Discussion Materials

July 13, 2022

Monetary Policy in a Stagflationary Environment

A stagflationary environment is fundamentally different from a typical

recession and therefore requires a different monetary policy response

 In a typical recession with low nominal growth and low inflation, policymakers can ease
monetary policy to stimulate demand

 E.g., easing cycles in the early 1990s, early 2000s and 2008 – 2009 recessions

 In a stagflationary environment with low real growth but high nominal growth,
policymakers need to adopt restrictive monetary policy to reduce inflation
 Under the Volcker-era tightening cycle of the early 1980s, inflation expectations stabilized

 Result: Federal Reserve maintains its inflation-fighting credibility

 Prematurely easing monetary policy in a stagflationary environment when real GDP

growth slows with inflation remaining high has been a serious policy mistake
 Under the Arthur Burns-era monetary policy in the 1970s, inflation expectations became
unanchored
 Result: Federal Reserve lost its inflation-fighting credibility

 Even if real GDP growth is negative, inflation can remain persistently high due to
continuing supply-demand imbalances, which are exacerbated by easy monetary policy
2
Monetary Policy Response During Typical Recessions

The last three recessions prior to the pandemic were characterized by negative
real GDP growth, modest or negative nominal GDP growth and low inflation

GDP Growth, Fed Funds Rate & Economic Conditions During Last Three Pre-Pandemic Recessions:

1990 - 1991 2001 2008 2009

Q4 Q1 Q1 Q2 Q3 Q1 Q2 Q3 Q4 Q1 Q2
QoQ Growth Annualized:
Nominal GDP Growth (0.7%) 2.0% 1.3% 5.0% 0.0% (0.2%) 4.4% 0.9% (7.6%) (4.8%) (1.4%)
Implicit Price Deflator 2.9% 3.9% 2.6% 2.5% 1.6% 1.4% 2.1% 3.0% 0.9% (0.2%) (0.7%)
Real GDP Growth (3.6%) (1.9%) (1.3%) 2.5% (1.6%) (1.6%) 2.3% (2.1%) (8.5%) (4.6%) (0.7%)

Monetary Policy Response:

Fed Funds Rate 7.0% 6.0% 5.0% 3.8% 3.0% 2.3% 2.0% 2.0% 0.1% 0.1% 0.1%

Economic conditions (as of quarter-end):

Unemployment Rate 6.3% 6.8% 4.3% 4.5% 5.0% 5.1% 5.6% 6.1% 7.3% 8.7% 9.5%
Core CPI - YoY 5.2% 5.2% 2.7% 2.7% 2.6% 2.4% 2.4% 2.5% 1.8% 1.8% 1.7%

In response to these typical recessions, the Federal Reserve appropriately lowered the Fed Funds rate to
stimulate demand and economic growth

Source: Bureau of Economic Analysis

3
Failed Monetary Policy During a Stagflationary Period

Under Arthur Burns’ tenure as the Chair of the Federal Reserve from 1970 to 1978,
monetary policy was insufficiently restrictive in light of extremely high inflation,
resulting in high inflation and inflationary expectations becoming unanchored

GDP Growth, Fed Funds Rate & Economic Conditions from 1970 to 1978:

Recession
'70 '71 '72 '73 '74 '75 '76 '77 '78
Annual GDP Growth:
Nominal GDP Growth 5.5% 8.5% 9.8% 11.4% 8.4% 9.0% 11.2% 11.1% 13.0% Stagflation: High nominal GDP
Implicit Price Deflator 5.3% 5.2% 4.6% 5.8% 8.9% 9.2% 5.8% 6.5% 7.4% growth & high inflation despite low
Real GDP Growth 0.2% 3.3% 5.2% 5.6% (0.5%) (0.2%) 5.4% 4.6% 5.6% or negative real GDP growth

Federal Reserve prematurely

Monetary Policy Response:
lowered the Fed Funds rate as real
Fed Funds Rate at Year-End 3.0% 3.5% 5.5% 9.0% 8.0% 4.9% 5.9% 6.5% 10.0% GDP growth slowed. Fed Funds rate
remained lower than inflation
Economic conditions (as of year-end):
Unemployment Rate 6.1% 6.0% 5.2% 4.9% 7.2% 8.2% 7.8% 6.4% 6.0%
Core CPI - YoY 6.6% 3.1% 3.0% 4.7% 11.1% 6.7% 6.1% 6.5% 8.5% Inflation remains persistently high
S&P 500 Annual Total Return 3.9% 14.3% 19.0% (14.7%) (29.7%) 37.2% 23.9% (7.2%) 6.6%

Inflationary pressures in the 1970s, like the current environment, were driven by energy price shocks resulting
from geopolitical uncertainty, government budget deficits and the growing bargaining power of labor

Source: Bureau of Economic Analysis

4
Successful Monetary Policy During a Stagflationary Period

Under Paul Volcker’s tenure as the Chair of the Federal Reserve from 1979 to
1987, monetary policy was successful in moderating inflation by maintaining a
high Fed Funds rate even in the face of slowing real GDP growth

GDP Growth, Fed Funds Rate & Economic Conditions from 1979 to 1987:

