Moodys Analytics US Alternative Scenarios

ECONOMIC & CONSUMER CREDIT ANALYTICS
FROM MOODYS ANALYTICS

September 2013
U.S. Macroeconomic Outlook
Alternative Scenarios
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U.S. MACROECONOMIC OUTLOOK ALTERNATIVE SCENARIOS Table of Contents
Scenario 1 Stronger Near-Term Rebound
Scenario 2
Scenario 3
Scenario 4
Scenario 5
Scenario 6
1
3
5
7
9
11
13
THE U.S. MACROECONOMIC OUTLOOK ALTERNATIVE SCENARIOS ARE WRITTEN BY EDWARD FRIEDMAN
Slower Near-Term Recovery
Second Recession
Protracted Slump
Below-Trend Long-Term Growth
Oil Price Increase, Dollar Crash Ination
Forecast Assumptions
MOODYS ANALYTICS / U.S. Macroeconomic Outlook Alternative Scenarios / September 2013 1
U.S. MACROECONOMIC OUTLOOK ALTERNATIVE SCENARIOS Baseline Forecast Assumptions
Monetary policy
The Federal Reserve has begun to prepare
nancial markets for an end to its quantita-
tive easing policy and an eventual normaliza-
tion of interest rates. According to the Fed,
the key unemployment rate thresholds are
7% for ending QE3 and 6.5% for raising inter-
est rates. Based on the Moodys Analytics
outlook, the Fed will begin tapering QE3 by
years end, and end it by summer 2014. Inter-
est rates will begin to rise by summer 2015.
Normalizing interest rates will take a
while. To be consistent with an economy op-
erating at full employment, the federal funds
target rate would need to rise near 4%. The
Fed has said it will be slow to increase short-
term rates, implying that a 4% funds rate
is not likely until long after the economy is
back to full employment. If the Moodys An-
alytics forecast holds, monetary policy will
not reach normal levels until summer 2017.
The behavior of bond investors could
complicate the task of normalizing monetary
policy. The outlook is based on a steady but
orderly rise in long-term rates, with 10-year
Treasury yields nearing 2.75% at the end
of this year, 3.75% by the end of 2014, and
4.75% by the end of 2015. Ten-year yields
are expected to peak just above 5% in spring
2016, before settling just below 5%the
normalized 10-year Treasury yield consistent
with an economy at full employment. If
interest rates follow this path, the economy
should be able to cope with the increase.
In theory, the Fed should be able to man-
age the transition back to normal monetary
policy, carefully calibrating its balance
sheet to adjust short-term interest rates,
and explaining its actions clearly to bond
investors. Empirical evidence from the Feds
management of earlier QE rounds also sug-
gests that long-term rates need not spike as
QE3 winds down. But the recent selloff in
the bond market suggests that this scenario
may be too rosy. Long-term yields could rise
sharply, going to 5% not over three years,
as envisaged in the outlook, but within a
few months. This would be too much for the
economy to bear; housing and stock prices
would wilt, and the road back to full em-
ployment would take much longer.
Fiscal policy
The federal budget decit is quickly nar-
rowing. This years decit is expected to
come in close to $625 billion, equal to about
4% of GDP. This is down from $1.1 trillion
in scal 2012 and the record $1.4 trillion in
scal 2009. Tax revenues are increasing at
almost a double-digit pace given the end
of the payroll tax holiday, and government
spending is at.
The improving decit reects the scal cliff
deal reached at the start of the year, which
allowed the Bush-era tax cuts to expire for
those taxpayers making more than $450,000
annually, and the expiration of the payroll tax
holiday. It also reects additional government
spending cuts, including the across-the-board
sequestration cuts. The sequester will reduce
outlays by $58 billion in 2013 and by $1.2 tril-
lion over the next decade.
Fiscal policy will be a signicant con-
straint on the economy this year, subtracting
1.5 percentage points from 2013 real GDP
growth. For context, this compares with to-
tal scal restraint, including state and local
governments, of 1% of GDP in 2012.
Under current scal policy, Washington
will come close to the goal of achieving scal
sustainabilityfuture budget decits that
are small enough (near 2% of GDP) that the
nations debt-to-GDP ratio stabilizes, at least
over the next decade. This will be enough
to satisfy nancial markets and allow the
recovery to gain traction as anticipated in the
Moodys Analytics baseline outlook.
U.S. dollar
The value of the real trade-weighted U.S.
dollar has remained roughly unchanged
since the Great Recession. Despite the scal
problems of the U.S., with no obvious alter-
native currency, investors are largely staying
put. From a long-run perspective, the dollar
is close to fair value against the euro ($1.25
per euro) and a bit overvalued against the
British pound ($1.75 per pound). The dollar
will strengthen against these currencies in
the next several years and will not return to
its long-run fair values against them until
the end of the decade.
