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ESSAYS ON ISSUES

THE FEDERAL RESERVE BANK
OF CHICAGO

FEBRUARY 1996
NUMBER 102

Chicago Fed Letter
Can the consumer keep
the expansion alive?
While 1995 witnessed the soft landing that had been widely forecast,
the economic outlook for 1996 is for
continued modest growth following
this slowdown. The Federal Reserve
Bank of Chicago held its Ninth Annual Economic Outlook Symposium
on December 8, 1995. More than 50
economists and analysts from business, academia, and government
attended the symposium. The sessions focused on the question, can
the consumer keep the expansion
alive? Prior to the symposium, participants were invited to submit both
annual and quarterly 1996 forecasts
for many gross domestic product
(GDP) components, as well as several
other economic series. Thirty-five
individuals provided forecasts, and a
consensus forecast was presented at
the symposium. This Fed Letter will
review the accuracy of the forecast
for 1995 presented at last year’s symposium and summarize the 1996
Economic Outlook Symposium.
The economy in 1995—forecast
and results
The expectation at last year’s Economic Outlook Symposium was for growth
in real GDP to average 2.4% for the
fourth quarter of 1994 through the
first three quarters of 1995, a reduction
from the extremely strong 4.4% pace
of the previous four quarters. Figure 1
shows that while the forecast was accurate as to the downward direction in
the growth rate, the softening was not
as significant as expected. Real GDP
averaged a fairly strong 3.3% over the
four quarters through the third quarter of 1995.
Among components of real GDP
which were stronger than forecast

were personal consump1. 1995 forecast of real GDP
tion expenditures,
business fixed investpercent change, annual rate
8
ment, and change in
business inventories.
Forecast range
However, many of the
Actual
other economic series
4
(both components and
indicators) that are
used to measure
strength in the econo0
my were weaker than
expected, including
residential construc-4
tion, net exports, and
government expendi1989
’90
’91
’92
’93
’94
’95
tures. Industrial proNote: The dashed line represents the mean of the consensus forecast.
Source: U.S. Bureau of Economic Analysis, National Income Product Accounts,
duction, which was
various years.
forecast to increase by
for 1996 real GDP is 2.5%. This de3.6%, averaged a growth rate of 3.1%
cline of 0.7% is based on softening
over the four quarters. Sales of cars
in the growth rates of personal conand light trucks, which were expected
sumption expenditures, business
to average 15.3 million units, fell
fixed investment, and change in
short by nearly half a million units.
business inventories. Residential
The 1995 forecasts were too pessimisconstruction is expected to grow by
tic on the unemployment rate, which
2.1% this year. The other area where
was 0.3% lower than forecast. Many
some slight improvement is forecast
of the forecasters expected the inflato occur in 1996 is net exports, which
tion rate to increase to 3.5% from an
are expected to average –$121.6 bilaverage 2.8% for the previous four
lion. Government is forecast to
quarters; in fact it averaged 2.7%.
match its no-growth performance of
Overall, the forecasters were surprised by the strength in the economy the past year.
in 1995, especially in business fixed
Following the slowdown in real GDP,
investment, and the relative weakness
industrial production is expected to
in the rate of inflation.
slow from 3.5% to 2.5% in 1996. Cars
and light trucks are expected to conLooking ahead to 1996
tinue their relatively modest output
rate of 14.7 million units. Housing
1996 is generally expected to be an
starts are expected to follow the 1.35
uneventful year in economic terms.
million unit pace that they experiThis is not necessarily a bad thing—
enced in 1995. The unemployment
consider that not a single forecaster
rate is forecast to rise by one-tenth of a
is expecting a recession over the
percent to 5.7%. Inflation is forecast
next five quarters. Figure 2 summato decline by one-tenth of a percent to
rizes what forecasters are expecting
2.8% in 1996. The prime rate is foreboth in 1995 (fourth-quarter numcast to fall by over 40 basis points next
bers not known) and in 1996. The
year. Finally, the trade-weighted dollar
consensus forecast is for 1995 real
is expected to rise by 1.5%.
GDP to average 3.2%. The forecast

2. Mean forecasts from the 1996 Economic Outlook Symposium
1994
Real GDP
4.1%
Personal consumption expenditures
3.5%
Business fixed investment
13.7%
Residential construction
8.6%
Change in business inventories (bil. constant $)
$47.8
Net exports of goods and services (bil. constant $) –$110.0
Government purchases of goods and services
–0.8%
Industrial production
5.3%
Cars and light-truck sales (millions)
15.1
Housing starts (millions)
1.45
Unemployment rate
6.1%
Inflation rate (consumer price index)
2.6%
Prime rate
7.14%
Federal Reserve trade-weighted dollar
–2.0%

1995
3.2%
2.9%
14.5%
–1.9%
$37.1
–$124.2
0.0%
3.5%
14.7
1.35
5.6%
2.9%
8.78%
–6.4%

1996
2.5%
2.4%
6.8%
2.1%
$28.9
–$121.6
0.1%
2.5%
14.7
1.34
5.7%
2.8%
8.35%
1.5%

Note: Data are actual for 1994 and forecast for 1995 and 1996.
Sources: U.S. Bureau of Economic Analysis; Federal Reserve Board of Governors, various releases; U.S.
Department of Commerce, Bureau of the Census; U.S. Department of Labor, Monthly Labor Review, various
years; U.S. Department of Labor, Bureau of Labor Statistics.

