Is OPEC Losing Its Ability to Influence Oil Prices?

From The St. Louis Fed On The Economy Blog.

The Organization for Petroleum Exporting Countries (OPEC) has exerted a great deal of control over world-wide oil production and prices since 1960.1 The figure below shows the percentage of oil production by country for 2015.


OPEC member nations made up 42 percent of world oil production, giving their production announcements significant weight. Historically, announcements from OPEC regarding future decreases in production have been accompanied by increases in prices.2

OPEC and Russia Agree to Cut Production

Late in 2016, OPEC and Russia agreed to cut production from 33.24 million barrels per day to between 32.5 and 33 million barrels per day in an effort to increase the price of oil. Prices had fallen from around $105 per barrel in June 2014 to around $30 per barrel in early 2016.

World oil production, on the other hand, increased 3.1 percent from 2014 to 2015. This increase is large in historical context; oil production has increased 1 percent on average per year since 1980.

Oil Prices

The next figure shows the time series of the price of oil measured by the spot price for West Texas Intermediate (WTI) over the past three years. The red lines indicate the timings of the announcement of the production reduction (Sept. 28) and the OPEC meeting to finalize this agreement (Nov. 30).

While prices have risen slightly since the announcement, neither of these events was accompanied by large spikes in oil prices.

Is OPEC Losing Its Impact on Prices?

So, why have oil prices not increased substantially? A combination of factors may have contributed (albeit not equally) to dampening the effect of the announcement.

First, oil inventories have accumulated over the past few years, and these accumulated inventories are preventing oil prices from rising quickly. Inventories dampen the effects of sudden changes in oil supply or demand.

When OPEC cuts production, supply is reduced, and Organization for Economic Cooperation and Development countries draw on their oil inventories to supplement the reduced production. The market price reaction to the production cut is delayed until the inventories are depleted. However, once inventories are drawn down, prices can be expected to rise.

Second, while OPEC members represent a large portion of oil production, a number of other countries—including the U.S.—account for 58 percent of the oil production and are not part of the OPEC agreement to reduce production.

U.S. Oil Production

The U.S., in particular, is projected to increase its production, especially if the price of oil experiences a sustained rise to more than $55 per barrel. In fact, prices above $35 per barrel are high enough to put some rigs into production.3

As prices increased through the summer of 2016, U.S. oil production rose, with the bulk of this increase coming from rigs in the Gulf of Mexico. The increase in production did not originate from the shale oil fields, suggesting that as prices rise, U.S. oil production can further increase.

In fact, U.S. oil production has increased to the point in which the U.S. has become an exporter. The figure below shows monthly U.S. oil exports.


Banning U.S. Oil Exports

Before 2015, the export of crude oil was banned in the U.S. The ban was a part of the Energy Policy and Conservation Act of 1975, and was meant to lessen the nation’s dependence on OPEC and foreign producers.

During the ban, the U.S. Department of Commerce could issue special licenses to allow certain producers to export specific types of crude oil, keeping exports just above zero. When technological advances increased the amount of oil production in the U.S., U.S. WTI prices started falling below global Brent oil prices. This gap motivated domestic producers to push back against the export ban, and Congress repealed it in December 2015.

Before the repeal, former President Barack Obama had already begun issuing more special licenses to export. Oil exports increased dramatically, from around 400,000 barrels per day at the end of 2015 to almost 700,000 in September 2016.

As the OPEC production restrictions take hold and global inventories are drawn down, the price of oil is expected to rise. This increase, however, may be gradual and prolonged, especially with non-OPEC countries having the ability to ramp up production.

Notes and References

1 OPEC currently has 13 member countries: Algeria, Iran, Iraq, Venezuela, Saudi Arabia, Kuwait, Nigeria, Qatar, the United Arab Emirates, Ecuador, Gabon, Libya and Angola. Indonesia suspended its membership late last year.