The sharp depreciation of the yen to
nearly 100 per dollar puts the Japanese
currency back closer to its fair value. Further
yen depreciation is not expected in the near
term but, longer run, it is more likely given
the ongoing struggles of the Japanese econ-
omy. The dollar is expected to depreciate
slowly and unevenly against the currencies
of most emerging economies, especially the
Chinese yuan. Over the long run, the broad
trade-weighted dollar is expected to depre-
ciate modestly in value.
Energy prices
Oil prices, as measured by the cost of
a barrel of West Texas Intermediate crude,
have recently risen to more than $100 per
barrel. Brent oil is trading near $115 per bar-
rel. WTI will remain near $100 per barrel this
year, assuming that tensions with Iran will
not boil over into an overt conict, and that
continued investment in the U.S., Canada
and Iraq will underpin an increase in global
crude oil production.
Longer run, oil and gasoline prices are
expected to trend higher, just outpacing the
overall rate of ination, as global oil produc-
tion struggles to keep pace with increasing
demand from faster-growing, less energy-
efcient emerging economies. However, this
view is challenged by the recent substantive
gains in technologies used to extract oil
and natural gas from shale. Given the large
deposits of shale in the U.S. and many other
parts of the world, this could temper the rise
in long-term oil prices.
Natural gas prices will remain low, par-
ticularly compared with oil prices, for the
next decade. A glut of natural gas has de-
veloped, as demand has not fully recovered
from the recession and supply has increased
given the surge in shale gas production.
Forecast Assumptions
BY MARK ZANDI
U.S. MACROECONOMIC OUTLOOK ALTERNATIVE SCENARIOS Baseline Forecast Summary
U.S. MACRO BASELINE FORECAST SUMMARY
Units 13Q3 13Q4 14Q1 14Q2 2013 2014 2015 2016 2017
Gross Domestic Product bcw$ 15,754.4 15,861.3 15,978.6 16,127.6 15,720.1 16,216.9 16,846.8 17,327.9 17,747.2
Change %AR 1.9 2.7 3.0 3.8 1.6 3.2 3.9 2.9 2.4
Federal Budget $ bil -262.6 -312.9 -381.1 71.5 -792.0 -834.8 -734.6 -674.4 -672.0
Total Employment mil 136.2 136.8 137.3 138.0 136.0 138.4 141.7 144.6 146.4
Change %AR 1.7 1.6 1.6 2.0 1.7 1.8 2.4 2.1 1.2
Unemployment Rate % 7.3 7.2 7.1 6.9 7.5 6.9 6.3 5.7 5.4
Light Vehicle Sales mil, SAAR 15.7 15.9 16.1 16.5 15.6 16.6 16.6 15.6 15.5
Residential Housing Starts mil, SAAR 0.98 1.09 1.22 1.39 0.98 1.51 2.01 2.01 1.88
Median Existing-House Price $ ths 203.2 203.7 204.2 204.8 197.7 205.2 209.1 213.1 217.7
Change %YA 14.0 12.9 9.7 3.4 12.6 3.7 1.9 1.9 2.2
Consumer Price Index %AR 2.4 1.8 1.9 1.9 1.5 1.9 2.3 2.5 2.5
Federal Funds Rate % 0.1 0.1 0.1 0.1 0.1 0.1 0.7 3.0 4.0
Treasury Yield: 10-Yr Bond % 2.74 2.88 3.02 3.23 2.39 3.35 4.18 4.98 4.85
Baa Corp. - 10-Yr Treasury DIFF 2.8 2.8 2.8 2.8 2.8 2.7 2.6 2.5 2.5
Corporate Profits With IVA & CCA $ bil 2,035.5 2,073.2 2,117.2 2,165.3 2,057.0 2,183.1 2,329.2 2,461.1 2,521.6
Change %YA 1.2 1.3 4.8 3.2 2.4 6.1 6.7 5.7 2.5
S&P 500 1941=10 1,660.1 1,657.1 1,652.9 1,666.7 1,610.4 1,654.8 1,640.4 1,665.3 1,720.0
Change %YA 18.4 16.8 9.1 3.5 16.7 2.8 -0.9 1.5 3.3
U.S. MACROECONOMIC OUTLOOK ALTERNATIVE SCENARIOS Scenario 1
Stronger Near-Term Rebound (S1) Scenario
This above-baseline scenario is de-
signed so that there is a 10% probability
that the economy will perform better
than in this scenario, broadly speak-
ing, and a 90% probability that it will
perform worse.