Recession
'79 '80 '81 '82 '83 '84 '85 '86 '87
Annual GDP Growth:
Nominal GDP Growth 8.7% 11.1% 7.5% 5.5% 6.0% 7.9% 7.7% 5.7% 3.3%
Implicit Price Deflator 5.5% 11.3% 4.9% 7.4% 1.4% 0.6% 3.5% 2.2% (0.2%)
Real GDP Growth 3.2% (0.2%) 2.6% (1.9%) 4.6% 7.3% 4.2% 3.5% 3.5% Federal Reserve maintained a high
Fed Funds rate, in excess of
Monetary Policy Response: inflation, even as inflation declined
Fed Funds Rate at Year-End 14.0% 18.0% 12.0% 8.5% 9.5% 8.3% 7.8% 6.0% 6.9%

Economic conditions (as of year-end):

Unemployment Rate 6.0% 7.2% 8.5% 10.8% 8.3% 7.3% 7.0% 6.6% 5.7%
Core CPI - YoY 11.3% 12.2% 9.5% 4.5% 4.8% 4.7% 4.3% 3.8% 4.2%
S&P 500 Annual Total Return 18.49% 32.40% (4.9%) 21.6% 22.6% 6.2% 31.7% 18.7% 5.3%

As a result of decisive and aggressive monetary policy, the Federal Reserve was able to restore its inflation
fighting credibility
Source: Bureau of Economic Analysis

5
A Future U.S. Recession Will Likely Be Stagflationary

In Q1 2022, both nominal GDP growth and inflation remained high despite
negative real GDP growth

Real and Nominal GDP Growth:

2020 2021 2022

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
QoQ GDP Growth Annualized:
Nominal GDP Growth (3.9%) (32.4%) 38.7% 6.6% 10.9% 13.4% 8.4% 14.5% 6.6%
Implicit Price Deflator 1.2% (1.2%) 4.9% 2.1% 4.6% 6.7% 6.1% 7.6% 8.2%
Real GDP Growth (5.1%) (31.2%) 33.8% 4.5% 6.3% 6.7% 2.3% 6.9% (1.6%)

Monetary Policy Response:

Fed Funds Rate at Quarter-End 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.4%

Economic conditions (as of quarter-end):

Unemployment Rate 4.4% 11.0% 7.9% 6.7% 6.0% 5.9% 4.7% 3.9% 3.6%
Core CPI - YoY 2.1% 1.2% 1.7% 1.6% 1.6% 4.5% 4.0% 5.5% 6.5%

Q1 2022 real GDP growth was negatively impacted by approximately 320bps due to a historically large net export
deficit. Excluding the impact of net exports, Q1 2022 GDP would have grown by 1.6% on a QoQ annualized basis

Source: Bureau of Economic Analysis

6
Inflation is Extremely High
and Likely to Persist
Current Run-rate Inflation Remains Extremely High

On a month-over-month basis, headline CPI and PCE figures are currently

increasing at a high-single-digit to low-double-digit annualized growth rate,
well in excess of the Federal Reserve’s 2% inflation target

CPI & PCE month-over-month inflation:

Nov-21 Dec-21 Jan-22 Feb-22 Mar-22 Apr-22 May-22

CPI 0.7% 0.6% 0.6% 0.8% 1.2% 0.3% 1.0%

MoM Annualized 8.7% 7.1% 8.0% 10.0% 15.9% 4.1% 12.3%
Trailing 3 Month Annualized 8.2% 8.9% 8.0% 8.4% 11.3% 9.9% 10.7%

Core CPI 0.5% 0.6% 0.6% 0.5% 0.3% 0.6% 0.6%

MoM Annualized 6.5% 7.0% 7.2% 6.2% 4.0% 7.0% 7.8%
Trailing 3 Month Annualized 5.7% 7.0% 6.9% 6.8% 5.8% 5.7% 6.3%

PCE 0.6% 0.5% 0.5% 0.5% 0.9% 0.2% 0.3%

MoM Annualized 7.1% 6.3% 6.2% 6.6% 11.3% 3.0% 3.9%
Trailing 3 Month Annualized 6.4% 7.1% 6.6% 6.4% 8.0% 6.9% 6.0%

Core PCE 0.5% 0.5% 0.4% 0.3% 0.3% 0.3% 0.3%

MoM Annualized 5.9% 6.3% 5.4% 3.7% 4.0% 4.2% 3.9%
Trailing 3 Month Annualized 4.9% 6.0% 5.9% 5.1% 4.4% 4.0% 4.1%

Source: Bureau of Labor Statistics (CPI Report), Bureau of Economic Analysis (PCE Data)

8
CPI is the Most Relevant Inflation Measure

We believe the Federal Reserve should carefully monitor CPI inflation in addition
to PCE inflation even though CPI is not explicitly identified as a target measure

 CPI more accurately represents inflation in out-of-pocket expenditures, particularly for

low- to middle-income consumers

“I look a lot at CPI and I know PCE headline is our number but I like both of them. The CPI is more
heavily weighted towards shelter and one reason I like to look at that is that’s more consistent with
what lower and moderate income groups face. They face a much bigger share of their disposable
income going to shelter, food and energy than upper income groups do.

So I don’t mind CPI as being kind of a good example of what lower and moderate income group in
terms of inflation so I don’t dismiss it. I look at it very seriously.”

