Uncertainty Shadowed the Economy--2011 Annual Report

Uncertainty shadowed the economy

tidal wave of currency notes

Several factors contributed to economic uncertainty throughout 2011. These factors included the ongoing European sovereign debt crisis, political turmoil in the Middle East, and questions about the direction of U.S. fiscal policy. The difficult and unresolved debates in Washington over the debt ceiling and concerns about regulation, taxes, and health care costs contributed to policy-related uncertainty.

Several shocks, especially in the earlier months of the year, exacerbated the uncertainty. Severe weather and natural disasters such as the Japanese tsunami slowed economic growth substantially during the first half of the year.

The uncertainty that slowed economic growth was both a result and a cause of other factors constraining the recovery. Numerous surveys, including some from the Atlanta Fed, indicated that uncertainty—about economic performance, government policy and regulation, and geopolitical disruptions—caused many businesses to delay or forego investments and hiring.

Definitely a factor, but hard to measure

Measuring the effects of widespread uncertainty on the economy in 2011 is difficult. For example, according to Atlanta Fed research economist John Robertson, it was unclear how much uncertainty as opposed to general economic weakness constrained hiring. Overall uncertainty was not as measurable an economic force as changes in business balance sheets or bank lending, for example. Nonetheless, it clearly affected the behavior of consumers and businesses, according to numerous anecdotal comments the Atlanta Fed gathered. A typical comment included this one from a small business owner in the real estate industry: "There is too much uncertainty in the marketplace, and we...are working closely with our owners, tenants, clients, and vendors to stay the course until consumers return to the market."

Economists at Stanford University and the University of Chicago created an index last year to measure a specific type of uncertainty related to policy. This index showed that 2011 had the highest level. Indeed, research by the index's creators
—Scott R. Baker, Nicholas Bloom, and Steven J. Davis—has indicated a connection between businesses' concerns about regulation, tax issues, and the unresolved debt ceiling and restrained corporate investment. See the chart.

In the late summer, the potential for the federal government to default on its debts arose as talks on the debt ceiling reached a stalemate. Then, Standard & Poor's downgraded the U.S. government's credit rating. Lawmakers eventually reached a temporary agreement to raise the debt ceiling. But as the year ended, the debt talks had not achieved a true consensus. Rather, political disagreement surrounded the critical task of lowering the federal government's debt burden. (See the section on adjustment and adaptation in the public sector.)

Other factors contributed to uncertainty

Political unrest in the Middle East contributed to rising oil prices. Popular revolutions in certain countries, violent crackdowns on some citizens in the Middle East, and ongoing concerns about proliferation of nuclear weapons contributed to a rise in global oil prices. Throughout 2011, oil prices were roughly 25 to 30 percent higher than they were in the middle of 2010.

The lingering European debt crisis was arguably the most serious uncertainty influencing the economic recovery in 2011. U.S. financial institutions worked to protect themselves by reducing their overall exposure to European banks and sovereigns. But a weakened European economy reduced demand for U.S. exports. And the potential of sovereign debt default threatened the stability of financial markets, causing some turbulence when default appeared likely. The year ended without major dramatic developments, but the debt crisis in the euro zone undermined the confidence of consumers and businesspeople in the United States. Furthermore, many economists believed Europe could be entering a recession.

Sidebar: Southern states vulnerable to euro troubles

Southeastern exports were relatively insulated from troubles in Europe. According to the U.S. International Trade Administration, only a small share of the region's exports was shipped to the euro area in 2011. However, some states, including Alabama, had larger portions of that share. Nearly 20 percent of Alabama's merchandise exports were shipped to the euro area. About half of those exports, mainly automobiles, went to Germany. See the chart for southeastern states' exports to three world regions.

Germany appeared to be one of the more resilient European economies, along with the Netherlands, Belgium, and France—the other large euro area markets for southeastern exporters. The economically weakest countries in the euro area—Greece, Ireland, and Portugal—accounted for only a small fraction of the region's exports.

