Presented by

Slide 1© 2004 Economy.com

The Economic Outlook

Mark ZandiChief Economist

Slide 2© 2004 Economy.com

-4

-2

0

2

4

6

'00 '01 '02 '03 '04

Demand

Output

Laborhours

% chg year agoSources: BEA, BLS

An Improved Economy...

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20

30

40

50

60

70

80

90

93 94 95 96 97 98 99 00 01 02 03 04

% of industries adding to payrollsover 3 month periodSource: BLS

...Across Industries...

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...and Across the CountryBased on employment and IP data as of July 2004

Recession (none)

Flat

Expanding

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41,500

42,500

43,500

44,500

'99 '00 '01 '02 '03 '04

But Incomes Have Not Kept Up...

Real Median Household Income2000$, Source: BEA, Economy.com

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325

350

375

400

425

'99 '00 '01 '02 '03 '04

...Nor Has Wealth

Real Average Household Net Worth2000$,Sources: FRB, Economy.com

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-0.5

0.0

0.5

1.0

1.5

2.0

'01 '02 '03 '04 '05

Spending

Tax policy

Monetary policy

Contribution to GDP growth% chg year agoSource: Economy.com

Fading Policy Stimulus

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-100

-50

0

50

100

150

200

45 50 55 60 65 70 75 80 85 90 95 00

West Texas Intermediate% Change Year Ago

Higher Energy Prices are a Growing Weight...

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...Particularly on the Northeast and Midwest...

Positive

Sm all N egative

Avg N egative

Large Negative

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5

10

15

20

'73 '78 '83 '88 '93 '98 '03

...But They Should Not Derail the Expansion

Thousands of BTUs per 1996$ of GDPSource: Energy Department

Petroleum

Total Energy

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Fundamental Reason For Optimism

0

1

2

3

4

5

'53-'73 '73-'93 '93-'04 '99-'04 '03-'04

Productivity GrowthNonfarm BusinessAverage Annual GrowthSources: BLS, Economy.com

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3

4

5

6

7

8

9

55 60 65 70 75 80 85 90 95 00

After-Tax corporate profit marginSource: BEA

Productivity Gains Have Lifted Profits...

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-30

-20

-10

0

10

20

30

40

70 75 80 85 90 95 00

-2

0

2

4

6

Profits growth 1 year lead (L)

Employment growth (R)

Sources: BEA, BLS

...Which Will Induce More Hiring

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-6

-2

2

6

10

-4 0 4 8 12

% chg year ago

annualized % change

Argentina

CanadaBelgium

Australia

Brazil

U.S.

China

France

Germany

India

Japan

Korea

Mexico

U.K.

Denmark

Netherlands

Chile

Real GDP Growth through 2004Q2

Expansion

Recession

Recovery

Struggling

Euro Area

FinlandIndonesia

Israel

Italy

New Zealand

Norway

Russia

Spain

Taiwan

Hong Kong

Strong Global Economy

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Sanguine Near-Term Economic Outlook

-2

0

2

4

6

'00 '01 '02 '03 '04 '05 '06

Real GDP

Employment

% change year ago

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Regional Recoveries

Year when new employment peak is projected

2006

20042005

2007 and after

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-6

-4

-2

0

2

4

6

8

10

'98 '99 '00 '01 '02 '03 '04E '05E '06E

State Tax Revenue GrowthSources: Census, Economy.com

Tax Revenue Growth Back on Track

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Source: Economy.com

Less than 3%3.0% to 4.5%O ver 4.5%

Tax Revenue Growth Back on TrackAvg Annual Growth FY '04–'06, U.S. = 4.5%

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-550

-500

-450

-400

-350

-300

00 01 02 03 '04

-140

-130

-120

-110

-100

-90

-80

-70

China (R)

Withering Global Competition

Total excludingOPEC (L)

Trade deficit$ bil, 12 mo moving sumSource: Census

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-10

-5

0

5

10

15

'90 '92 '94 '96 '98 '00 '02 '04

Growth in Federal DebtSources: Treasury, Economy.com

Long-Term Rates are Set to Rise...

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10

20

30

40

50

'90 '92 '94 '96 '98 '00 '02 '04

Share of Treasury DebtOwned by ForeignersSources: FRB, Economy.com

...Particularly if Foreign Investors Become Skittish

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Boston

San Francisco

San Jose

Orange CountySan Diego

Las Vegas

MiamiFt. Lauderdale

Sarasota

Washington DC

Monmouth

Bergen-PassaicNassau

Newark

Highly Overpriced > 2 SD from historic average

Overpriced> 1 SD from historic average

Higher Rates Pose a Threat to the Housing Market

Tampa

Middlesex

Naples

Sacramento

Source: Economy.com

West Palm Beach

Lansing

Riverside

New York

Oakland

Los Angeles

Modesto

Santa Rosa

Santa Barbara

Vallejo

Phoenix

Stockton

TrentonVentura

Based on the aggregate CSW house price index

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Weighty Household Financial Obligations

22

23

24

25

26

27

28

29

30

31

32

33

'80 '85 '90 '95 '00

13.0

13.5

14.0

14.5

15.0

15.5

16.0

16.5Financial obligation ratioSource: Federal Reserve

Homeowners (R)

Renters (L)

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Darkening Federal Fiscal Outlook

0

1

2

3

4

5

Current Law Permanent Tax Cuts AMT Adjustment

Trillions $

Share of GDP

10-Year Cumulative Budget Deficit, FY '05-14Source: Congressional Budget Office

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Outlook Summary

• The economy is much improved. Demand and output are expanding and profits have never been stronger.

• The recovery has been disappointing. The job market continues to lag as do real incomes and net worth.

• Growth has slowed recently due to fading policy stimulus and higher energy prices.

• The expansion will remain in tact as strong productivity and profit gains induce business to invest and hire.

• The global economy is stronger and combined with a softer dollar should support U.S. growth.

• The expansion will struggle with fierce global competition and higher interest rates. Higher rates will be particularly hard on the vehicle and housing markets.

• High household leverage and ballooning federal budget and current account deficits are longer-term threats.