A monthly report produced for CommerCe reAl estAte solutions by stephen P. A. Brown, PhD, Center for Business & economic research university of nevada, las Vegas

Is U.s. Monetary PolIcy creatIngan InflatIonary envIronMent?

IssUe 17 May 2012

With the u.s. economy still performing poorly, u.s. monetary policy remains quite easy. Because expected inflation is greater than short-term interest rates, real short-term interest rates are negative. in addition, the Federal open market Committee (FomC) announced on Wednesday, June 20 that it will take steps to further reduce long-term interest rates by selling some of the shorter-term government bonds it holds and using the proceeds to buy longer-term government bonds. Is conduct of monetary policy creating an environment in which we should worry about inflation?

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evidence of Monetary ease

The most convincing evidence of monetary ease is real short-term interest rates—that is, interest rates on short-term treasury bills minus expected inflation. In late 2007, the FOMC began targeting interest rates below expected inflation, and that action has yielded negative real interest rates for nearly five years. To maintain these exceedingly low real interest rates, the Federal Reserve System (Fed) greatly boosted monetary liquidity. Since late 2007, the U.S. monetary base has grown at a 28.3 percent annual rate.1 The biggest gains occurred in 2008 and 2009, when annualized growth rates in the monetary base were around 100 percent.gold Prices suggests Possible Inflation; actual Inflation remains subdued

Gold prices typically rise in an inflationary environment or from fears that monetary policy is creating an

inflationary environment. In the first four years after U.S. monetary policy took real short-term interest rates negative, the price of gold rose by 121 percent, which provides a strong indication of inflationary fears. After reaching a high in November 2011, however, gold prices have slipped by 11 percent, perhaps because the feared inflation had not been realized or the dollar began strengthening.U.S. inflation has been relatively subdued. As measured by the consumer price index (CPI), inflation has been fairly volatile over the past five years, but it has averaged about 2.0 percent. Much of the volatility in the CPI owes to fluctuations in food and energy prices. Excluding food and energy prices from the index yields a much less volatile series known as “core CPI.” Core CPI shows inflation has averaged 1.8 percent over the

1 The monetary base is a relatively narrow measure of money. It includes cash and reserve accounts that commercial banks hold at the Fed.

the drop in velocity suggests a different explanation for relatively mild inflation—the considerable excess capacity in the economy.

neVADA’s EConomy May 2012

CommERCE REal ESTaTE SoluTionS | Comre.Com

past five years. By the historical standards set over the past 40 years, these inflation rates are quite low. Why not Much Inflation?

Several different reasons have been offered for monetary ease not generating much inflation. One reason offered for lack of inflation is that the broader monetary aggregates—such as M2—have not grown nearly as fast as the monetary base.2 Another reason offered for the lack of inflation is the considerable excess capacity in the economy. Both of these developments are the result of the financial crisis that created the most recent recession.Examining M2, we do find that it has grown much more slowly than the monetary base since late 2007, with the former showing an annualized growth rate of only

6.6 percent. As the Fed pushed more liquidity into the economy through the monetary base, it found weaker growth in the broader monetary aggregates. Because commercial banks have not been lending very much, they

have not turned all of the additional liquidity provided by the Fed into equally strong growth of M2. Nonetheless, the growth rate of M2 since late 2007 is consistent with a considerably higher inflation rate than we have actually seen. Given the annualized growth rate of real GDP has been only 0.3 percent since late 2007, we might have expected an annualized inflation

rate of more than 6 percent since late 2007. In fact, the velocity of money—which measures the amount of economic activity supported by a given quantity of money—has dropped considerably over the past five years.The drop in velocity suggests a different explanation for relatively mild inflation—the considerable excess capacity in the economy. At 8.2 percent, the U.S. unemployment rate is much higher than the 5.6 percent rate the Congressional Budget Office (CBO) estimates as the natural rate of unemployment. Similarly, the first quarter 2012 reading of U.S. GDP was 5.5 percent below potential. With such excess capacity in the economy, competition keeps prices from rising, and inflationary pressure remains subdued. the Inflation outlook

These findings suggest that current monetary ease is unlikely to generate much inflationary pressure in the near future. Inflation is likely to remain subdued as long as the U.S. economy has considerable excess capacity. As the economy nears full capacity and the relationship between money and the economy tightens, the Fed must be prepared to act quickly to remove any excess liquidity. Otherwise, the liquidity will quickly turn into inflationary pressure.