– Christopher Waller, Member of the Federal Reserve Board of Governors

Virtual NABE Event, July 7, 2022

 CPI has outsized headline and media relevance compared with PCE, and therefore has a
greater role in shaping consumer and business inflation expectations

 CPI is a key input variable in cost-of-living adjustments, wage negotiations and various
other lagged price escalators

9
CPI / PCE Discrepancy is Primarily Due to
Scope Differences
PCE inflation has lagged CPI inflation primarily due to its lower weighting of
out-of-pocket expenditures like shelter and energy and its higher weighting of
categories that reflect imputed costs like healthcare and financial services
CPI & PCE Category Weightings:
“Scope effects. The CPI measures the change in the
out-of-pocket expenditures of all urban households
CPI PCE and the PCE index measures the change in goods and
Out-of-pocket expenditures: services consumed by all households, and nonprofit
institutions serving households.
Energy 8% 5%
Food (incl. away from home) 13% 14% This conceptual difference means that some items and
expenditures in the PCE index are outside the scope of the
Shelter 33% 16% CPI. For example, the expenditure weights for medical
Energy, food & shelter 54% 34% care services in the CPI are derived only from out-of-
pocket expenses paid for by consumers. By contrast,
medical care services in the PCE index include those
Categories with imputed costs: services purchased out of pocket by consumers and those
services paid for on behalf of consumers—for example,
Healthcare services 7% 16%
medical care services paid for by employers through
Financial services 0% 5% employer-provided health insurance, as well as medical
Healthcare & financial services 7% 21% care services paid for by governments through programs
such as Medicare and Medicaid.”
– Bureau of Labor Statistics

PCE inflation was not formally adopted as the Federal Reserve’s target inflation measure until the January 2012
FOMC meeting. Prior to 2012, both PCE and CPI inflation were referenced by FOMC participants in their
discussion of the Federal Reserve’s price stability mandate
Source: Bureau of Labor Statistics (CPI Report), Bureau of Economic Analysis (PCE Data)

10
Inflation is Increasingly Driven by Services
CPI in recent months has been increasingly driven by inflation in core
services, which tends to be more persistent and has a ~60% weighting in the
overall index
Month-Over-Month CPI Inflation by Consumption Category:

% of CPI Nov-21 Dec-21 Jan-22 Feb-22 Mar-22 Apr-22 May-22

CPI 100% 0.7% 0.6% 0.6% 0.8% 1.2% 0.3% 1.0%
Food 13% 0.8% 0.5% 0.9% 1.0% 1.0% 0.9% 1.2%
Energy 8% 2.4% 0.9% 0.9% 3.5% 11.0% (2.7%) 3.9%

Core CPI 78% 0.5% 0.6% 0.6% 0.5% 0.3% 0.6% 0.6% Contribution from
Annualized MoM 6.5% 7.0% 7.2% 6.2% 4.0% 7.0% 7.8% shelter alone accounts
for ~3% annualized
from Shelter Only 2.4% 2.2% 1.5% 2.6% 2.6% 2.6% 3.1%
run-rate inflation in
from Core Services Only 3.4% 3.1% 3.9% 4.7% 5.3% 6.5% 5.5% Core CPI
Trailing 3M Annualized 5.7% 7.0% 6.9% 6.8% 5.8% 5.7% 6.3%

Core goods:
New cars & used cars 8% 1.8% 2.2% 0.7% 0.0% (1.8%) 0.4% 1.4%
Household furnishings 4% 0.8% 1.2% 1.6% 0.8% 1.0% 0.5% 0.1%
Other core goods 9% 0.2% 0.3% 1.0% 0.7% 0.1% (0.1%) 0.3%
Core goods 21% 0.9% 1.2% 1.0% 0.4% (0.4%) 0.2% 0.7%

Core services:
Shelter 32% 0.5% 0.4% 0.3% 0.5% 0.5% 0.5% 0.6%
Airline fares 1% 1.9% 2.5% 2.3% 5.2% 10.7% 18.6% 12.6%
Other core services 24% 0.2% 0.2% 0.6% 0.5% 0.5% 0.5% 0.3%
Core services 57% 0.4% 0.3% 0.4% 0.5% 0.6% 0.7% 0.6%
% Core CPI Inflation from Core Services 52% 44% 54% 76% 134% 92% 70%

Source: Bureau of Labor Statistics (CPI Report)

11
Shelter Inflation is Likely to Remain Elevated

We believe shelter inflation, which accounts for approximately a third of

overall CPI, is likely to remain elevated

 CPI and PCE shelter inflation measures understate observed market trends

 CPI and PCE report approximately 5% to 6% year-over-year increase in shelter costs

 CoreLogic and Zillow market indices show an approximately 20% year-over-year increase in
home prices and a mid- to high-teens year-over-year increase in asking rents

 Higher mortgage rates and higher cost of home ownership drive rental demand

 Rental markets likely to face additional pricing pressure as households increasingly view
renting as a more affordable alternative to homeownership

 New housing will remain supply constrained

 Rent control & rent stabilization policies, environmental concerns and NIMBY-ism have
discouraged the construction and increased the cost of new affordable housing

12
Trimmed CPI and PCE Show Inflation Accelerating

Trimmed mean measures of CPI & PCE, which exclude outlier categories, are
rapidly rising, reflecting the increasingly broad-based nature of underlying inflation
Year-over-year growth in CPI / PCE and Trimmed Mean CPI / PCE:

