. Louis

28. St. Louis’ unemployment rate is well above other key Missouri cities 28 The trend is in the right direction. Faster-growing areas of the state have much lower unemployment rates. St. Louis Columbia

29. Weak labor force growth in St. Louis explains much of its weaker job growth. 29 To achieve faster growth, state and local policymakers need to focus on the fundamentals.

30. How cities (or countries) grow and prosper: An economist’s perspective – One model is to use natural resource endowments; however, that rarely works for the long-run. – The most successful entities rely on a well educated work- force, cutting edge technologies, and growth-oriented public policies. – Inevitably, this means top-notch primary and secondary education systems and research universities. – The goal is to adapt to a rapidly changing global economy. – Since many firms start small, access to venture capital and policies that encourage start-ups are also key. 30

31. Where will the jobs of the future come from? 31

32. Questions? 32

33. To receive a copy of my slides, please e-mail me at: kliesen@stls.frb.org 33