Figure 3 shows that the consensus
forecast for quarterly GDP is for a
fairly weak fourth quarter 1995 with
growth in real GDP of 2%, increasing
and holding steady at around 2.5%
in 1996. Personal consumption expenditures, business fixed investment, residential construction, and
change in business inventories all
display patterns of softening in their
growth rates as 1996 progresses.
Only net exports are expected to
strengthen going into 1997.
Looking at the quarterly patterns for
the other economic series, both industrial production and the tradeweighted dollar are expected to grow
at the same pace as they have recently. Cars and light-truck sales and the
unemployment rate are expected to
hold relatively steady at current levels. The prime rate and housing
starts are expected to decline over
the forecast horizon. Figure 4 illustrates that a slight pickup in inflation
is anticipated during 1996.
The consumer sector holds its ground
The personal consumption expenditures component comprises over
two-thirds of GDP. Knowing how
the durables sector, which is the
most volatile part of consumer ex-

employment growth, consumer debt
loads, and prices of autos are factors
that will determine this trend. In the
event that the federal budget talks
drag on with no significant easing
from the Federal Reserve, rising interest rates could bring consumption to
a lower level than anticipated.
An economist from a major home
appliance manufacturer indicated
that sales for the core group of appliances (i.e., washers, dryers, refrigerators, ovens, ranges, dishwashers, and
freezers), which tend to move with
the business cycle, are holding steady
at about 31 million units per year.
This economist believes appliance
producers will try to pass-through
some price increases during 1996,
but that they will not be successful.
Competition from within the industry will hold prices down. Very little
growth is expected in home appliance sales in 1996. One issue that
bears watching is the level of consumer debt. Should the consumer
debt service burden continue to rise,
it may also have a dampening effect
on economic growth.

penditures, will perform in 1996 is
key to understanding whether the
consumer will keep the economic
expansion alive. An economist from
a Big 3 auto manufacturer indicated
that the consensus forecast of 2.5%
The investment sector remains
growth in real GDP leaves little
relatively strong
room for growth in the auto market.
This economist projected light-vehiWhile the investment component of
cle sales of 14.9 million units in
GDP is expected to increase by only
1996, up only 1% from 1995 levels.
half as much in1996 as in the past
Expectations are for the Federal
year, it still represents a key driver to
Reserve to ease monetary policy
the economy. Like consumer durasoon, but growth in consumption
bles, investment is an extremely
may still be at an even lower rate
volatile component of GDP, and the
than GDP growth.
One potential positive
effect on auto sales in
3. 1996 forecast of real GDP
1996 is that the strong
percent change, annual rate
sales of the late 1980s
8
may generate some
Forecast range
new sales as owners
Actual
consider replacing
4
those seven- to tenyear-old vehicles.
However, improvements in durability
0
may dampen replacement demand, and
the bulk of the growth
in auto sales is likely
-4
to be trend-driven.
1990
’91
’92
’93
’94
’95
’96
Population growth,
Note: The dashed line represents the mean of the consensus forecast.
household formation,
Source: U.S. Bureau of Economic Analysis.

domestic sales and
production in 1996.
The growth potential
percent change in the CPI, annual rate
9
for this industry durForecast range
ing 1996 is limited by
the relatively slow
growth forecast for the
6
economy; however,
Actual
export markets should
provide growth opportunities. Sales to Chi3
na have been very
encouraging and South
America is expected to
0
provide $9 billion in
machine-tool orders
1990
’91
’92
’93
’94
’95
’96
over the next five years.
Note: The dashed line represents the mean of the consensus forecast.
Source: U.S. Department of Labor, Bureau of Labor Statistics.
While orders are estimated to have risen by
10% during 1995, they are forecast to
heavy-duty truck segment is arguably
grow by only 5% in 1996.
its most erratic performer. An analyst from a heavy-duty truck research
Basic materials industries are at the
company forecasts a soft landing for
leading edge
the U.S. economy. At this time, twoA consultant to the steel industry
thirds of all manufactured goods are
expects steel shipments to be up a
hauled by truck. Trucks continue to
modest 2% to 3% in 1996. Roughly
gain share of the freight market be75% of all steel goes into construction
cause the manufactured goods that
and producer durable equipment.
are transported by truck are experiThe other 25% goes into consumer
encing growth. However, for 1996,
durable equipment. Imports of
slow growth in industrial production
is expected to lead to an 18% decline steel continue to decline. A shift in
the types of steel being produced is
in sales and a 22% decline in proanticipated, away from sheet steel,
duction of Class 8 heavy-duty trucks.
which is used in the auto and appliWhile the backlog-to-build ratio
ance industries, toward structural
reached nearly 14 months during
steel, which is used for plant and
1994, it has more recently slipped to
equipment applications. The projust over six months. The current
portion of domestic steel used in
level is relatively good, when historiauto production is expected to incally the ratio has been under four
crease in 1996 as the share of domonths. Due to the waning of pentmestically produced autos continup demand for heavy-duty trucks after
ues to increase. Continued strong
two record production years in 1994
plant and equipment expenditures
and 1995, the industry may be facing a
during 1996 should also help the
very tough year in 1996. However,
steel industry.
forecast production levels for 1996
should still make it the fourth-best
An analyst from a paper manufacturyear in the industry’s history.
er stated that there is almost a one4. Inflation rate

