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ESSAYS ON ISSUES

THE FEDERAL RESERVE BANK
OF CHICAGO

AUGUST 2010
NUMBER 277

Chicag­o Fed Letter
Economy on cruise control in 2010 and 2011
by William A. Strauss, senior economist and economic advisor, and Britton Lombardi, senior associate economist

According to participants in the Chicago Fed’s annual Automotive Outlook Symposium, solid
economic growth is forecasted for the nation this year and in 2011. Inflation is expected to remain
contained, but the unemployment rate is anticipated to remain high. Light vehicle sales are
forecasted to improve moderately in 2010 and 2011.
The Federal Reserve Bank of Chicago

held its seventeenth annual Automotive
Outlook Symposium on June 3–4, 2010,
at its Detroit Branch. More than 60
economists and analysts from business,
academia, and government attended
the conference. This
1. Median forecast of GDP and related items
Chicago Fed Letter reviews
last year’s forecasts for
2009
2010
2011
2009, analyzes the
(Actual) (Forecast) (Forecast)
forecasts for 2010 and
Real gross domestic product
0.1
3.1
3.1
2011 (see figure 1),
Real personal consumption expenditures
1.0
3.2
2.6
Real business fixed investment
–14.1
4.6
6.7
and summarizes the
Real residential investment
–12.6
2.2
14.3
presentations at this
Change in private inventories
–19.7
45.1
52.5
Net exports of goods and services
–348.0
–389.7
–391.8
year’s conference.1
a

a

a

a

b

b

Real government consumption
expenditures and gross investmenta
Industrial productiona
Car and light truck sales (millions of units)
Housing starts (millions of units)
Unemployment ratec
Consumer Price Indexa
One-year Treasury rate (constant maturity)c
Ten-year Treasury rate (constant maturity)c
J. P. Morgan Trade-Weighted Dollar Indexa
Oil price (dollars per barrel of
West Texas Intermediate)c

1.3
–4.7
10.4
0.55
10.0
1.5
0.35
3.46
–7.5

0.6
5.7
11.6
0.68
9.5
1.7
0.63
3.85
2.0

0.6
4.2
13.3
0.94
8.8
1.9
1.60
4.60
0.3

The U.S. economy’s
output peaked in
December 2007, and
the U.S. entered a recession in January 2008.
However, for the first
eight months of 2008,
76.07
82.00
87.81
conditions were relaPercent change, fourth quarter over fourth quarter.
tively flat; real gross
Billions of chained (2005) dollars in the fourth quarter at a seasonally adjusted annual rate.
Fourth quarter average.
domestic product
Note: These values reflect forecasts made in May 2010.
Sources: Actual data from authors’ calculations and Haver Analytics; median forecast from
(GDP) actually rose
Automotive Outlook Symposium participants.
0.5% (seasonally adjusted annual rate, or
SAAR) in the first half of 2008.2 It was
not until the financial crisis began in
September 2008 that real GDP began to
decline, to –2.7% in the third quarter.
Output fell more significantly in the
next two quarters, to –5.4% in the fourth
quarter of 2008 and –6.4% in the first
quarter of 2009.
a
b
c

The decline in economic activity reached
its fastest pace in the first quarter of
2009. The Chicago Fed National Activity
Index3 (a measurement of growth in
the economy relative to its long-term
trend) fell to its lowest reading in nearly
35 years in January 2009. However, the
decline in output, as measured by real
GDP, began to moderate as the year
progressed; and output showed a much
smaller decline, –0.7%, in the second
quarter. Job losses also picked up steam
following the financial crisis. Over
8.4 million workers lost their jobs in 2008
and 2009, with the most significant
monthly declines occurring in early 2009.
With substantial job losses, consumer
spending began to retrench—to a rate
of –2.5% in the second half of 2008 and
–0.7% in the first half of 2009. Vehicle
sales plunged to average 9.5 million
units in the first half of 2009—a selling
rate this low was last seen in the 1960s.
As the economy bottomed out toward the
middle of 2009, the federal government
introduced the Car Allowance Rebate
System (CARS)—also known as the cashfor-clunkers program—at the beginning
of the third quarter to help jump-start
the economy. This program boosted the
selling rate of light vehicles (cars and
light trucks) from 9.6 million units in
the second quarter to 11.5 million units
in the third quarter. It also helped real
GDP grow 2.2% in the third quarter.