2 Lin, Sharon Xiaowen; and Tamvakis, Michael. “OPEC Announcements and Their Effects on Crude Oil Prices,” Energy Policy, February 2010, Vol. 38, Issue 2, pp. 1010-16.

3 Mlada, Sona. “North American Shale Breakeven Prices: What to Expect from 2017?” Rystad Energy, Feb. 16, 2017.

By Michael Owyang, Assistant Vice President, and Hannah G. Shell, Senior Research Associate

Fed Embarks on New Phase of Normalization

The US Federal Reserve’s (the Fed) decision to hike interest rates by 25bps represents the beginning of a new phase of US monetary policy normalization, says Fitch Ratings.

The prediction for three hikes in 2017 in the Federal Open Market Committee’s (FOMC) December 2016 Summary of Economic Projections was initially met with some skepticism in financial markets. However, by moving rates up again so quickly, the Fed now looks well on track to deliver. Two rate hikes within the space of just over three months and some marginal toughening up of the statement on forward guidance underscore the contrast with the glacial and hesitant approach to unwinding stimulus seen in the past few years. More broadly, Fitch believes that the recent US rate hikes could mark the beginning of a significant shift in the global interest rate environment, with benchmark US policy rates settling higher over the long term than current market expectations.

The decision to raise the Fed Funds target rate to 0.75%-1.00% marks the second rate hike in just over three months. This represents a major acceleration in Fed action. Fitch now expects a total of seven hikes in 2017 and 2018, bringing the policy rate to 2.50%. This contrasts with just two rate hikes in total between the end of 2008 and 2016.

Macro indicators through 2H16 and early 2017 reinforce the likelihood of a pickup in rate normalization over the medium term. GDP growth of 2.6% (annualized) in 2H16 was a significant recovery from 1H16, underpinned by improvements in private investment and industrial output. So far, jobs data this year have also been supportive, with the latest nonfarm payrolls, unemployment and private sector earnings figures all pointing to tightening labor market conditions.

Material fiscal easing should bolster positive domestic demand trends. President Trump’s agenda of tax cuts, fiscal stimulus and deregulation in the financial services and other sectors strongly indicates that some level of growth boost is likely. Although the precise form of stimulus remains uncertain, Fitch believes that fiscal policy could add up to 0.3pp to economic growth in both 2017 and 2018. Fitch recently revised up its US growth expectations in recognition of the increased likelihood of fiscal easing, higher private investment and improving global outlook. Fitch forecasts US GDP growth to accelerate to 2.3% and 2.6% in 2017 and 2018, respectively.

Fitch does not believe that the increased pace of Fed rate hikes poses a risk to US economic growth. However, the impact from dollar strengthening could have wider global effects, especially should this result in prolonged monetary policy divergence. US rate rises, combined with fiscal stimulus, at a time when the European Central Bank and Bank of Japan are continuing to pursue ultra-loose monetary policy, should prolong the dollar strengthening trend. Rising rates and dollar strength have historically added to external financing risks for emerging markets.

Fitch believes that market expectations for a permanently lower equilibrium interest rate in the US and the continuation of ultra-loose monetary policy for several more years could be increasingly challenged. This could result in a rapid shift in consensus expectations toward a higher terminal rate and a faster pace of normalization. Notably, market consensus was not expecting a March rate hike as early as last month, although healthy macro data releases and hawkish public statements from FOMC members resulted in a quick shift in expectations ahead of the actual decision.

Rising interest rates in 2017 and 2018 will not be a broad concern for US corporates in aggregate, but pockets of risk could challenge entities at the lower end of the rating spectrum, according to Fitch Ratings.

With current LIBOR levels at or above most pricing floors – USD 3M LIBOR was 1.11% as of March 8 – subsequent rate hikes would expose leveraged loan issuers to reset risk that could pressure credit profiles and cash flow generation. This risk is most acute for deeply speculative-grade credits with large amounts of floating rate debt, already large interest burdens, and limited to negative FCF.