2 M2 includes the monetary base plus checking and savings accounts.

Is U.s. Monetary PolIcy creatIngan InflatIonary envIronMent?

IssUe 17 | ©Copyright 2012 - All Rights Reserved

Story continues after graphs

U.S. economic growth slowed substantially in first quarter 2012. Consumer spending remained fairly strong, and investment expenditures made positive contributions, but government spending and net exports made negative contributions. Nevada’s tourism and gaming industries continue to drive the state’s economic recovery. Nevada’s construction sector remains mired at relatively low levels. Rising employment and reduced labor force participation meant a lower statewide unemployment rate in April.U.s. economy continues to show slowing growth

The U.S. economy continues to show signs of slowing growth. Revised data show U.S. real GDP grew at an annualized rate of 1.9 percent during first quarter 2012, which represents a substantial slowing from the fourth-quarter rate of 3.0 percent. Consumer spending drove most of the gains. Business fixed investment, residential investment and inventories also made positive contributions. Government spending and net exports made negative contributions. U.S. nonfarm employment rose by only 69,000 jobs in May, marking the weakest gain since May 2011. The unemployment rate ticked up to 8.2 percent in May, as labor force participation rose by more than new employment opportunities. More favorably, housing prices stabilized, and sales of both new and existing homes rose in April. Consumer sentiment increased slightly in May, but consumer confidence slipped. Personal consumption expenditures increased for the tenth straight month in April, but retail slipped in May for the second straight month. The Kansas City Financial Stress Index rose to just about its long-run average in May, which suggests financial headwinds are not impeding economic growth. The quantity of commercial paper outstanding remains low, which means relatively little external financing is being used to support business investment, Table 1. some evidence of slowing economic growth in nevada

The Nevada economy shows some evidence of slowing. Seasonally adjusted, statewide employment decreased

by 600 jobs (0.1 percent) from March to April. The Nevada unemployment rate decreased from 12.0 percent in March to 11.7 percent in April as the result of reduced labor force participation. Visitor volume was 1.2 percent lower in April than a year earlier. Nonetheless, gaming revenue was 6.2 percent higher in April than a year earlier—mostly as a result of baccarat and slot play. Taxable sales were 7.2 percent higher in March than a year earlier, Table 2. signs of slowing economic growth in clark county

Clark County’s economy also shows signs of slowing. Seasonally adjusted, the region’s employment fell by 600 jobs (0.1 percent) from March to April. The Las Vegas unemployment rate fell from 12.6 percent in March to 12.4 percent in April. Compared to a year earlier, visitor volume was down by 1.2 percent in April. Nonetheless, gaming revenue was 8.9 percent higher in April than a year earlier—mostly as a result of baccarat and slot play. Taxable sales for March were only 1.9 percent above those for a year earlier. Residential construction permits slipped in April after rising sharply in March. Commercial construction permits dropped to a very low level, Table 3. slowing economic growth in Washoe county

Washoe County also shows slowing economic growth. Seasonally adjusted, Reno-Sparks employment fell by

nevada economic conditions

neVADA’s EConomy May 2012

CommERCE REal ESTaTE SoluTionS | Comre.Com

*Growth data represents change in percentage rate**Reflects the Reno-Sparks MSA which includes Washoe and Storey Counties***Recent growth is an annualized rateSources: Nevada Department of Taxation; Nevada Department of Employment, Training, and Rehabilitation; UNR Bureau of Business and Economic Research; UNLV Center for Business and Economic Research; McCarran International Airport; Reno/Tahoe International Airport; Las Vegas Convention and Visitors Authority; Reno-Sparks Convention and Visitors Authority; U.S. Department of Commerce; U.S. Bureau of Labor Statistics; U.S. Census Bureau; U.S. Federal Reserve Bank.Note: NSA = Not Seasonally Adjusted, SA = Seasonally Adjusted