9.0%
8.6%
8.0%
7.0%
6.5%
6.0% 6.3%
5.0%
4.0% 4.0%
3.0%
2.0%
1.0%
0.0%

CPI PCE Cleveland Fed Trimmed Mean CPI Dallas Fed Trimmed Mean PCE
Month-over-month change: Dec-21 Jan-22 Feb-22 Mar-22 Apr-22 May-22
CPI 0.6% 0.6% 0.8% 1.2% 0.3% 1.0%
Cleveland Fed - 16% Trimmed Mean CPI 0.5% 0.6% 0.5% 0.5% 0.4% 0.8%
PCE 0.5% 0.5% 0.5% 0.9% 0.2% 0.6%
Dallas Fed 24% Lower / 31% Upper Tail Trimmed Mean PCE 0.4% 0.5% 0.3% 0.2% 0.2% 0.4%

Source: Bureau of Labor Statistics (CPI Report), Bureau of Economic Analysis (PCE Data), Federal Reserve Bank of Cleveland, Federal Reserve Bank of Dallas

13
One-Year-Ahead Inflation Expectations
Have Become Unanchored

Survey-based measures of near-term inflation expectations have become

unanchored, anticipating approximately 4% to 7% inflation over the next year
Median One-Year-Ahead Inflation Expectations:
7.0%
6.8%
6.0%
5.3%
5.0%

4.0%
3.6%
3.0%

2.0%

1.0%

Atlanta Fed Business Inflation Expectations, 1 Year Ahead U. of Michigan Consumer Inflation Expectations, 1 Year Ahead
(n = ~300 businesses of various sizes) (n = ~600 households)
NY Fed Survey of Consumer Expectations, 1 Year Ahead
(n = ~1,300 households)

Although the Federal Reserve and market participants place greater importance on long-term inflation
expectations, one-year-ahead inflation expectations likely play a pivotal role in shaping price-setting behavior by
firms and increased wage demands of employees
Source: Business Inflation Expectations Survey conducted by the Federal Reserve Bank of Atlanta; University of Michigan Survey of Consumers, Survey of Consumer Expectations conducted by the
Federal Reserve Bank of New York.
14
Long-Term Inflation Expectations Are Rising
Survey-based measures of longer-term inflation expectations have also risen
sharply over the last twelve months, currently projecting approximately 3% to 4%
inflation per annum over the next five- to ten-year period
Median Long-Term Inflation Expectations:
4.5%

4.0%
3.6%
3.5% 3.5%
3.1%
3.0%
2.9%
2.5%

2.0%

1.5%

1.0%

Atlanta Fed Business Inflation Expectations, next 5 to 10 Years Survey of Professional Forecasters, 5-Year PCE Inflation
(n = ~300 businesses of various sizes) (n = 34 Forecasters)

U. of Michigan Consumer Inflation Expectations, next 5 to 10 Years NY Fed Survey of Consumer Expectations, next 3 Years
(n = ~600 households) (n = ~1,300 households)
Source: Business Inflation Expectations Survey conducted by the Federal Reserve Bank of Atlanta; Survey of Professional Forecasters conducted by the Federal Reserve Bank of Philadelphia;
University of Michigan Survey of Consumers, Survey of Consumer Expectations conducted by the Federal Reserve Bank of New York.
15
Wage Inflation Remains High
On a month-over-month basis, average hourly earnings have consistently
grown at a 4% to 5% annualized rate. For production and non-supervisory
employees, who represent approximately 80% of the labor force, hourly
earnings are growing at an even faster pace of approximately 5% to 6%

Average hourly earnings of all employees on private nonfarm payrolls by industry (seasonally adjusted):

Dec-21 Jan-22 Feb-22 Mar-22 Apr-22 May-22 Jun-22

All Private Nonfarm Employees:
Average Hourly Earnings $31.4 $31.6 $31.6 $31.8 $31.9 $32.0 $32.1
YoY Growth 4.9% 5.4% 5.2% 5.6% 5.5% 5.3% 5.1%
MoM Growth 0.5% 0.6% 0.1% 0.5% 0.3% 0.4% 0.3%
MoM Annualized 5.9% 7.1% 1.5% 5.8% 4.2% 4.6% 3.8%
Trailing 3 Month Growth Annualized 6.1% 5.9% 4.8% 4.8% 3.9% 4.9% 4.2%

Production and Non-Supervisory Employees:

Average Hourly Earnings $26.7 $26.9 $27.0 $27.1 $27.2 $27.3 $27.5
YoY Growth 6.2% 6.7% 6.7% 6.7% 6.6% 6.4% 6.4%
MoM Growth 0.7% 0.5% 0.3% 0.4% 0.4% 0.5% 0.5%
MoM Annualized 8.9% 6.0% 3.6% 5.0% 5.5% 6.4% 5.9%
Trailing 3 Month Growth Annualized 7.5% 7.0% 6.2% 4.9% 4.7% 5.6% 5.9%

Rising inflation expectations and high levels of wage inflation create a self-reinforcing cycle that drives
higher levels of future price and wage inflation

Source: Bureau of Labor Statistics (Employment Situation Report)

16
Inflationary Pressures Likely to Persist

We believe inflationary pressures arising from the current supply-demand

imbalance are likely to persist due to a combination of elevated nominal
spending and continued tight supply conditions

Nominal Spending Likely to Remain Elevated

 Rotation in spending from goods to services

 Significant excess household savings of ~$2.6 trillion

 Equal to approximately 11% of nominal GDP and 15% of nominal PCE

 Large untapped borrowing capacity

 Record low loan-to-deposits ratio in banking system
 Modest household leverage levels relative to history