Real GDP continued to rise—the economy grew 5.6% in the fourth quarter of
2009 and 2.7% in the first quarter of
2010; these values averaged out to a rate
above what most economists consider
the long-term trend for the U.S. economy’s growth rate. Yet the pace of the
recovery has not felt very brisk, partly
because growth in real GDP is being
driven by changes in private inventories.
For example, the growth rate of final
sales (which is real GDP minus the
change in private inventories) was 1.5%,
1.7%, and 0.8% in the third quarter and

that occurred during 2009. In large part,
the inflation forecast was wrong because
of a substantial miss on energy prices:
Oil prices, which had plunged to a low of
just over $30 per barrel in late December
of 2007, were anticipated to average
$56 per barrel in the fourth quarter of
2009; however, oil prices increased to a
much higher level, averaging just over
$76 per barrel in the final quarter of last
year. Light vehicle sales were expected
to fall substantially, from 13.2 million in
2008 to 9.7 million in 2009. The actual
drop was much less drastic, with light

Light vehicle sales are expected to rise to 11.6 million units in
2010 and then improve to 13.3 million units in 2011.
fourth quarter of 2009 and the first quarter of 2010, respectively. These values
are about a percentage point or more
below the 2.6% growth that final sales
have averaged over the past 20 years.
Most sectors of the economy have been
described as either improving at a moderate pace or “bumping along the bottom.” However, the manufacturing sector
has experienced outsized growth, which
is more in line with a strong recovery.
Manufacturing output reached its alltime high in December 2007; but from
that time through June 2009, it declined
by over 17%. However, from the middle of 2009 through May 2010, it has
increased at a 10.7% rate, recovering
45% of this loss.
Forecasts versus results

At last year’s symposium, which took
place as economic activity bottomed out,
participants forecasted a decline of 1.8%
for the economy in 2009, but the economy actually fell less than expected in
the second quarter and grew at a more
robust pace in the second half of the year.
By the end of 2009, real GDP was actually
slightly positive at 0.1%. The unemployment rate was predicted to average 9.9%
in the final quarter of 2009—this was
quite close to the actual average of
10.0%. Inflation, as measured by the
Consumer Price Index (CPI), was predicted to average –0.5%, off significantly
from the actual 1.5% increase in prices

vehicle sales falling to 10.4 million units
in 2009. The housing sector was very
accurately predicted to be quite weak in
2009. Housing starts were forecasted to
fall to 0.53 million units in 2009, and
they actually fell to 0.55 million units.
Outlook for 2010 and 2011

The forecast for 2010 and 2011 is for the
economy to grow at a solid pace. The
growth rate of real GDP is predicted to
be 3.1% in both 2010 and 2011. The
quarterly pattern has growth just above
3% in each quarter over the forecast
horizon (2010:Q2–2011:Q4). While this
slightly-above-trend rate would be the
best since 2005, it would be considered
relatively restrained compared with the
historical performance of the economy
following a sharp contraction in real
GDP. Given this forecast for a moderate
recovery, the unemployment rate is expected to edge lower to 9.5% by the
fourth quarter of 2010 and then fall to
a still quite high 8.8% by the final quarter of 2011. Inflation, as measured by the
CPI, is expected to edge higher over the
next two years, for an annual rate of 1.7%
in 2010 and 1.9% in 2011. This pattern
is being driven by economic growth that
is somewhat above the long-term trend,
as well as increases in oil prices, which
are predicted to average $82 per barrel
in the final quarter of this year and
about $88 per barrel at the end of 2011.
Personal consumption expenditures are

forecasted to expand at a solid rate of
3.2% in 2010 and a slightly slower rate
of 2.6% in 2011. Light vehicle sales are
expected to rise to 11.6 million units this
year and then improve to 13.3 million
units next year. Business fixed investment
is predicted to show strong growth of
4.6% in 2010 and 6.7% in 2011. Industrial
production is forecasted to grow 5.7%
this year and a still solid 4.2% next year.
The housing sector is predicted to improve over the forecast horizon. Residential investment is anticipated to grow 2.2%
this year and 14.3% in 2011. Housing starts
are expected to rise to 0.68 million units
in 2010 and 0.94 million units in 2011.
This would still leave housing starts well
below the roughly 1.4 million units that
they have averaged in the past 20 years.
The long-term interest rate (ten-year
Treasury rate) is forecasted to increase
39 basis points in 2010 and 75 basis points
in 2011. The short-term interest rate (oneyear Treasury rate) is expected to rise
28 basis points this year and 97 basis points
next year. The trade-weighted U.S. dollar
is predicted to rise 2.0% this year and 0.3%
in 2011. The trade deficit (net exports
of goods and services) is predicted to
deteriorate slightly this year and next.
Auto sector outlook