The upside scenario, Stronger Near-
Term Rebound, is based on the assumption
that increased household wealth as a result
of cumulative stock market gains since fall
2012 lifts consumer spending more than
expected. Further, the euro zone recovers
faster than expected, boosting exports, busi-
ness sentiment, and therefore nonresidential
investment. Faster than expected federal
tax collections reduce the decit more
quickly, decreasing the pressure for added
near-term scal contraction. As a result,
payroll employment accelerates faster than
in the baseline.
The Federal Reserve slowly begins to end
quantitative easing and to raise the federal
funds rate in the fourth quarter of 2013, a
year and a half earlier than in the baseline.
However, the gradual nature of these chang-
es in 2014 is accommodative to growth, and
the expansion of credit supports the above-
baseline recovery.
As a result, house prices rise somewhat
faster than in the baseline in the rest of
2013 and 2014. Consequently, in both
the baseline and S1, the trough in house
prices was in the third quarter of 2011,
based on the National Association of Real-
tors median sale price measure, and the
peak-to-trough decline from 2006 to 2011
was 27.5%. In S1, stronger demand and
improving condence raise the pace of
new housing permits above the baseline
pace in the fourth quarter of 2013 and
throughout 2014.
The stronger near-term growth in GDP
results in enough additional hiring compared
with the baseline that the unemployment
rate declines faster. Whereas the unemploy-
ment rate falls to 6.6% by the end of 2014,
it drops to 5.7% in S1.
Over calendar 2014, real GDP rises ap-
proximately 1.5 percentage points faster
than in the baseline. On an annual average
basis, real GDP growth rates in 2014 and
2015 are 4.2% and 4.3%, respectively, com-
pared with 3.2% and 3.9%, respectively, in
the baseline.
U.S. MACRO S1 SCENARIODIFFERENCE FROM BASELINE
Units 13Q3 13Q4 14Q1 14Q2 2013 2014 2015 2016 2017
Gross Domestic Product bcw$ 5.3 20.6 76.3 140.1 6.5 165.6 245.1 115.4 7.7
Change %AR 0.1 0.4 1.4 1.6 0.0 1.0 0.4 -0.8 -0.6
Federal Budget $ bil 0.1 1.6 7.7 14.8 1.7 66.6 100.0 55.1 5.5
Change %AR 0.1 0.4 0.8 0.6 0.0 0.5 0.0 -0.4 -0.1
Unemployment Rate % -0.0 -0.1 -0.3 -0.5 -0.0 -0.6 -0.7 -0.3 -0.0
Median Existing-House Price $ ths 0.1 0.6 2.7 3.5 0.2 4.5 3.8 1.2 -0.0
Change %YA 0.1 0.3 1.4 1.8 0.1 2.2 -0.4 -1.2 -0.6
Consumer Price Index %AR 0.2 0.2 0.6 0.5 0.0 0.4 0.0 -0.3 -0.1
Baa Corp. - 10-Yr Treasury DIFF -5.4 -5.7 -6.0 -6.5 -4.7 -6.7 -8.2 -9.9 -9.7
Corporate Profits With IVA & CCA $ bil 0.0 1.8 7.9 15.9 0.5 23.9 52.7 10.3 -0.1
Change %YA 0.0 0.1 0.4 0.8 0.0 1.1 1.2 -1.9 -0.4
S&P 500 1941=10 0.4 2.4 25.4 18.4 0.7 40.2 96.6 40.2 0.3
Change %YA 0.0 0.2 1.7 1.1 0.1 2.5 3.3 -3.3 -2.4
U.S. MACRO S1 SCENARIOFORECAST SUMMARY
Units 13Q3 13Q4 14Q1 14Q2 2013 2014 2015 2016 2017
Change %AR 2.0 3.1 4.4 5.4 1.7 4.2 4.3 2.1 1.8
Change %AR 1.8 1.9 2.5 2.7 1.7 2.3 2.4 1.7 1.1
Change %YA 14.0 13.2 11.2 5.2 12.7 5.9 1.6 0.7 1.6
Change %YA 1.2 1.4 5.2 3.9 2.4 7.3 7.9 3.8 2.0
S&P 500 1941=10 1,660.5 1,659.5 1,678.3 1,685.1 1,611.1 1,695.0 1,737.1 1,705.6 1,720.3
Change %YA 18.4 17.0 10.8 4.7 16.8 5.2 2.5 -1.8 0.9
Slower Near-Term Recovery (S2) Scenario
In this slow-growth scenario, there is
a 75% probability that economic condi-
tions will be better, broadly speaking, and
a 25% probability that conditions will
be worse.