tabl

e 1 U.s. Date Units current Previous change year ago change

employment 2012M05 million, sA 133.009 132.940 0.1% 131.227 1.4%unemployment rate* 2012M05 %, SA 8.2 8.1 0.1% 9.0 -0.8%Consumer Price index 2012M04 82-84=100, SA 229.2 229.1 0.0% 224.0 2.3%Core CPi 2012M04 82-84=100, SA 229.0 228.4 0.2% 223.8 2.3%employment Cost index 2012Q1 89.06=100, SA 115.3 114.7 0.5% 113.2 1.9%Productivity index 2012Q1 2005=100, SA 110.5 110.7 -0.2% 110.1 0.4%retail sales 2012M05 $billion, sA 404.6 405.3 -0.2% 384.2 5.3%Auto and truck sales 2012M05 million, sA 13.73 14.37 -4.5% 11.69 17.4%Housing starts 2012M04 million, sA 0.717 0.699 2.6% 0.552 29.9%real GDP*** 2012Q1 2005$billion, SA 13,491.0 13,429.0 1.9% 13,227.9 2.0%u.s. Dollar 2012M05 97.01=100 100.724 99.027 1.7% 95.307 5.7%trade Balance 2012M04 $billion, sA -50.062 -52.617 -4.9% -43.556 14.9%S and P 500 2012M05 monthly close 1,310.33 1,397.91 -6.3% 1,345.20 -2.6%Real Short-term Rates* 2012M04 %, NSA -3.12 -3.82 0.7% -4.54 1.4%treasury Yield spread* 2012M05 %, NSA 1.71 1.97 -0.3% 3.13 -1.4%

tabl

e 2 nevada Date Units current Previous change year ago change

employment 2012M04 000s, sA 1,128.6 1,129.2 -0.1% 1,123.2 0.5%unemployment rate* 2012M04 %, SA 11.7 12.0 -0.3% 13.6 -1.9%taxable sales 2012M03 $billion 3.910 3.223 21.3% 3.649 7.2%Gaming revenue 2012M04 $million 855.71 854.59 0.1% 806.05 6.2%Passengers 2012M04 million persons 3.881 4.000 -3.0% 3.827 1.4%Gasoline sales 2012M03 million gallons 90.40 83.72 8.0% 91.47 -1.2%Visitor Volume 2012M04 million persons 4.160 4.377 -5.0% 4.212 -1.2%

tabl

e 3 clark county Date Units current Previous change year ago change

employment 2012M04 000s, sA 809.5 810.1 -0.1% 807.7 0.2%unemployment rate* 2012M04 %, SA 12.4 12.6 -0.2% 14.1 -1.7%taxable sales 2012M03 $billion 2.791 2.416 15.5% 2.738 1.9%Gaming revenue 2012M04 $million 743.67 733.49 1.4% 682.95 8.9%residential Permits 2012M04 units permitted 612 841 -27.2% 375 63.2%Commercial Permits 2012M04 permits 5 23 -78.3% 16 -68.8%Passengers 2012M04 million persons 3.554 3.655 -2.7% 3.462 2.7%Gasoline sales 2012M03 million gallons 62.72 57.89 8.4% 63.14 -0.7%Visitor Volume 2012M04 million persons 3.609 3.836 -5.9% 3.654 -1.2%

tabl

e 4 Washoe county Date Units current Previous change year ago change

employment** 2012M04 000s, sA 188.9 190.2 -0.7% 189.6 -0.4%unemployment rate* 2012M04 %, SA 11.5 11.7 -0.2% 13.1 -1.6%taxable sales 2012M03 $billion 0.466 0.398 17.1% 0.452 3.0%Gaming revenue 2012M04 $million 54.20 61.43 -11.8% 64.11 -15.5%residential Permits 2012M04 units permitted 82 42 95.2% 38 115.8%Commercial Permits 2012M04 permits 5 9 -44.4% 13 -61.5%Passengers 2012M04 million persons 0.276 0.293 -5.8% 0.296 -6.6%Gasoline sales 2012M03 million gallons 13.50 13.10 3.0% 13.44 0.5%Visitor Volume 2012M04 million persons 0.353 0.333 6.1% 0.357 -1.2%

nevaDa econoMIc conDItIons

IssUe 17 | ©Copyright 2012 - All Rights Reserved

1,300 jobs (0.7 percent) from March to April. The Reno-Sparks unemployment rate fell from 11.7 percent in March to 11.5 in April. Compared to a year earlier, April visitor volume was down by 1.2 percent. Gaming revenues were down by 15.5 percent over the same period. Residential construction permits rose sharply in April, and commercial construction permits fell to extremely low levels, Table 4.nevada economic outlook in Brief

The pace of national economic growth slipped during first quarter, and a number of signs—such as employment and the pace of spending—point to relatively weak economic growth in second quarter. The most recent data suggest slowing in Nevada’s tourism and hospitality sectors—both in Southern Nevada and Washoe County. Employment gains are proving to be elusive in most areas of the state.

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