Ellen Hughes-Cromwick, chief economist,
Ford Motor Co., provided the vehicle sales
outlook from an auto manufacturer’s
perspective. She said that light vehicle
sales to businesses had increased by about
40% in the first half of 2010. She noted
that leaner vehicle inventories suggest
continued production gains in the near
term. She mentioned both auto parts
suppliers’ capacity and auto financing as
two potential constraints on sales growth.
She explained that Ford has been studying whether the supplier base as currently
configured has enough production capacity to accommodate a rise in annual auto
sales to either 13 million or 14 million
units. Although suppliers have been reinvesting to add capacity, 5% to 10% of
them are projected to be unable to meet
the rising demand for parts. She also
indicated that the limited availability of
auto financing and continuing tight credit conditions in the wake of the financial
crisis could dampen auto sales.

Over the period 2008–20, the driving-age
population in China and India will go
up by 15%, whereas this population in
the U.S. and other mature markets will
rise by only 7%, according to HughesCromwick’s projections. Income levels
are also rising in China, India, Turkey,
Brazil, and other developing countries,
enticing Ford and other automakers to
increase their market presence in those
countries. As the demand for light vehicles expands overseas, Ford will change
its global portfolio mix to match this
growing demand.
Kenny Vieth, partner, Americas
Commercial Transportation (ACT)
Research Co., delivered the outlook on
commercial vehicles (medium- and
heavy-duty trucks). Vieth showed that
currently the commercial fleet has an
average age higher than at any time since
1979; given this fact, there is pent-up
demand to purchase new vehicles, he
contended. Over the next few years,
about 225,000 units will be purchased
annually to replace existing trucks in
use, according to Vieth’s projections.
During the recession, there was excess
trucking capacity—too many trucks for
too little freight. But by the end of 2010
and into 2011, a shortage of trucks is
expected. That said, the higher 2010
Environmental Protection Agency emissions standards may put a damper on
new truck purchases. These higher standards have driven up new truck prices
while lowering the trade-in value of older
trucks, thereby increasing trucking companies’ replacement costs. Lastly, Vieth
explained that medium-duty truck sales
are correlated with housing construction,
so as the housing sector recovers at a
moderate pace, slow but steady growth
in medium-duty truck sales is expected
through 2015.
Paul Taylor, chief economist, National
Automobile Dealers Association, presented the light vehicle sales outlook from the
dealers’ perspective. According to Taylor,
the trade-in value of light vehicles—in
particular sport utility vehicles—has increased because there have been fewer
trade-ins over the past few years. Therefore, the difference in cost between a
new vehicle and a used one has narrowed,
leading some to buy new vehicles. During

the recent recession, gas prices remained
low; and because gas prices are negatively
correlated with the value of used light
vehicles, these low gas prices have helped
to bolster used vehicles’ prices as well.
Taylor also discussed the success of the
federal government’s cash-for-clunkers
program in stimulating new demand for
light vehicles. The program gave incentives to individuals to purchase new, more
fuel-efficient vehicles, and stimulated auto
manufacturers to rebuild their inventories
through most of the final quarter of
2009. He said that home prices would
need to improve further before car purchases would drastically increase because
homeowners tend not to purchase cars
when they are concerned about their
home equity value.
David Andrea, vice president, Original
Equipment Suppliers Association, presented the outlook on the auto parts supplier
industry. The suppliers acknowledged
their “shared destiny” with their two major customers—General Motors (GM)
and Ford. Andrea said that original
equipment suppliers in North America
will ramp up production to meet the expected demand from these and other
automakers over the next year and a
half. As suppliers recover through 2010,
Andrea said, they expect both hourly
employment and compensation levels
to rebound from their repressed levels
in 2009. During the recession, suppliers
restructured their business operations
to remain viable as the number of car
sales plummeted, e.g., by consolidating
plants and reducing their work force.
As the economy improves and auto sales
increase, suppliers are expected to utilize
both labor and capital productivity gains
to produce more out of fewer plants,
said Andrea. However, suppliers did note
concerns over higher material and freight
costs, lower credit availability, and shortages of electronic chips, all of which
could inhibit production.
The view from Wall Street