The downside 25% scenario, Slower
Near-Term Recovery, is based on the as-
sumption that concern that the Federal
Reserve will end quantitative easing abruptly
causes interest rates to rise almost as fast as
in the baseline, reducing business sentiment
and causing business investment to deceler-
ate in 2014. Additionally, worries about U.S.
scal policies, including the national debt
ceiling, decit reduction, and the costs as-
sociated with healthcare reform, prevent
improvement in private sector condence.
Further, the euro zone recovery is weaker
than expected, causing U.S. exports to level
off in the rst half of 2014. As a result, the
economy grows more slowly in 2014 than in
the baseline, though it avoids recession. The
stock market declines moderately during this
time, and corporate bond spreads rise above
baseline levels. Federal scal contraction as a
result of sequestration causes growth in con-
sumer spending to slow more than expected.
Additionally, though they are a bit lower than
in the baseline, gasoline prices remain elevat-
ed, keeping consumer condence low.
The deceleration in GDP growth causes
the unemployment rate to remain above
7.5% next year, leaving it more than a full
percentage point above the baseline by the
end of 2014. As a result, house prices are
essentially at in 2014 and below baseline
levels. Lower consumer condence, em-
ployment and income than in the baseline
cause the recovery in unit car sales to pause
around 15.5 million units in 2014, 1 million
units lower than in the baseline.
Over calendar 2014, real GDP rises by
just 2.3%, compared with 4.4% in the base-
line. To support the economy, the Fed does
not begin to tighten monetary policy signi-
cantly until the fourth quarter of 2015, six
months later than in the baseline.
The economy begins to recover more
strongly in 2015 as nancial markets adjust
to the end of quantitative easing, the Eu-
ropean recovery gains traction, and scal
policy issues begin to resolve. On an annual
average basis, real GDP growth is 1.7% in
2014 and 3.1% in 2015.
Units 13Q3 13Q4 14Q1 14Q2 2013 2014 2015 2016 2017
Gross Domestic Product bcw$ -6.9 -14.9 -106.1 -176.0 -5.5 -231.9 -372.8 -170.7 -13.5
Change %AR -0.2 -0.2 -2.3 -1.8 -0.0 -1.4 -0.8 1.3 0.9
Federal Budget $ bil -0.4 -1.7 -7.8 -16.2 -2.1 -83.0 -163.1 -76.2 2.1
Total Employment mil -0.0 -0.2 -0.4 -0.6 -0.1 -0.8 -2.0 -1.2 0.0
Change %AR -0.1 -0.5 -0.5 -0.8 -0.0 -0.6 -0.8 0.5 0.9
Unemployment Rate % 0.0 0.0 0.3 0.6 0.0 0.8 1.2 0.5 -0.0
Light Vehicle Sales mil, SAAR -0.1 -0.1 -0.7 -1.0 -0.1 -1.1 -1.0 -0.1 -0.0
Residential Housing Starts mil, SAAR -0.04 -0.05 -0.10 -0.18 -0.02 -0.21 -0.25 -0.04 -0.00
Median Existing-House Price $ ths -0.1 -0.2 -0.5 -1.4 -0.1 -1.1 -2.7 -0.9 -0.0
Change %YA -0.1 -0.1 -0.3 -0.7 -0.0 -0.5 -0.7 0.9 0.4
Consumer Price Index %AR -0.2 -0.4 -0.6 -1.0 -0.0 -0.5 -0.2 0.3 0.4
Federal Funds Rate % 0.0 0.0 0.0 0.0 0.0 -0.0 -0.5 -1.3 -0.2
Treasury Yield: 10-Yr Bond % 0.00 -0.04 -0.21 -0.16 -0.01 -0.20 -0.24 -0.23 0.00
Corporate Profits With IVA & CCA $ bil 0.0 -3.0 -31.6 -59.2 -0.8 -66.6 -83.6 -40.2 -0.5
Change %YA 0.0 -0.1 -1.6 -2.8 -0.0 -3.2 -0.6 2.1 1.7
S&P 500 1941=10 -0.4 -0.9 -9.0 -67.5 -0.3 -54.5 -49.2 -7.0 -0.2
Change %YA -0.0 -0.1 -0.6 -4.2 -0.0 -3.4 0.3 2.7 0.4
Units 13Q3 13Q4 14Q1 14Q2 2013 2014 2015 2016 2017
Change %AR 1.7 2.5 0.7 2.0 1.6 1.7 3.1 4.1 3.4
Change %AR 1.6 1.1 1.1 1.2 1.6 1.2 1.6 2.6 2.1
Change %YA 13.9 12.8 9.5 2.7 12.5 3.2 1.2 2.8 2.6
Change %YA 1.2 1.1 3.2 0.3 2.3 2.9 6.1 7.8 4.1
S&P 500 1941=10 1,659.7 1,656.2 1,643.9 1,599.1 1,610.0 1,600.3 1,591.2 1,658.3 1,719.8
Change %YA 18.4 16.8 8.5 -0.7 16.7 -0.6 -0.6 4.2 3.7
Second Recession (S3) Scenario
In this recession scenario, there is
a 90% probability that the economy
will perform better, broadly speak-
perform worse.