Near-term interest rate risk is most evident for leveraged issuers who took advantage of longstanding favorable market conditions to issue large amounts of floating-rate debt, but whose credit profiles deteriorated due to secular challenges or idiosyncratic issues that resulted in higher leverage, depressed cash flows and limited liquidity.

Retail companies, for example, with high floating-rate debt exposure could be particularly exposed to interest rate risk if secular challenges offset the benefits of an accelerating economy on top-line growth.

From a credit profile perspective, we are less concerned about exposure to fixed-rate high-yield (HY) bonds. Historically, HY spreads do not increase meaningfully until after the Fed has concluded its tightening cycle. As a result, modest policy rate increases may not be accompanied by corresponding increases in spreads.

Interest rates typically rise in response to higher inflation, usually during economic recoveries, implying generally improving credit profiles. Fitch’s Stable Outlook for US Corporates in 2017 supports this view.

Moreover, companies have been proactive in managing maturity profiles. US corporates have aggressively refinanced during nearly a decade of low interest rates, pushing out maturities with long-dated, low-coupon debt to maintain historically strong interest coverage metrics and solid liquidity profiles. We expect fundamentals to remain stable as expectations of growth in cash flow are fueled by persistent cost controls, efficiencies, and revenue growth, albeit weak.

The Trump administration’s tax proposal to cut the corporate tax rate to 15% and eliminate the tax-deductibility of interest expenses adds another layer of risk. Negative cash flow impact from the removal of interest expense deductibility may outweigh the positive cash flow impact from the corporate tax cut for issuers with high debt burdens and debt costs

The US is healing but we can’t even admit we’re ill

From The NewDaily.

The Federal Reserve’s widely anticipated rate rise is a reminder that while the US has learned from its housing market crash, our political leaders have created a record bubble of mortgage debt by shying away from reform.

When Fed chair Janet Yellen announced Thursday morning (Australian time) the fed-funds rate had risen to a new target range of 0.75 to 1 per cent, it caused barely a stir in markets. The New York Stock Exchange rose 0.8 per cent, as the Fed signalled future rate rises are likely to arrive sooner than previously expected.

These days the Fed telegraphs each move so effectively that markets no longer ask ‘will they move or not?’, but more ‘does that move reflect what’s really happening in the economy?’

Yes, with its years of super low rates, the Fed did set the scene for the 2009 housing collapse that hit global markets like a tsunami. But its three rate rises since the GFC have been spot on – late enough to avoid choking the recovery, but early enough to prevent inflation getting out of hand.

At a press conference Ms Yellen said the Fed is pushing rates back towards “normal” levels because the US economy has returned to reasonable health – growing at a “moderate pace”.

Meanwhile, Australia’s rates remain at historic lows. So what are we doing wrong?

The biggest reason we’re not seeing US-style growth is, gallingly, entirely self-imposed. Our political leaders have skewed the economy heavily towards real estate investing.

The vast sums of capital tied up in housing could be establishing new businesses, or backing the expansion of existing ones. Instead, we’re a nation hypnotised by capital gains that thinks buying and selling the same houses back and forth is a productive industry.

It all began in 1999, when treasurer Peter Costello cut capital gains tax to a rate well below the personal tax rates of middle- and upper-middle class Australians. It was one of the most economically harmful policies ever dreamt up in Canberra.

It did not take the nation’s accountants long to point out to clients that investing in a property, negatively gearing it for a few years, and then banking the capital gain at the new rate would slash the investor’s tax bills.

During the same period, the US was experiencing a credit bubble for different reasons – super low rates, plus the advent of sub-prime mortgages.

When the early ‘sub-prime’ phase of the GFC finally began to be felt, US house prices tumbled. And when the sub-prime crisis worked its way through the banking system, global stock markets crashed too.

Whereas the US learned from this and started rebuilding, we arrested our correction and did everything possible to keep the credit bubble growing.

As the share market tanked in 2009, Australian policy makers decided that the sacred cow of house prices must be protected at all costs. The 2009 first home buyer’s grant kickstarted that defence, and was topped up by most state governments too.