John Murphy, Chartered Financial Analyst,
Bank of America Merrill Lynch, gave an
outlook on the automotive industry from
a Wall Street perspective. For 2010,
Murphy had originally forecasted sales
of 13.3 million units, but given the auto

sector’s poor performance in the first
quarter, he recently lowered his forecast
to 12.5 million units. However, he said
the longer-term trend for light vehicle
sales is closer to 15 million units per year.
Even though auto sales have been down
recently, he argued that the true underlying demand for light and commercial
vehicles, as measured in miles driven, has
not changed significantly over the past
decade. The number of miles driven
dipped slightly during the recession
but is now rising in 2010. Therefore,
Murphy said he is optimistic about the
automotive industry: He said he had buy
ratings on 16 of the 22 auto company
stocks he analyzes.
Next, Murphy presented his firm’s research on the competitive landscape of
the auto industry. His firm found that
the “replacement rate” (the percentage
of a manufacturer’s products that are
entirely new or new versions of an existing model) affects all other metrics for
evaluating an automaker’s performance,
including showroom age, market share,
profitability, and stock price. Given the
major automakers’ respective replacement rates, Murphy said his firm expects
Honda and Ford to gain 2 percentage
points of market share in the U.S. by
2013 (the largest gain) and Chrysler to
lose 2 percentage points. By 2013, he

Charles L. Evans, President; Daniel G. Sullivan, Senior
Vice President and Director of Research; Douglas D. Evanoff,
Vice President, financial studies; Jonas D. M. Fisher,
Vice President, macroeconomic policy research; Daniel
Aaronson, Vice President, microeconomic policy research;
William A. Testa, Vice President, regional programs, and
Economics Editor; Helen O’D. Koshy and Han Y. Choi,
Editors; Rita Molloy and Julia Baker, Production
Editors; Sheila A. Mangler, Editorial Assistant.
Chicago Fed Letter is published by the Economic
Research Department of the Federal Reserve Bank
of Chicago. The views expressed are the authors’
and do not necessarily reflect the views of the
Federal Reserve Bank of Chicago or the Federal
Reserve System.
© 2010 Federal Reserve Bank of Chicago
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Prior written permission must be obtained for
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ISSN 0895-0164

estimated GM should have a domestic
market share of 18.8%, followed by Ford
with 17.3% and Toyota with 16.5%.
Murphy argued that large auto industry restructurings, such as GM’s and
Chrysler’s in 2009, will not occur in the
future; in the wake of the recent auto
downturn, a more stable marketplace has
been established, and subsequently, only
smaller market share shifts should occur.
Government perspective

Ron Bloom, the Obama administration’s
senior counselor for manufacturing policy, shed further light on the federal government’s role in GM’s and Chrysler’s
restructuring. He said the government
had to step in to help redesign the two
automakers’ businesses in a substantial
way, but without handing over blank
checks. The government challenged them
to rethink how they did business—
leading to GM shrinking its number of
brands and Chrysler no longer being a

standalone company, among other
changes. Bloom stated that the government intervention, while kept to a minimum, was necessary last year, especially
since GM and Chrysler are central to
the nation’s manufacturing economy.
However, he recognized that the government’s role was to allow the firms’
boards of directors, which were selected
by the Obama administration’s auto task
force, to take the lead and run day-today management of the companies. GM
and Chrysler now operate as independent enterprises, with government oversight limited to voting once per year on
the members of their boards of directors.
In addition, Bloom gave his insight into
how the auto industry will reinvent itself. First, he argued that the way cars
work will change as the internal combustion engine gives way to other fundamentally different and more-efficient
technologies. Then, he said that automobiles in the future will become

“smarter” as manufacturers incorporate
more advanced technologies.
Conclusion

The participants at this year’s Automotive
Outlook Symposium predicted the economy to grow at a solid pace in 2010 and
2011. However, because economic growth
is relatively restrained compared with
its historical performance following a
sharp contraction in real GDP, the unemployment rate is expected to remain
high. Inflation is anticipated to remain
contained. Light vehicle sales are forecasted to improve moderately this year
and in 2011.
1 Some materials presented at the symposium
are available at www.chicagofed.org/
webpages/events/2010/automotive_
outlook_symposium/index.cfm.

2 All partial year growth rates in this article
are SAAR.

3 For more details, see www.chicagofed.org/
cfnai.