The downside 10% scenario, Second
Recession, is based on a number of as-
sumptions. First, nancial market concern
that the Feds quantitative easing will
end sooner rather than later causes inter-
est rates to rise nearly as much as in the
baseline through the end of 2013, reducing
business sentiment. Second, uncertainty
about whether U.S. policymakers will suc-
cessfully address the national debt ceiling
rises signicantly and the still-large decit
results in additional scal contraction.
Third, the euro zone drops back into reces-
sion. Greece leaves the euro zone, causing
investors to worry that other high-debt
countries such as Portugal and Spain might
follow. U.S. exports decline signicantly,
and U.S. banks suffer from their exposure
to European banks, reducing credit avail-
ability in the U.S. The economy sinks into
a second recession in early 2014. The stock
market falls sharply and corporate bond
spreads rise above the baseline trend,
lowering business investment. Moreover,
disagreements in Congress over priorities
prevent initiatives that might soften the
second downturn.
The recession is less severe than
the 2008-2009 downturn, but lasts
through the third quarter of 2014.
Though oil and gasoline prices fall below
the baseline levels, the declines do not
provide an offsetting improvement in
consumer confidence.
Rising unemployment during the reces-
sion causes the housing market to weaken
again. Reduced federal support to housing
relative to that in the 2008-2009 reces-
sion contributes to the weakness. House
prices, as measured by the NAR median sale
price, decline cumulatively by 11% from the
fourth quarter of 2013 through the second
quarter of 2015. However, the trough is
above the trough in 2011. Housing starts
decline throughout much of 2014, falling a
cumulative 49%, back to approximately the
2009 trough.
The decline in real GDP causes the labor
market to contract throughout 2014, and
another wave of consumer retrenchment
ensues. Unit auto sales decline starting in
early 2014, and are continuously below 14
million units from mid-2014 to 2015. Low
capacity utilization in manufacturing and
weak demand cause business investment to
fall signicantly throughout 2014.
The recovery begins in the fourth quarter
of 2014 but proceeds slowly over the next
year. With the economy weak, the Fed keeps
the fed funds target rate near 0% until the
second quarter of 2016, nearly a year later
than in the baseline. The cumulative peak-
to-trough decline in real GDP is 2.8%. The
percentage change in real GDP, on an annual
average basis, is -1.4% in 2014 and 0.8% in
2015. The contraction in the labor market
causes the unemployment rate to hit a peak
of 10.6% in early 2015. Because of weakness
in consumer spending, ination is slightly
negative for most of 2014.
Units 13Q3 13Q4 14Q1 14Q2 2013 2014 2015 2016 2017
Change %AR -0.2 -1.1 -6.8 -7.7 -0.1 -4.6 -3.1 1.2 2.2
Federal Budget $ bil -0.4 -2.4 -26.8 -65.7 -2.8 -313.3 -634.7 -665.4 -481.2
Total Employment mil -0.1 -0.3 -1.5 -3.0 -0.1 -3.3 -6.0 -6.6 -5.4
Change %AR -0.2 -0.7 -3.7 -4.4 -0.1 -2.4 -1.9 -0.4 0.9
Residential Housing Starts mil, SAAR -0.06 -0.16 -0.34 -0.73 -0.05 -0.84 -1.20 -0.52 0.09
Change %YA -0.1 -0.2 -1.6 -6.1 -0.1 -7.4 -6.7 2.3 4.0
Consumer Price Index %AR -0.3 -0.5 -2.7 -3.0 -0.1 -1.8 -1.2 0.3 1.1
Treasury Yield: 10-Yr Bond % 0.00 -0.06 -0.31 -1.17 -0.01 -1.14 -1.81 -1.25 -0.09
Change %YA 0.0 -0.2 -6.4 -15.0 -0.0 -17.3 -10.2 4.3 11.1
S&P 500 1941=10 -0.8 -1.5 -94.9 -311.5 -0.6 -281.6 -310.4 -202.3 -113.7
Change %YA -0.1 -0.1 -6.3 -19.4 -0.0 -17.5 -2.3 8.5 6.5
Units 13Q3 13Q4 14Q1 14Q2 2013 2014 2015 2016 2017
Change %AR 1.7 1.6 -3.8 -3.9 1.5 -1.4 0.8 4.1 4.6
Federal Budget $ bil -263.0 -315.3 -407.9 5.9 -794.8 -1,148.2 -1,369.4 -1,339.8 -1,153.2
Change %AR 1.5 0.9 -2.0 -2.3 1.6 -0.6 0.5 1.6 2.1
Change %YA 13.9 12.6 8.1 -2.7 12.5 -3.6 -4.7 4.2 6.2
Consumer Price Index %AR 2.0 1.4 -0.8 -1.0 1.4 0.1 1.0 2.8 3.6
Change %YA 1.2 1.1 -1.7 -11.8 2.3 -11.2 -3.5 9.9 13.6
S&P 500 1941=10 1,659.3 1,655.6 1,558.0 1,355.2 1,609.8 1,373.1 1,330.1 1,463.1 1,606.3
Change %YA 18.3 16.7 2.9 -15.8 16.7 -14.7 -3.1 10.0 9.8
Protracted Slump (S4) Scenario
In this recession scenario, there is a
96% probability that the economy will
perform better, broadly speaking, and a
4% probability that it will perform worse.