Aggregate
Supply
 wage growth
Conditions Likelydriven by bothTight
to Remain job gains and hourly wage inflation

 Labor market is extremely tight, with a 3.6% unemployment rate that is near historical lows
 Nearly twice the number of job openings as the number of unemployed persons

 Industrial capacity utilization rates at peak levels

 Inventories on a real basis, adjusted for inflation, are in-line with historical levels

17
 Nominal Spending
Likely to Remain Elevated
Shift in Consumption from Goods to Services

While recession concerns have focused on the recent decline in goods

spending, services spending – which accounts for ~60% of real personal
consumption – has maintained consistent growth and remains below trend

Real Personal Consumption Expenditure (PCE) by Category as % of December 2019 Levels:

125%
120%
115%
113%
% of December 2019 Level

110%
107%
105% 105%
100% 101%

95%
90%
85%
80%
75%
Mar-20

Mar-21

Mar-22
Jul-20

Nov-20

Jul-21

Nov-21
Aug-20

Oct-20

Aug-21

Oct-21
Dec-19

Apr-20

Dec-20

Apr-21

Dec-21

Apr-22
Feb-20

Feb-21

Feb-22
Jan-20

May-20
Jun-20

Sep-20

Jan-21

May-21
Jun-21

Sep-21

Jan-22

May-22
Real PCE Goods (39% of Real PCE)
Real PCE Trendline ('14 - '19 CAGR: 2.7%) Services (61% of Real PCE)

Source: Bureau of Economic Analysis

19
Approximately $2.6 Trillion in Excess Savings
A combination of significantly above-trend disposable income and below-trend
personal consumption during the pandemic has resulted in the accumulation of
approximately $2.6 trillion in excess savings, equal to 11% of nominal GDP

Quarterly Disposable Personal Income and Consumption | Trendline vs Actual (Nominal $ in trillions):

~$1.7tn in cumulative above-trend disposable income

$5.0 driven by government stimulus programs (CARES Act
in March 2020, American Rescue Plan in March 2021)
and a rapid recovery in aggregate wages

$4.5

$4.0
$ in trillions

$3.5
~$0.9tn in cumulative below-trend personal
consumption as a result of pandemic
$3.0 related closures and restrictions

$2.5
Q3 2019 Q4 2019 Q1 2020 Q2 2020 Q3 2020 Q4 2020 Q1 2021 Q2 2021 Q3 2021 Q4 2021 Q1 2022
Disposable Personal Income - Trend Disposable Personal Income - Actual
Personal Consumption Expenditures - Trend Personal Consumption Expenditures - Actual
Source: Bureau of Economic Analysis
20
Personal Savings Rate Remains Within
Long-Term Historical Range
The personal savings rate recently declined to 5.4%, below its pre-pandemic
level of ~7.4%, but consistent with levels seen before the GFC in 2008
Personal Savings Rate (Personal Savings / Disposable Personal Income):

35.0%

30.0%

25.0%

20.0%

15.0%

'14 - '19 Average: 7.4%

10.0%

5.0% 5.4%

0.0%

Source: Bureau of Economic Analysis

21
Excess Savings Buffer Can Sustain a Low Savings Rate

The monthly savings deficit resulting from the recent decline in the
savings rate represents a relatively small portion of the approximately $2.6
trillion in cumulative excess savings
Monthly Personal Income & Outlays | Seasonally Adjusted (nominal $ in trillions):

Dec-21 Jan-22 Feb-22 Mar-22 Apr-22 May-22

Disposable Personal Income $1,527 $1,508 $1,517 $1,525 $1,532 $1,540
Less: Personal Outlays (1,395) (1,420) (1,428) (1,445) (1,453) (1,456)
Personal Savings (A) $133 $87 $88 $80 $79 $84
Savings rate 8.7% 5.8% 5.8% 5.3% 5.2% 5.4%
Even if the savings rate were
Normalized Personal Savings (B) $113 $112 $112 $113 $114 $114 to reach and stay at 0%, it
'14 - '19 Avg. Savings Rate 7.4% 7.4% 7.4% 7.4% 7.4% 7.4% would take approximately two
years for consumers to fully
Savings Surplus / (Deficit) (A - B) $19 ($25) ($24) ($33) ($35) ($30) deplete the approximately $2.6
trillion in excess savings
% of Excess Savings 0.8% (1.0%) (0.9%) (1.3%) (1.3%) (1.2%)

We believe the substantial excess savings reserve will continue to allow consumers to fund a high level
of nominal spending growth even as their savings rate declines

Source: Bureau of Economic Analysis

22
Share of Excess Savings by Income Level

Excess savings are estimated to be concentrated within households in the top

20% of the income distribution, which account for nearly 40% of all spending

Goldmans Sachs Estimate of the Share of Excess Savings by Income Level:

40% 40%
“People in the bottom 20% of the income
distribution spend some 31% of their after-tax
income on gasoline and food at home, where
prices are up 30% and 7% respectively since last
September, when extended/enhanced
unemployment benefits ended. But these
households account for only about 9% of total
20% consumption; they don’t drive the economic
cycle. By contrast, the top 20 of the income
distribution account for 39% of all spending.”