Even though the Rudd government’s own tax review – the Henry Tax Review – had recommended reining in negative gearing and the capital gains tax discount, all that was ignored.

The tax lurks stayed, gleefully maintained by the Abbott and Turnbull governments, and the RBA joined in by cutting interest rates that blew the credit bubble larger still.

The lack of action by politicians has pushed responsibility for reining in the bubble to the Australian Prudential Regulatory Authority, which imposed a fairly weak ‘speed limit’ on credit growth two years ago.

And now the RBA itself is threatening to put more “sand in the gears” of the credit machine.

It’s all too little, too late.

Australia, having ‘escaped’ the house price collapse that swept through so many nations in 2009, is now stuck in a self-imposed debt bubble.

Fed Lifts Rates Again

No surprise that the Fed lifted the Federal Fund Rate to 3/4 to 1 percent, it had been so well telegraphed. They point to ongoing accommodative financial conditions and the statement is quite dovish actually, so the rate of continued adjustment will be slow, and they have not rolled into the forecasts any upside from Trump’s policies.

The knock on effect will be significant, with further rises in the international capital market interest rates likely in response. The benchmark T10 bond yield is higher, once again but the market had already locked in the expected rise. The US dollar dropped.

The DOW was up after the news.

The AU Dollar was up, unexpectedly.

The Fed move will likely have a flow on effect to the Australian banks international funding costs (30-40% of the majors funds comes from this source), so expect continues upward pressure on mortgage rates here.

So far owner occupiers have seen out of cycle rates rises in the 20-30 basis point range, whilst investors have seen larger moves, up 50-60 basis points for variable loans. There is more to come.

Information received since the Federal Open Market Committee met in February indicates that the labor market has continued to strengthen and that economic activity has continued to expand at a moderate pace. Job gains remained solid and the unemployment rate was little changed in recent months. Household spending has continued to rise moderately while business fixed investment appears to have firmed somewhat. Inflation has increased in recent quarters, moving close to the Committee’s 2 percent longer-run objective; excluding energy and food prices, inflation was little changed and continued to run somewhat below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, labor market conditions will strengthen somewhat further, and inflation will stabilize around 2 percent over the medium term. Near-term risks to the economic outlook appear roughly balanced. The Committee continues to closely monitor inflation indicators and global economic and financial developments.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 3/4 to 1 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; Jerome H. Powell; and Daniel K. Tarullo. Voting against the action was Neel Kashkari, who preferred at this meeting to maintain the existing target range for the federal funds rate.

How Tourism Affects China’s Current Account Surplus

From The St. Louis Fed Economic Synopsis.

China has been running a current account surplus since 2000, which has been a policy issue regarding exchange rates and currency manipulation. A current account surplus means that China has been a net lender to the rest of the world. China’s current account surplus reached 10 percent of gross domestic product (GDP) in 2007 and then started to decline until 2011, when it fell to 1.8 percent of GDP. The current account surplus has been stable since then, with a slight tendency to increase in more recent years. In particular, in 2015, the current account was around 3 percent of China’s GDP, but it has not returned to the high levels reached in 2007. What are the main factors behind the decline?

The current account is composed of three main categories: (i) the trade balance (net earnings on exports of goods and services minus payments on imports of goods and services); (ii) the net income to foreign factors (compensation of employees, investment income); (iii) and transfers.

In China’s case, the main component behind the current account trend is a decline in its trade surplus. A trade surplus indicates that China has been earning more on its exported goods and services than it has been paying for its imports (i.e., it has had positive net exports). As Figure 1 shows, net exports in China, as a percentage of GDP, closely track the current account and have been declining since 2007. Indeed, the trade surplus was around 9 percent of GDP in 2007 and fell to 3.5 percent of GDP in 2015. This decline has been driven by both a decline in the surplus of traded goods and an increase in the deficit of traded services (Figure 2). However, the goods surplus has picked up again since 2011, while the services deficit has become more pronounced. Interestingly, trade in services was roughly balanced between 2000 and 2007 and later became a deficit, reaching around –1.7 percent of GDP by 2015. Thus, even though the value of China’s exported goods has exceeded the costs of its imports, China has been importing more services than it has been exporting. Even more interesting is the fact that the increase in China’s services deficit has prevented its current account surplus from rising despite the increased trade surplus in goods.