The downside 4% scenario, Protracted
Slump, is caused by multiple factors. Ini-
tially, nancial markets worry that quanti-
tative easing will end abruptly. This causes
interest rates to rise nearly as much as in
the baseline through the end of 2013, limit-
ing growth in business investment. Second,
worries intensify that policymakers will fail
to address the national debt ceiling, long-
term decit reduction, and the burden of
healthcare costs. Third, the euro zone drops
back into a deep recession and Greece has a
disorderly departure from the euro zone. The
risk that other countries such as Portugal or
Spain would also leave rises signicantly. As
a result, U.S. exports decline sharply, causing
business condence and hiring to fall. The
U.S. banking system is strained as a result of
its ties to the European banks, leading credit
availability to shrink signicantly.
The stock market and business sentiment
decline sharply, and a second recession
develops in the rst quarter of 2014. Just
as in S3, the impasse among policymakers
prevents a response to stem the downturn.
Consumer sentiment and spending decline
much more sharply than expected. Reduced
household wealth and high unemploy-
ment cause consumers to pull back further
on their spending. Unit auto sales decline
steadily from the fourth quarter of 2013
through the rst quarter of 2015 to a trough
of fewer than 12 million, compared with the
baseline pace of well more than 16 million.
Corporate bond spreads rise signicantly
above baseline levels, causing business in-
vestment to decline throughout 2014. As a
result, the second downturn in real GDP is
protracted, lasting from the rst quarter of
2014 through the rst quarter of 2015.
Foreclosures rise again, and federal sup-
port to housing is more limited than in the
2008-2009 recession. The result is another
cycle of house price declines. The overall
decline during the second dip, from the third
quarter of 2013 through the fourth quarter
of 2015, is 21%. The cumulative decline from
the 2006 peak is 29%. Housing starts also
decline, falling 58% from the second quarter
of 2013 through the rst quarter of 2015.
The recovery is slow until 2016.
In this deep slump, real GDP declines a
cumulative 4.4% peak to trough. On an an-
nual average basis, the percentage change
in real GDP is -2.3% in 2014 and -0.9% in
2015. The unemployment rate reaches a
high of 12.2% in the third quarter of 2015
and remains in double digits until mid-2017.
Ination is negative throughout 2014. To
prevent the economy from sliding further,
the Fed keeps interest rates near 0% for
most of 2016.
