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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 FEDERAL RESERVE BANK OF CHICAGO 1993 Public Information Center P.O. Box 834 Chicago, Illinois 60690-0834 (312) 322-5111 1992 PRESORTED FIRST-CLASS MAIL ZIP + 4 BARCODED U.S. POSTAGE PAID CHICAGO, ILLINOIS PERMIT NO. 1942