Figure 3 shows the main categories of China’s international trade in services. One category stands out: travel services, which includes mainly tourism. China’s increasing services deficit has been driven mainly by overseas tourism- related consumption. According to a recent report, two population groups in China have been driving tourism: Millennials (young people 15 to 35 years of age) and a growing middle class. The report indicates two primary reasons for increased tourism by these two groups. On the one hand, young people travel for exposure to overseas experiences. On the other hand, Chinese travel for shopping, which accounted for 30 percent of overseas Chinese spending in 2015. The prime shopping destination currently is Hong Kong, but new destinations such as Japan, Korea, and Europe are expected to become increasingly popular.

Overall, the increasing trade deficit in services, spurred mainly by the rise in tourism, seems to be an important factor in the recent trend in China’s current account. As a result, the current account surplus is increasing only slightly despite a larger increase in net exported goods in recent years. What factors could change this trend? Fluctuations in exchange rates in the main destinations for Chinese tourists could affect tourism. For instance, a depreciation of the yuan could slow the increase in the travel services deficit while concurrently increasing the earnings in exports of goods—all of which could generate a larger current account surplus.

Aging and Wealth Inequality

Interesting piece from the St. Louis Federal Reserve looking at the connection between age and wealth and its implications for aging and wealth inequality.

An individual’s wealth varies with age. Most people are born with little to no financial wealth and, as they age, they save part of their income to accumulate wealth or sometimes borrow to finance education, which creates debt. Once people reach retirement, they stop accumulating wealth and start spending down their savings. Thus, the richest people can often be found among those who are about to retire.

Age is not the only determinant of wealth. People’s wealth varies with how much they are given by their parents, their income, and their decisions on how much to consume or save and how to invest their wealth.

In this essay, however, we focus on the connection between age and wealth and its implications for aging and wealth inequality. The issue is salient because the U.S. population is aging and inequality is a frequent concern. Today, less than 15 percent of the overall population is 65 years of age or older, and that share is projected to rise above 30 percent by 2030. Is this going to exacerbate or mitigate wealth inequality in the United States?

The figure shows wealth per capita (black line) by age group in 2010. As indicated earlier, the richest people tend to be 65 to 74 years of age. The figure also shows the fraction of wealth (dashed line) held by households, ranked by the age of the head of household. A key message is that age is a significant source of inequality: The largest and youngest groups hold the least wealth—those under 35 years of age (blue line) represent over 25 percent of the population but hold only about 5 percent of total wealth. If the dashed and blue lines overlapped, each group’s share of the population and share of wealth would be the same and age would not contribute to wealth inequality. In this case, the black line would be flat: Each individual would hold the same amount of wealth, regardless of age.

One can examine the effect of the age distribution using a standard measure of wealth inequality: the Gini index (sometimes called the Gini coefficient), which varies from 0 to 1. A value of 0 indicates no inequality—everyone holds the same wealth. A positive Gini index indicates some inequality. If one individual held all the wealth—maximal inequality—the Gini index would equal 1. In the United States, for example, the richest 1 percent of the population holds 42 percent of total wealth.1 As the figure shows, the age group with the highest share of wealth—those 55 to 64 years of age—holds almost 31 percent of the wealth but represents only about 16 percent of the population. The Gini coefficient implied by the figure is 0.385.2 Because this Gini coefficient measures only the dispersion of wealth by age group, it omits additional sources of wealth inequality and therefore understates the true Gini coefficient for the United States.