–Ian Shepherdson, Chief Economist

Pantheon Macroeconomics
May 23, 2022

Top 20% 40% - 80% Bottom 40%

The economic cost of inflation is most acute for lower income households who have a lower level of excess
savings and spend an outsized portion of their income on necessities like food and energy, which have
experienced substantial inflation
Source: Goldman Sachs Research
23
Aggregate Wage Growth Remains Robust

Aggregate wages for private nonfarm employees is currently increasing at an

annualized rate of approximately 7%, driven by job gains and wage inflation

Aggregate wages for private nonfarm employees:

Dec-21 Jan-22 Feb-22 Mar-22 Apr-22 May-22 Jun-22
Private Nonfarm Employees (mm) 127.1 127.6 128.3 128.7 129.0 129.4 129.8
Payroll adds (K) 561 492 704 385 368 336 381
MoM Growth 0.4% 0.4% 0.6% 0.3% 0.3% 0.3% 0.3%
MoM Annualized 5.5% 4.7% 6.8% 3.7% 3.5% 3.2% 3.6%
YoY Growth 5.2% 5.2% 5.2% 5.0% 5.1% 5.0% 4.9%

Average Hourly Earnings $31.4 $31.6 $31.6 $31.8 $31.9 $32.0 $32.1
MoM Growth 0.5% 0.6% 0.1% 0.5% 0.3% 0.4% 0.3%
MoM Annualized 5.9% 7.1% 1.5% 5.8% 4.2% 4.6% 3.8%
YoY Growth 4.9% 5.4% 5.2% 5.6% 5.5% 5.3% 5.1%
Average Weekly Hours 34.8 34.6 34.7 34.6 34.6 34.5 34.5

Aggregate Wages (Annualized bn) $7,217 $7,245 $7,315 $7,351 $7,397 $7,423 $7,468
MoM Growth 0.9% 0.4% 1.0% 0.5% 0.6% 0.3% 0.6%
MoM Annualized 11.7% 4.7% 12.3% 6.0% 7.9% 4.2% 7.5%
YoY Growth 10.7% 9.7% 11.0% 9.9% 9.9% 9.4% 9.3%

Even if consumers do not draw from their excess savings or borrowing capacity, we believe robust growth
in aggregate wages should sustain a high level of nominal spending growth

Source: Bureau of Labor Statistics (Employment Situation Report)

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Significant Lending Capacity in Banking System

The substantially lower growth in credit relative to deposits has resulted in a

historically low loan-to-deposits ratio of only 63%, which is down 13
percentage points from its pre-pandemic level of 76%
Loan-to-Deposits Ratio | U.S. Commercial Banking System:

110%

100%

90%

80% 76%

70%
63%
60%

50%

40%

We believe a normalization of the loan-to-deposits ratio can substantially offset the impact of quantitative
tightening on deposit and credit growth. If deposits were to stay at the same level, a return to the pre-
pandemic loan-to-deposits ratio of 76% would support approximately $2.4 trillion in additional lending
Source: Federal Reserve (Release H.8 Assets and Liabilities of Commercial Banks in the United States)

25
Modest Household Leverage

Gross household leverage is in-line with historical levels. Net leverage, as a

result of an accumulation in excess savings and cash holdings, has decreased
materially relative to its pre-pandemic level
Gross and net household leverage:
1.4x

1.2x

1.0x 1.0x

0.8x

0.6x

0.4x

0.2x

0.0x 0.0x
Mar-90
Mar-91
Mar-92
Mar-93
Mar-94
Mar-95
Mar-96
Mar-97
Mar-98
Mar-99
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Mar-12
Mar-13
Mar-14
Mar-15
Mar-16
Mar-17
Mar-18
Mar-19
Mar-20
Mar-21
Mar-22
Gross household debt / Disposable Personal Income Net household debt / Disposable Personal Income

Source: Federal Reserve (Release Z.1 Financial Accounts), Bureau of Economic Analysis
Note: Gross household debt is comprised of home mortgages, consumer credit and other household liabilities. Net household debt is gross household debt less cash and cash-like deposits.
Disposable personal income denominator reflects the average disposable personal income of the trailing four quarters.

26
 Supply Conditions
Likely to Remain Tight
Strong Labor Market

The economy has nearly recovered the entirety of the employment shortfall
caused by the pandemic, with total employment only 755K jobs lower than its
level in February 2020
Current vs Pre-Pandemic Employment Summary | Figures in millions:

Feb-20 Jun-22 Difference

Total employed in labor force 158.9 158.1 (0.8)

Unemployed in labor force 5.7 6.0 0.2

Headline U-3 unemployment rate 3.5% 3.6% 0.1%
1
U-6 unemployment rate 7.0% 6.7% (0.3%)

Total civilian labor force 164.6 164.0 (0.6)

Labor force participation rate 63.4% 62.2%
Total civilian non-institutional population (16+) 259.6 263.8 4.2
Employed / Population 61.2% 59.9%

The headline U-3 unemployment rate is only 10bps higher than its February 2020 level. The U-6
unemployment rate is 30bps below its February 2020 level and is at a historical low
Source: Bureau of Labor Statistics (Employment Situation Report)
(1) U-6 unemployment rate represents total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor
force plus all persons marginally attached to the labor force

28
Unemployment Rate at Historical Lows

Over the last 50 years, there have only been three months when the
headline unemployment rate was lower than the current level of 3.6%
Headline U-3 & U-6 Unemployment Rate:

20.0%

18.0%

16.0%

14.0%

12.0%

10.0%

8.0%
6.7%
6.0%

4.0%
3.6%
2.0% 50-Year-Low Unemployment Level: 3.5%
Reached September 2019, January & February 2020
0.0%

