Too Big to FailEconForecast 2014

Members: Kay Ayeni, Anastasia Paluch, John Lee, Michael Ort, Saigeetha Narasimhan, Jinjin Song, Vaibhav Sharma

Executive Summary

In a nutshell, Too Big to Fail predicts minimal short-term growth and a wait-and-see policy.

Growth in the Previous Year

Consumer Confidence Pushes up Consumption1) Consumer Confidence Increase2) Evidence of “Pent-up Demand” for consumer durables

Personal Consumption, Investment Likely to Rise

Fiscal Policy to create a Drag on GDP

TBTF 2014 GDP Prediction: 2.0%● Kiplinger: 2.5- 3.0%

● personal consumption expenditures● unemployment levels

● Fed: 2.8 to 3.2 %● unemployment levels decreasing and income levels rising,

much stronger overseas growth● Pent-up demand for consumer durables

Labor Markets & the Unemployment Rate

● Current Unemployment Rate: 6.7% (BLS)● Current Labor Participation Rate: 62.8%

Prediction:

● Labor Participation Rate: 62.5%

● Unemployment Rate: 6.3%

Understanding the Unemp. Rate● Unemployment rate will drop, but doesn’t

mean much by itself

● Labor market examination to see real meaning behind the lower rate

Labor Markets● Current Participation Rate: 62.8% (March 2014, BLS)

○ Lowest since 1978

● Improving economy, but labor participation rate is expected to drop indefinitely

● Multiple factors involved

Many still have not yet recovered from the recent recession and doesn’t seem as if they will in any rapid rate compared to previous recoveries

Note:Participation rate and unemployment rates have had an inverse relationship in previous recoveries.

Note the drop in labor force participation rate even while unemployment drops.

Trends of the Civilian Unemployment Rate

Inflation Forecasts

● Federal Reserve – 1.55% (core and headline)

•PIMCO – 1.5% (core and headline)

•Too Big To Fail (TBTF) – 1.27% (core), 1.23% (headline)

The EIA Predicts Flat Energy Prices

10-Year TIPS Break Even Rate

Declining Health Care Inflation

• The federal government’s new readmission penalties.• Major employers now contract directly with big-name health systems.

Rental Market Tightness Index Predicts Flattening Shelter Inflation

● Market tightness index is a leading indicator of housing costs

Monetary Policy Predictions

● FOMC rate is 0.36%● Inflation rate is 1.65%● Unemployment rate is 6.3%

Forecasted Fed Funds Rate (FOMC)● Forecasted Fed Funds Interest Rate is 0.36%

● This number determines that the quantitative easing procedure will continue

● Narayana Kocherlakota believes that the FOMC rate is a “Negative Fed Fund Rate”

● This basically states that the FOMC rate will be lower than the rate of inflation

Fed’s Inflation Rate Predictions● Inflation is projected to be about 1.65%, which is nearing the 2% stable

rate in normal economic times.

● As a result of this, it is paramount that the Fed not raise interest rates.

● Narayana Kocherlakota believes that both inflation and unemployment rates will guide the Fed interest rate policy

Application of the Taylor Rule● As long as unemployment is above 5.5% and inflation is below 2.25%,

the process of extraordinary accommodation will proceed

● A fall in interest rates means a decrease in demand for money, will cause an increase in demand for bonds, which increases the money supply, and increases aggregate demand. Thus increasing real GDP and the price level.IR $ Bond Demand MS

AD GDP Price Level

Fiscal Policy● Increase government savings● Research and Development● Infrastructure● Education● Minimum wage ● Defense

Government expenditures have decreased since the financial crisis, as investors regain confidence

Discretionary Defense Cuts

495.6 Billion Dollar Proposal

Increase in Government Savings● $580 billion in revenue from tax reform closing loopholes to those that

need it least● $200 billion in savings from reduced interest on debt● $200 billion in savings from mandatory programs, reducing farm subsidies

$68.6 Billion Invested in Education● Includes $150 million to redesign high schools (24/65)● Make college more affordable by increasing Pell Grant

Investment of $135 Billion in R&D (overall)● Clean energy/ handle nuclear waste, cut energy waste● Improve vehicle manufacturing

Four Year - $302 Billion Invested in Infrastructure

● Establishment of national infrastructure bank● $837 million to modernize aviation system● “Fix it first”

Raising Minimum Wage to $10.10

● Payroll tax credit● Middle class tax cut

10 Year Treasury Bond Yield: Pressure from Foreign Market Uncertainty

● Japan announced its first sales tax increase by 3% since 1997, suppressing consumer confidence and demand

● Asset purchasing of 7 trillion Yen a month will keep rates at a medium to long term low

● Low inflation (.5% in February) in EU and unemployment at 12%. Rate Cut predictions by:

➢ Credit Agricole SA - .15%➢ Danske Bank A/S - .15%➢ Goldman Sachs Group Inc. - .1%

10 Year Treasury Yield: Pressure from Term Structure

● Steady short term Fed Funds Rate but expected increase within a year

➢ market expectations pressuring rates on long term data

● 10 Year yield has already increased by over 100 basis points from a year ago without current change in Fed Funds Rate

● Projection: 3.1% to 3.4% (nominal)1.6% to 2.0% (real using Fisher Equation)

Average Earnings GrowthWe expect 10 year cyclically average earnings growth to stabilize at .0028 due to increased market activty and gradual stability in labor market yet offset by decreasing market liquidity

We expect 10 year cyclically average earnings growth to stabilize at .0028 due to increased market activity and gradual stability in labor market yet offset by decreasing market liquidity

Cyclically Adjusted P/E 10 Ratio

Average YTD P/E Ratio of 25 and Earnings of 72. Computed price is 1805

Real Estate Market

● Housing prices will increase by 4% nationally● Mortgage rate will go up to about 5%● Demand of houses will go up ● Supply of houses will go down

Factors for Demand of Houses● Unemployment will decrease to 6.3%, more young

people likely want to move out● In Trulia’s latest survey, 74% of Americans said that

homeownership was part of achieving their personal American Dream

● According to the U.S. Census Bureau, 2014, the United States population will be 317,297,938. This represents an increase of 2,218,622, or 0.7 percent, from New Year's Day 2013

Factors for Supply of Houses● Cold weather

● Interest rates will remain high in 2014, which discourages developers to build houses.

● More workers will enter construction markets, but it will have a less strong impact on supply

The End

Thank you!