A simple example helps illustrate that wealth inequality by age contributes to overall wealth inequality: Consider an economy, as shown in the table, with 100 people. Each young person holds $1 of wealth, while each old person holds $10 of wealth (top panel). The population shares of young and old are 80 percent and 20 percent, respectively. Note that this panel represents, in a stylized way, the features of the U.S. economy displayed in the figure: There are many more young people than old people, but the old hold more wealth than the young. The total wealth of this economy is $280, where the young collectively hold $80 and the old collectively hold $200. The young’s share of total wealth is (80/280) = 29 percent, which is noticeably less than their 80 percent share of the population. The Gini coefficient associated with this distribution of wealth is 0.51.

Suppose now that the economy ages and there are 50 old people and 50 young people (bottom panel). Because older people have more money, total wealth in the economy rises from $280 to $550. If each young person still holds $1 of wealth, their share of total wealth becomes (50/550) = 9 percent instead of 29 percent—a decline of 20 percentage points. But their share in the population decreased by 30 percentage points, from 80 percent to 50 percent, so the Gini coefficient declines from 0.51 to 0.41.

So the aging of the population, per se, is a factor that can reduce wealth inequality. This example, however, must be interpreted with caution. It does not imply that the forecasted aging of the U.S. population will be accompanied by a reduction in wealth inequality. As mentioned in the introduction, the calculation presented here abstracts from other forms of inequality not related to age. It is conceivable that these other forms of inequality may increase as the population becomes older and offset the effects described here.

US Financial Accounts 4Q 2016 Shows Household Debt Higher

The Fed released the US Accounts to Dec 2016.  It shows growth in household debt, but a lowering of business investment and government debt down from the 2008 highs.

Domestic nonfinancial debt outstanding was $47.3 trillion at the end of the fourth quarter of 2016, of which household debt was $14.8 trillion, nonfinancial business debt was $13.5 trillion, and total government
debt was $19.1 trillion.

Domestic nonfinancial debt growth was 2.9 percent at a seasonally adjusted annual rate in the fourth quarter of 2016, down from an annual rate of 5.8 percent in the previous quarter.

Household debt increased at an annual rate of 3.8 percent in the fourth quarter of 2016. Consumer credit grew 6.2 percent, while mortgage debt (excluding charge-offs) grew 3.1 percent at an annual rate. Percentage changes calculated as seasonally adjusted flow divided by previous quarter’s seasonally adjusted level, shown at an annual rate

Nonfinancial business debt rose at an annual rate of 2.6 percent in the fourth quarter, down from an annual rate of 6.3 percent in the previous quarter.

Federal government debt increased 2.9 percent at a seasonally adjusted annual rate in the fourth quarter of 2016, down from an annual growth rate of 8.2 percent in the previous quarter.

State and local government debt rose at an annual rate of 0.2 percent in the fourth quarter of 2016, down from an annual growth rate of 0.7 percent in the previous quarter.

The net worth of households and nonprofits rose to $92.8 trillion during the fourth quarter of 2016. The value of directly and indirectly held corporate equities increased $728 billion and the value of real estate rose
$557 billion.



U.S., European Economies and the Great Recession

From The St. Louis Fed Blog.

As the U.S. economy has gotten stronger, labor markets across the country have improved substantially, albeit slowly, from the shocks they suffered during the Great Recession. Here, we highlight the unemployment rate dynamics in the U.S. and across Europe during and after the Great Recession and global financial crisis.

As the figure below shows, the U.S. unemployment rate increased rapidly in 2008 and 2009.

Unemployment Rates

The U.S. unemployment rate rose from 5 percent in January 2008 to its peak of 10 percent in October 2009, with the year-over-year changes being at least 3 percentage points for 10 consecutive months. Since then, however, the unemployment rate has declined at a mostly consistent average year-over-year pace of 0.6 percentage points, reaching 4.7 percent in December 2016.

The experiences of the United Kingdom and Germany were somewhat similar, with a quick uptick and a prolonged decline in the unemployment rate. It is important to note that Germany’s unemployment rate had already been declining from a prior peak in the early 2000s, and the U.K.’s hovered around 8 percent for about four years before it started declining.