Units 13Q3 13Q4 14Q1 14Q2 2013 2014 2015 2016 2017
Change %AR -0.6 -1.7 -7.5 -8.4 -0.2 -5.4 -4.8 0.1 2.2
Change %AR -0.3 -0.8 -4.0 -4.9 -0.1 -2.9 -2.8 -0.5 0.6
Change %YA -0.2 -0.3 -2.3 -8.2 -0.1 -10.1 -14.4 -1.4 2.6
Consumer Price Index %AR -0.4 -0.5 -3.2 -3.6 -0.1 -2.2 -2.4 -0.3 1.1
Change %YA 0.0 -0.2 -8.3 -18.9 -0.1 -21.5 -16.5 0.4 6.3
S&P 500 1941=10 -1.3 -2.1 -120.4 -351.2 -0.8 -373.8 -532.7 -496.0 -371.3
Change %YA -0.1 -0.2 -7.9 -21.8 -0.1 -23.2 -12.7 4.0 12.1
Units 13Q3 13Q4 14Q1 14Q2 2013 2014 2015 2016 2017
Change %AR 1.3 1.0 -4.5 -4.6 1.4 -2.3 -0.9 2.9 4.6
Federal Budget $ bil -263.2 -316.2 -415.0 -9.4 -795.9 -1,219.8 -1,581.1 -1,658.8 -1,562.5
Change %AR 1.4 0.8 -2.4 -2.8 1.6 -1.0 -0.4 1.5 1.8
Change %YA 13.8 12.5 7.4 -4.8 12.5 -6.3 -12.5 0.5 4.7
Consumer Price Index %AR 1.9 1.3 -1.3 -1.6 1.4 -0.3 -0.1 2.1 3.6
Change %YA 1.2 1.1 -3.5 -15.7 2.3 -15.4 -9.8 6.1 8.8
S&P 500 1941=10 1,658.9 1,655.0 1,532.5 1,315.4 1,609.5 1,281.0 1,107.7 1,169.4 1,348.8
Change %YA 18.3 16.7 1.2 -18.3 16.7 -20.4 -13.5 5.6 15.3
Below-Trend Long-Term Growth (S5) Scenario
With this low-performance long-term
scenario, there is a 96% probability that
the economy will perform better, broadly
speaking, and a 4% probability that it will
perform worse.
In the downside 4% scenario, Below-
Trend Long-Term Growth, the U.S. recovery
continues throughout 2013, but the growth
rate is below the baseline pace because of
nancial market concerns over quantitative
easing ending too soon and causing interest
rates to rise further than expected, the slow-
er than expected euro zone recovery, and
the debt ceiling and further scal contrac-
tion. There are also private sector concerns
about healthcare costs.
However, whereas other downside sce-
narios feature a subsequent demand-driven
recovery back to the baseline trend, supply-
side constraints prevent that outcome in S5.
The economy grows more slowly in 2014
than in the baseline, and the pace remains
below that of the baseline for an extended
time for several reasons. Households engage
in relatively more precautionary saving and
therefore less spending. Less risk-taking re-
ects in higher yield spreads and lower stock
prices than in the baseline. Capital accumu-
lation and productivity gains are lower than
in the baseline, owing to the higher cost of
borrowing and lower business investment.
Real GDP growth is lower than in the
baseline over much of the decade, al-
though the gap in the GDP growth rate
subsequently closes and the rate ultimately
matches the baseline pace. The level of real
GDP, however, is permanently lower than
in the baseline. On an annual average basis,
real GDP increases 2.2% in 2014 and 2.5%
in 2015.
The unemployment rate stays higher
than in the baseline by nearly a percentage
point and remains above 7% throughout
2014 and 2015. Although the jobless rate
ultimately declines to the baseline level,
this occurs only slowly, and full convergence
does not occur until after 2020. The long
dislocation in the labor market hampers the
typical long-term pattern of advances in
worker productivity, as employees nd fewer
opportunities to develop their skills while
on the job. The result is productivity growth
that is below the long-run trend for the
entire decade.
Units 13Q3 13Q4 14Q1 14Q2 2013 2014 2015 2016 2017
Gross Domestic Product bcw$ 4.5 -5.4 -52.1 -107.0 -0.2 -150.0 -376.7 -413.8 -413.8
Change %AR 0.1 -0.3 -1.2 -1.4 -0.0 -1.0 -1.4 -0.2 0.1
Change %AR -0.1 -0.2 -0.2 -0.4 -0.0 -0.2 -0.4 -0.3 -0.1
Change %YA -0.1 -0.1 -0.3 -0.6 -0.1 -0.6 -1.3 -0.7 -0.7
Consumer Price Index %AR -0.2 -0.3 -0.2 -0.6 -0.0 -0.3 -0.3 -0.2 -0.1
Change %YA 0.0 -1.6 -2.1 -2.6 -0.4 -2.4 -1.3 -1.4 -0.9
S&P 500 1941=10 -0.4 -0.9 -9.0 -41.6 -0.3 -31.1 -42.9 -59.8 -62.2
Change %YA -0.0 -0.1 -0.6 -2.6 -0.0 -1.9 -0.7 -1.0 -0.0
Units 13Q3 13Q4 14Q1 14Q2 2013 2014 2015 2016 2017
Change %AR 2.0 2.5 1.8 2.4 1.6 2.2 2.5 2.7 2.5
Federal Budget $ bil -400.7 -451.0 -519.2 -66.6 -1,068.2 -1,387.2 -1,287.0 -1,226.7 -1,224.4
Change %AR 1.6 1.4 1.4 1.7 1.6 1.6 2.0 1.8 1.1
Change %YA 13.9 12.7 9.5 2.8 12.5 3.2 0.6 1.2 1.5
Change %YA 1.2 -0.3 2.7 0.6 2.0 3.7 5.4 4.2 1.6
S&P 500 1941=10 1,659.7 1,656.2 1,643.9 1,625.1 1,610.0 1,623.7 1,597.5 1,605.6 1,657.8
Change %YA 18.4 16.8 8.5 0.9 16.7 0.8 -1.6 0.5 3.3
Oil Price Increase, Dollar Crash Ination (S6) Scenario
In this stagation scenario, there is
a 90% probability that the economy
will perform better, broadly speak-
perform worse.