A representative from a machine-tool
association announced that during
1995 the U.S. returned to being the
top consumer of machine tools in
the world. Research and development expenditure in the machinetool industry is the highest of any
manufacturing industry. This analyst
is cautiously optimistic regarding

to-one correspondence between
paper production growth and real
GDP growth. The analyst forecasts
paper and paperboard production
to grow by 2.5% in 1996. As paper
prices have risen dramatically over
the last year, consumers are shifting to
lower grades of paper and considering
ways of using the product more effi-

ciently. The industry is now beginning to deal with the problem of
overcapacity; it had been operating
at over 100% levels. As a result,
downward pressure on paper prices
is anticipated.
Conclusion
The soft landing forecast for 1995
turned out to be bumpier than expected but generally on target.
A trend-driven growth rate from this
lower level of GDP growth is forecast
for 1996, and most likely the quarterly path will be far less smooth than
indicated in the consensus forecast.
Nevertheless, the symposium found
widespread support for slow but positive economic growth in the year
ahead. If accurate, this moderate
growth rate may mean some very
good news on the inflation front, as
price pressures from the economy
will be very slight.
—William A. Strauss
Senior Economist

Michael H. Moskow, President; William C.
Hunter, Senior Vice President and Director of
Research; Douglas Evanoff, Assistant Vice President,
financial studies; Charles Evans and Kenneth
Kuttner, Assistant Vice Presidents, macroeconomic
policy research; Daniel Sullivan, Assistant Vice
President, microeconomic policy research; William
Testa, Assistant Vice President, regional programs;
Anne Weaver, Manager, administration; Helen
O’D. Koshy, Editor.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve
Bank of Chicago. The views expressed are
the authors’ and are not necessarily those of
the Federal Reserve Bank of Chicago or the
Federal Reserve System. Articles may be
reprinted if the source is credited and the
Research Department is provided with copies of
the reprints.
Chicago Fed Letter is available without charge
from the Public Information Center, Federal
Reserve Bank of Chicago, P.O. Box 834,
Chicago, Illinois, 60690-0834, 312-322-5111.
ISSN 0895-0164

Tracking Midwest manufacturing activity
Manufacturing output indexes, 1987=100
145

Manufacturing output indexes
(1987=100)
MMI
IP

Nov.

Month ago

Year ago

144.1
124.9

141.9

139.8
122.7

124.7

MMI

130

Motor vehicle production
(millions, seasonally adj. annual rate)
Nov.

Month ago

Year ago

6.0

6.1

6.5

Light trucks 5.4

5.3

5.4

Cars

IP

115

Purchasing managers’ surveys:
net % reporting production growth
Nov.

Month ago

Year ago

MW

52.1

62.0

67.0

U.S.

45.8

48.4

64.5
100

The recent pattern in the MMI is consistent with reports from Midwest purchasing managers’ surveys. Aside from auto-related industries, most surveys for
December were indicating expanding orders and production in the region.
With light-vehicle production virtually flat and auto inventories rising, some
softening in this sector is to be expected and could continue into the first quarter of 1996.

1995

Sources: The Midwest Manufacturing Index (MMI)
is a composite index of 15 industries, based on
monthly hours worked and kilowatt hours. IP represents the Federal Reserve Board industrial production index for the U.S. manufacturing sector.
Autos and light trucks are measured in annualized
units, using seasonal adjustments developed by the
Board. The purchasing managers’ survey data
for the Midwest are weighted averages of the seasonally adjusted production components from the
Chicago, Detroit, and Milwaukee Purchasing Managers’ Association surveys, with assistance from
Bishop Associates, Comerica, and the University of
Wisconsin–Milwaukee.

Chicago Fed Letter

The Midwest Manufacturing Index for November rebounded from its dip in
October, reaching its highest level of the year. While the Federal Reserve’s production index for manufacturing followed a similar pattern, the national index
was flat over the last three months. Thus, the Midwest appears to be recovering
from the mid-year inventory correction more quickly than the rest of the nation.

1994

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1993

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