But the experience for countries in Europe’s periphery, like Spain and Italy, was quite different. Spain and Italy both had a second prolonged rise in the unemployment rate well after the financial crisis, as their economies struggled to recover. This is highlighted in the figure below, where the real GDP growth in both of these countries quickly slowed and dipped back into negative territory for a second time in 2011, and this time for a much longer period.

Real GDP Growth

The final figure below shows how Italy’s economy has struggled to grow back to its pre-recession level, explaining why its unemployment rate has remained elevated for several years.

real gdp indexed

On the other hand, Spain’s economy has just recently reached its pre-recession level, and it has grown at an average pace of 3.2 percent over the past two years. Spain’s recent growth has had a positive impact on its unemployment rate, which declined at an average year-over-year pace of 2.4 percentage points in 2015 and 2016.

Finally, the U.S., the U.K. and the German economies have grown and surpassed their pre-recession levels, pointing to why their unemployment rates have declined considerably

The Impact of the Dodd-Frank Act

From The St.Louis Fed Blog.

One of the outcomes of the 2008 financial crisis was recognizing the cascading effects that the severe financial stress or failure of a large institution can have on financial markets and the economy at large. A primary goal, therefore, of post-crisis financial reform was heightened supervision and regulation of those institutions whose sheer size or risk-taking posed the greatest threat to financial stability.

These reforms were primarily codified in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Under the Dodd-Frank Act, US financial institutions with $50 billion or more in assets are subject to enhanced prudential regulatory standards. These standards are designed to accomplish two primary objectives:

  • Improve an institution’s resiliency to both decrease its probability of failure and increase its ability to carry out the core functions of banking
  • Reduce the effects of a bank’s failure or material weakness on the financial system and the economy at large

To meet these objectives, the Federal Reserve employs a number of tools to monitor institutions and reduce the risks they pose to the U.S. financial system.

Capital Stress Testing

The Fed annually assesses all bank holding companies with more than $50 billion in assets to ensure they have sufficient capital to weather economic and financial stress. This exercise, called the Comprehensive Capital Analysis and Review (CCAR), also allows the Fed to look at the impact of various financial scenarios across firms.

If the Fed determines that an institution cannot maintain minimum regulatory capital ratios under two sets of adverse economic scenarios, the institution may not make any capital distributions such as dividend payments and stock repurchases without permission.

A complementary exercise to CCAR is Dodd-Frank Act stress testing (DFAST). The DFAST exercise is conducted by the financial firm and reviewed by the Fed. It aids the Fed in assessing whether institutions have sufficient capital to absorb losses and support operations during adverse economic scenarios. This forecasting exercise applies to banks and bank holding companies with more than $10 billion in consolidated assets.

Liquidity Stress Testing

The financial crisis made it clear that a firm’s liquidity, or ability to convert assets to cash, is important during periods of financial stress. In response, the Fed launched the Comprehensive Liquidity Assessment and Review (CLAR) in 2012 for the country’s largest financial firms.

CLAR allows the Fed to assess the adequacy of the liquidity positions of the firms relative to their unique risks and to test the reliability of these firms’ approaches to managing liquidity risk.

Resolution and Recovery Plans

Banking organizations with total consolidated assets of $50 billion or more are also required to submit resolution plans to the Fed and the Federal Deposit Insurance Corp. Each plan must describe the organization’s strategy for rapid and orderly resolution in the event of material financial distress or failure.

Have these tools made a difference? The answer is clearly “yes,” as shown in the figure below.

Capital Ratios

The capital ratios of the country’s largest firms (those with more than $250 billion in assets) have shown solid positive progress. In fact, one important measure of capital strength for this group of institutions, the average Tier 1 risk-based capital ratio, has increased 48.1 percent since 2007.