The downside 10% scenario, Oil Price
Increase, Dollar Crash Ination, assumes
geopolitical tensions in energy-producing
countries worsen signicantly and result
in sharp cutbacks in global oil supplies. Oil
prices rise sharply and hit $165 per barrel
in mid-2014. Pressures on core consumer
prices begin to build as the higher oil prices
push up the costs of delivering goods and
services, and the beginnings of a wage-price
spiral emerge. Additional ination pressures
develop as the dollar falls sharply as foreign
investors cut back on purchases of U.S. Trea-
sury securities because of a lack of progress
on long-run scal problems.
The Fed abruptly shifts gears to ght
ination and increases the fed funds rate
from nearly 0% in mid-2013 to 4.65% in
the fourth quarter of 2014. Yields on 10-year
Treasury securities rise to 6.6% in the second
quarter of 2014 as a result of inationary ex-
pectations and Fed tightening. The economy
weakens substantially and drops into reces-
sion in the third quarter of 2014. Forced to
make a choice in the stagation environment,
the Fed keeps interest rates high to ght in-
ation, and as a result the downturn persists
through the second quarter of 2015. The job-
less rate rises to 10.5% by mid-2015.
The crisis begins to resolve when oil
prices decline and progress on addressing
the scal crisis begins. Ination expectations
start to decline, and the economy recovers
back to baseline levels over the next several
years. However, the level of real GDP is
ultimately lower than in the baseline by a
small amount.
On an annual average basis, the change
in real GDP is 1.1% in 2014 and -2.5% in
2015. Ination, as measured by the CPI, rises
to nearly 5% over calendar 2014, 3 percent-
age points above the baseline, before begin-
ning to decelerate.
Units 13Q3 13Q4 14Q1 14Q2 2013 2014 2015 2016 2017
Gross Domestic Product bcw$ 25.2 33.9 -3.2 -64.9 14.8 -314.9 -1,341.7 -1,227.6 -711.6
Change %AR 0.7 0.2 -1.0 -1.6 0.1 -2.1 -6.4 1.0 3.4
Federal Budget $ bil -44.4 -40.4 -35.3 -30.3 -84.8 -115.3 -62.7 -36.0 0.0
Change %AR -0.0 -0.2 -0.1 -0.7 -0.0 -0.9 -3.1 -0.6 1.2
Change %YA -0.1 -0.1 -0.2 -0.5 -0.0 -2.4 -11.5 -0.1 3.4
Consumer Price Index %AR 0.2 2.0 4.0 3.4 0.1 2.4 -0.0 -1.4 -0.8
Federal Funds Rate % 0.5 1.9 3.4 4.2 0.6 4.2 1.6 -1.4 -0.3
Treasury Yield: 10-Yr Bond % 0.00 1.03 3.44 3.40 0.26 2.81 -0.48 -0.33 0.02
Change %YA 0.0 -1.6 -2.1 -3.9 -0.4 -7.9 -19.3 0.4 9.3
S&P 500 1941=10 -0.4 -0.9 -2.8 -46.6 -0.3 -108.5 -321.6 -246.3 -166.6
Change %YA -0.0 -0.1 -0.2 -2.9 -0.0 -6.7 -13.8 6.1 6.2
Units 13Q3 13Q4 14Q1 14Q2 2013 2014 2015 2016 2017
Change %AR 2.5 3.0 2.0 2.2 1.7 1.1 -2.5 3.8 5.8
Change %AR 1.6 1.4 1.5 1.4 1.6 1.0 -0.8 1.4 2.4
Change %YA 13.9 12.8 9.5 2.8 12.5 1.3 -9.6 1.8 5.6
Change %YA 1.2 -0.3 2.7 -0.8 2.0 -1.7 -12.6 6.0 11.8
S&P 500 1941=10 1,659.7 1,656.2 1,650.1 1,620.1 1,610.1 1,546.3 1,318.8 1,419.1 1,553.4
Change %YA 18.4 16.8 9.0 0.6 16.7 -4.0 -14.7 7.6 9.5
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