Headline U-3 Unemployment Rate U-6 Unemployment Rate

Source: Bureau of Labor Statistics (Employment Situation Report)

29
Job Openings at Historical Highs

There are an unprecedented 11.3 million job openings in the economy, 5.3
million more than the number of unemployed persons, the widest gap since
job openings data first became available
Number of Job Openings and Total Unemployed Persons in Labor Force | Figures in millions:

22.0
20.0
18.0
16.0
14.0
12.0
11.3
10.0
8.0
6.0 5.9
4.0
2.0
0.0

Unemployed persons Job openings

Source: Bureau of Labor Statistics (Job Openings and Labor Turnover Survey)

30
Recovery in Labor Demand vs Supply

Labor demand (employment plus job openings) has rapidly recovered with
approximately 4 million more jobs available today than in December 2019, whereas
the labor force remains approximately 300k workers below its December 2019 level

Labor Demand (Employment plus Job Openings) & Labor Supply (Labor Force) | Figures in millions:
170

160

150

140

130

120

110

100

Total Employed Job Openings Labor Demand (Employed plus Openings) Labor Supply (Labor Force)

Source: Bureau of Labor Statistics (Job Openings and Labor Turnover Survey)
31
Low Job Layoff and High Voluntary Quit Rates
Current high rate of job separations is primarily comprised of voluntary quits.
Job layoffs, as a percentage of nonfarm payrolls, are at their lowest level since
data first became available
Monthly job layoffs and job quits as % of nonfarm payrolls:
3.50%

3.00%
2.8%

2.50%

2.00%

1.50%

1.00%
0.9%

0.50%

0.00%

Job quits as % of nonfarm payrolls Job layoffs as % of nonfarm payrolls

Source: Bureau of Labor Statistics (Job Openings and Labor Turnover Survey)
32
Recent (June 29, 2022) Commentary from Paychex
Confirms Economic Strength and Continued Job Growth

Paychex is a leading provider of payroll and human resource outsourcing

services for small- to medium-sized businesses

“Macroeconomic trends have been positive this year, but with inflation at a 40-year high, there are concerns for
potential of a recession in the near future. We continue to monitor key leading indicators for any signs of a
change in the macroeconomic environment, but have not seen any signs of deterioration at this time.

Typically, the first signs of a macroeconomic recession would be a decline in employment levels at
existing clients and uptick in non-processing clients or a slowdown in sales activities. These indicators
continue to trend in a positive direction.

The latest Paychex IHS Small Business Employment Watch reflected a 12-month consecutive -- a 12th
consecutive month of increasing hourly earnings gains, though we did notice slowing a bit of the pace
of job growth in May. However, this is more reflective of being near full employment and the difficulty of
finding employees.

Job growth at U.S. small businesses remained strong in the face of a tight labor market and inflation
pressures.”

– Martin Mucci, Chairman and CEO of Paychex

Paychex Q4 FY 2022 Earnings Call, June 29, 2022

33
U.S. Industrial Capacity Growth Remains Limited

Whereas industrial production is highly cyclical, industrial capacity is

relatively inelastic and has typically grown at a low-single-digit rate per annum

Year-over-year growth in U.S. industrial capacity & production:

20.0%

15.0%

10.0%

5.0%

0.0%

(5.0%)

(10.0%)

(15.0%)

(20.0%)
Industrial Capacity Growth Industrial Production Growth

Source: Federal Reserve (Release G.17 Industrial Production and Capacity Utilization)

34
Industrial Capacity Utilization at Peak Levels

Current industrial capacity utilization is nearing peak levels seen over the last
twenty years

U.S. Industrial Capacity Utilization (Production / Capacity):

90.0%

85.0%

80.0%
79.0%

75.0%

70.0%

65.0%

60.0%

Capacity Utilization

Source: Federal Reserve (Release G.17 Industrial Production and Capacity Utilization)

35
Real Inventory as % of GDP Is Below Historical Trend

Real private inventory levels, which reflect inventory units on a price-adjusted

basis, do not appear to be at unsustainably high levels relative to real GDP
Real Private Inventories as % of Real GDP:

17.0% Private Inventories

% of Real GDP
16.5% 2000s 15.3%
2010s 15.0%
16.0% Q4 '19 15.1%
Q1 '22 14.6%
15.5%

15.0%
14.6%
14.5%

14.0%

13.5%

The economy may stabilize at a higher level of real private inventories relative to GDP as companies recalibrate
towards a “just in case inventory” vs a “just in time inventory” operating model
Source: Bureau of Economic Analysis

36
Retail Inventory-to-Sales In-line With Historical Levels

Current nominal inventory-to-sales ratios are in-line with their historical pre-
pandemic levels across most retail sales categories

Nominal inventory-to-sales ratios by category:

Historical Averages % Above / (Below)