Some in the industry and in Washington, D.C., are calling for a re-evaluation of the Dodd-Frank Act provisions. While modifications for smaller, non-systemic firms would be welcomed by many, the damage from the financial crisis makes it sensible to continue strong expectations for the largest firms.

Why Does Economic Growth Keep Slowing Down?

From The St. Louis Fed Blog.

The U.S. economy expanded by 1.6 percent in 2016, as measured by real gross domestic product (GDP). Real GDP has averaged 2.1 percent growth per year since the end of the last recession, which is significantly smaller than the average over the postwar period (about 3 percent per year).

These lower growth rates could in part be explained by a slowdown in productivity growth and a decline in factor utilization.1 However, demographic factors and attitudes toward the labor market may also have played significant roles.

The figure below shows a measure of long-run trends in economic activity. It displays the average annual growth rate over the preceding 40 quarters (10 years) for the period 1955 through 2016. (Hence, the first observation in the graph is the first quarter of 1965, and the last is the fourth quarter of 2016.)

Real GDP

Long-run growth rates were high until the mid-1970s. Then, they quickly declined and leveled off at around 3 percent per year for the following three decades.

In the second half of the 2000s, around the last recession, growth contracted again sharply and has been declining ever since. The 10-year average growth rate as of the fourth quarter of 2016 was only 1.3 percent per year.

Total output grows because the economy is more productive and capital is accumulated, but also because the population increases over time. The next figure compares long-run growth rates of real GDP and real GDP per capita. Both series display similar behavior.


Although population growth has been slowing, the effect is not big enough to change the qualitative results described above.

The third figure adds long-run growth rates of real GDP divided by the labor force.2 Dividing by the labor force instead of the total population accounts for the effects of changing demographics and labor market attachment.


From the 1970s until the 2000s, long-run growth rates of real GDP divided by the labor force remained well below those of real GDP per capita. There are two main factors that explain this:

  • Lower fertility and longer lifespans steadily increased the potential labor force relative to the total population.
  • Labor force participation increased significantly from the 1960s until 2000, largely driven by increased female labor force participation.

When accounting for both of these factors, economic activity from 1975 to 1985 looks more depressed than in the two decades that followed. This seems consistent with the negative effects that the 1970s oil shocks and efforts to reduce inflation in the early 1980s3 had on the economy.

The trend in labor force participation reversed in 2000, as participation rates have been steadily decreasing since then. This explains why real GDP divided by labor force growth rates are now higher than real GDP per capita growth rates.

Having accounted for the long-term effects of changes in demographics and labor market attitudes, we can now look at the effects of productivity growth and factor utilization. The final figure compares long-run growth rates in real GDP divided by the labor force with long-run growth rates in total factor productivity and long-run averages of capacity utilization (i.e., the actual use of installed capital relative to potential use).4 Note that data for capacity utilization are only available since 1967.


The poor long-run performance of 1975-1985 can be attributed to low productivity growth and a decline in capacity utilization. Afterwards, long-run growth rates in output started to pick up, first associated with an increase in capacity utilization and then with increased productivity growth.

The current path of decline in output growth follows from both a slowdown in productivity growth and lower capacity utilization, though the latter factor started earlier and may have leveled off sooner.

Notes and References

1 As argued by St. Louis Fed President James Bullard, we seem to be currently in a low productivity-growth regime. See Bullard, James. “The St. Louis Fed’s New Characterization of the Outlook for the U.S. Economy,” announcement, June 17, 2016.

2 The labor force includes all persons classified as employed or unemployed in the Bureau of Labor Statistics’ Current Population Survey.

3 For more on the monetary policy actions of the early 1980s, see Medley, Bill. “Volcker’s Announcement of Anti-Inflation Measures,Federal Reserve History, November 22nd, 2013.

4 The series for total factor productivity is taken from the Federal Reserve Bank of San Francisco. Capacity utilization is published by the Federal Reserve’s Board of Governors and covers only the industrial sector of the economy (manufacturing, mining, utilities and selected high-tech industries).