For Florida, the euro troubles brought another concern. Among the southeastern states, the Sunshine State's exporters appeared to be least exposed to the euro area. But firms in Florida's large tourism industry feared that fewer Europeans might visit. Europeans also comprised a significant market for Florida real estate. For example, in the Miami-Fort Lauderdale-Miami Beach market, Germans accounted for nearly a quarter of all nonresident foreign buyers in the 12 months ending in June 2011, according to the National Association of Realtors.

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Shocks hit economy especially hard early in the year

Oil and commodity price shocks early in the year along with severe weather events helped explain why the nation's economy underperformed expectations in the first quarter. Moreover, the March earthquake and tsunami devastated parts of Japan and caused major loss of life. The Japanese tragedy disrupted industrial supply chains, particularly in the automotive industry. That impact was felt in the middle of the year. The International Monetary Fund wrote in its September 2011 World Economic Outlook that, according to some estimates, the number of cars manufactured worldwide may have declined by up to 30 percent in the two months after the Japanese earthquake and tsunami.

Several severe weather events in the first half of the year also affected the nation's economic performance. As early as June, the National Oceanic and Atmospheric Administration declared that 2011, with eight disasters costing more than $1 billion each, was already among the most extreme weather years in history.

All these factors constrained economic growth in 2011.

Sidebar: Change marked the payments system

The Federal Reserve plays a key role in the nation's payments system. As a provider of payments services, the Fed must remain competitive and recover its costs, in accordance with its legal mandates. It must also remain flexible, as the ways that people and businesses pay for goods and services, and how those payments are processed, are rapidly evolving.

Three factors continued to push steady change in the payments world throughout 2011: technology, regulation, and globalization, said Cheryl Venable, Atlanta Fed senior vice president and retail payments product manager for the Federal Reserve's national Retail Payments Office (RPO). See the video.

Changes in technology

Just as currency replaced barter, and credit cards replaced some cash payments, new technologies continued to spawn new ways to pay for things. Rapid growth in electronic payments has been fueled by the growth of the Internet, the proliferation of powerful mobile computing devices such as smartphones, and more secure and robust means of electronically exchanging financial data. According to a Federal Reserve payments study released last year, the number of electronic payments made in 2009 was 84.5 billion, nearly double the number made in 2003.

Changes in regulation

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) affected payments as well as banking. In particular, the "Durbin Amendment," a provision of the act that took effect in October 2011, capped the fees that debit card issuers can charge merchants whenever a consumer uses a debit card. The Durbin Amendment stirred debate about who would ultimately bear the costs—banks, merchants, or customers. Some large banks—smaller financial institutions were exempted from the cap—imposed monthly fees for debit card users in an attempt to recover costs. In some cases, banks quickly withdrew those fees when customers protested.

Changes due to globalization

Last year, the RPO participated in efforts to bring efficient payments services to more people in Latin America. For years, the sender of a cross-border wire transfer or check had to pay additional charges at various stops the payment made along its way. In addition, complexities in country rules, laws, and payment formats and standards slowed transformations. These complexities have made the cross-border payment process relatively inefficient and costly. At the regional Payments Week (Semana de Pagos) meeting in Paraguay, FedGlobal ACH helped the Western Hemisphere Payments Initiative work toward establishing a regional payments hub to link all of the payments systems in the Americas, thereby improving efficiency.

The Atlanta Fed as convener

The Federal Reserve Bank of Atlanta played an important role in bringing industry participants together in 2011 to address the uncertainty that arises from rapid innovation and changes in regulation. Throughout the year, the RPO assembled payments providers, regulators, law enforcement, and other industry players to explore ways to make the payments system as efficient, safe, and accessible as possible.

In addition to the RPO, the Fed's Atlanta-based Retail Payments Risk Forum served as a hub of research and collaboration on issues affecting the security of payments. For example, in November, the forum assembled regulators, legal professionals, and law enforcement representatives to explore the role of federal and state governments in the payments industry. Conference papers are available.

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