% of Sales '00-'09 '10-'19 2019 2020 2021 Current '10-'19 2019
Total Retail Sales 100% 1.54x 1.44x 1.47x 1.34x 1.13x 1.18x (18%) (20%)
Total Ex. Motor Vehicle and Parts 78% 1.37x 1.24x 1.22x 1.15x 1.07x 1.15x (7%) (6%)
Motor Vehicle and Parts 22% 2.04x 2.11x 2.31x 2.07x 1.32x 1.28x (39%) (45%)
Furniture, Electronics, & Appliance 3% 1.76x 1.61x 1.57x 1.65x 1.34x 1.62x 1% 3%
Building Materials & Garden 7% 1.72x 1.83x 1.84x 1.66x 1.72x 1.87x 2% 2%
Food and Beverage 13% 0.81x 0.79x 0.79x 0.73x 0.74x 0.78x (1%) (2%)
Clothing & Accessories 4% 2.55x 2.42x 2.42x 4.24x 1.90x 2.12x (12%) (12%)
General Merchandise 12% 1.66x 1.44x 1.37x 1.27x 1.26x 1.58x 10% 15%
Department Stores 2% 2.11x 2.11x 2.07x 2.11x 1.76x 2.12x 1% 2%
Other 36% 2.10x 2.11x 2.07x 2.11x 1.76x 2.12x 1% 2%

Source: Census Bureau Monthly Retail Trade Report

37
Rapid Inventory Growth is Driven by Inflation

Although inventory levels appear to be growing rapidly on a nominal basis, the

growth is entirely due to elevated levels of price inflation. In Q1 2022, on a
price-adjusted basis, real inventories (units) were only up 1% year-over-year
Year-over-year growth in nominal and real private inventories:

20% Inventory Growth - YoY

Nominal Real Price
2000s 6% 2% 4%
15% 2010s 3% 3% 1%
2019 3% 3% 0%
10% Q1 '22 18% 1% 17%

5%

0%

(5%)

(10%)

(15%)

(20%)
Nominal Inventories YoY Growth Real Inventories YoY Growth

We expect that large growth in nominal inventories due to price should have very different discounting dynamics
than large growth primarily due to units, which suggests that widespread discounting is unlikely

Source: Bureau of Economic Analysis

38
Long-Term Structural Headwinds to Supply Growth

Several emerging structural forces, which are not yet reflected in recently
reported data, will likely add substantial long-term inflationary pressures

 Renewed focus on national and resource security

 Desire for energy independence drives local resource production

 De-globalization and re-shoring of supply chains

 Recent supply chain disruptions have highlighted the need for improved supply chain control
and redundancy

 Adoption of ESG standards and de-carbonization

 Long-term capacity growth for commodities production (e.g., new mines, pipelines, drilling rigs)
remains highly challenged due to environmental and regulatory considerations

 Labor bargaining power

 Rise of unionization (e.g., Starbucks and Amazon)

 Lack of immigration

 Stakeholder capitalism

39
Conclusion

While there are some early signs of a slowdown in real economic growth, we
believe inflationary pressures are likely to persist due to ongoing supply-
demand imbalances

 High inflation is a tax on economic growth

 Inflation has an outsized negative impact on low- to middle- income households

 Persistently high inflation hampers the ability of consumers and businesses to plan and
invest for the long-term

 Historical precedents suggest that prematurely easing monetary policy in a

stagflationary environment is a serious policy mistake

 Insufficiently restrictive monetary policy in the 1970s led to high persistent inflation and
inflationary expectations becoming unanchored

 Raising and maintaining the Fed Funds rate at a sufficiently high level has been the
only proven policy response to stabilizing inflation and inflationary expectations

 Once inflation has been quelled, the economy can experience a lengthy and robust
expansion similar to the recovery that followed the Volcker-era tightening cycle

40
Prudent Risk Management & Inflation Expectations

We agree with Cleveland Federal Reserve President Loretta Mester’s proposed

risk management approach to monetary policy and inflation expectations

“In the current situation, from a risk-management perspective, it is important for policymakers to ask which
situation would be more costly: erroneously assuming longer-term inflation expectations are well anchored
at the level consistent with price stability when, in fact, they are not? Or erroneously assuming that they are
moving with economic conditions when they are actually anchored? Simulations of the Board’s FRB/US
model suggest that the more costly error is assuming inflation expectations are anchored when they are not.
If inflation expectations are drifting up and policymakers treat them as stable, policy will be set too loose.
Inflation would then move up and this would be reinforced by increasing inflation expectations. If, on the
other hand, inflation expectations are actually stable and policymakers view the drift up with concern, policy
will initially be set tighter than it should. Inflation would move down, perhaps even below target, but not for
long, since inflation expectations are anchored at the goal.

These simulation results, coupled with research suggesting that persistent elevated inflation poses an
increasing risk that inflation expectations could become unanchored, strongly argue against policymakers
being complacent about a rise in longer-term expectations. Indeed, inflation expectations are determined not
only by movements in inflation but also by policymakers’ actions to follow through on their strongly stated
commitment to return inflation to its longer-run goal, thereby justifying the public’s belief in the central
bank’s commitment.”

– Loretta Mester, President of the Federal Reserve Bank of Cleveland

The Role of Inflation Expectations in Monetary Policymaking: A Practitioner’s Perspective
June 29, 2022

41
Disclaimer
Bill Ackman is the CEO of Pershing Square Capital Management, L.P. (“Pershing Square”), a registered investment adviser. Pershing Square
considers inflation and increasing interest rates to be material risks to equity markets and owns interest rate swaptions to hedge these risks.
Pershing Square may purchase, hold, sell, or otherwise change the form of its investments at any time and for any reason. Pershing Square hereby
disclaims any duty to provide any updates or changes to the information in this presentation or information regarding the manner or type of any
Pershing Square investment. All information provided herein is for information purposes only. The information provided in this presentation should
not be considered a recommendation to purchase or sell any particular financial instrument.

42