The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
ESSAYS ON ISSUES TH E FEDERAL RESERVE BANK OF CHICAGO FEBRUARY 1999 NUMBER 138 Chicago Fed Letter 1998 Economic Outlook Symposium T he Federal Reserve Bank o f C h icago’s twelfth an n u al Econ om ic O utlook Symposium, held on Decem ber 4, 1998, focused on how international issues m ight affect U.S. econ om ic growth in 1999. M ore than 60 econom ists and analysts from business, academ ia, an d governm ent atten d ed the conference. In this Chicago Fed Letter, we review the accuracy o f last year’s con feren ce fo re cast for 1998 an d sum m arize the out look for 1999. C onsensus outlook fo r the economy In 1998, the econom y showed trem en dous strength in the first quarter, grow ing 5.5%. This was the strongest quarter o f growth in nearly two years. Growth slowed to a relatively weak 1.8% in the second quarter, due largely to the G en eral M otors strikes. T he strikes low ered vehicle produ ction b egin n in g in Ju n e and, com b in ed with strong sales, caused light vehicle (cars an d light truck) inventories to reach fairly low levels. As a result, the ch ange in busi ness inventories, which h ad been aver agin g over $56 billion p e r quarter for the previous two years, reach ed only $38.2 billion in the secon d quarter, reducin g real gross dom estic produ ct (GDP) growth by 1 percen tage point. T he GM strikes were settled by the end o f July and production began to rebuild both sales an d inventories. T hird q uar ter GDP (fourth quarter num bers are not yet available) rose by a strong 3.7% as the ch an ge in business inventories ap p ro ach ed the rate it had averaged over the previous two years. If the sec ond an d third quarters are averaged, then GDP growth falls into the range that traditionally has been associated with its long-run trend o f close to 2.5%. In the first half o f 1998, the Asian crisis m ade its presence felt. M anufacturing output growth b egan to soften an d in dustrial production , which had been averaging nearly 6% growth during 1997, slowed to 1.5% in the first h alf o f the year an d 0% in the third quar ter. Nonetheless, unem ploym ent rates rem ain ed low, at 4.4% in the secon d quarter an d 4.5% in the third quarter. Inflation concerns also rem ained sub dued, with inflation averaging 1.4% for the first three quarters of1998. In the third quarter, international is sues con tin u ed to dom inate the eco nom ic risk horizon. C on cern s about the collapse o f the Russian econom y an d the im pact it m ight have on other econ om ies caused significant disrup tion in world financial m arkets. Inter est spreads, the difference between Treasury securities an d m ore risky types o f assets, such as corporate secu rities, increased substantially and econ om ists in the U.S. raised concerns about a potential credit crunch. Partly in respon se to these concerns, the Federal O pen M arket Com m ittee low ered the federal funds rate three tim es over a seven-week period begin ning in late Septem ber, for a total rate reduction o f 75 basis points. Looking over our shoulder In gen eral participants in the D ecem ber 1997 sym posium un derestim ated the strength o f the econom y in 1998. They expected real GDP to increase by 2.6% ; for the first three quarters, it averaged 3.7%. This tendency to un derestim ate growth held fo r m ost of the subcategories o f GDP. T he 4.3% growth rate o f industrial production for the first three quarters o f 1998 com pared with the first three quarters of 1997 was h igh er than the 3.5% rate forecast last year. L igh t vehicle sales averaged roughly 400,000 units m ore than forecast. H ousing starts added 1.59 m illion units (annualized) in the first three quarters o f 1998 versus a forecast o f 1.41 m illion units rate for the year, follow ing a very strong year in 1997. The trade-weighted dollar appre ciated m ore than 6% for the first three quarters, com pared with an anticipated increase of 1.0%. Analysts overestimated unem ploym ent rate growth by 0.4 per cen tage points. They expected infla tion to rem ain at a 2.4% rate in 1998, but inflation averaged 1.4% for the first three quarters o f 1998. T he prim e rate was forecast to rise, reaching 8.75% in the fourth quarter and averaging 8.70% fo r the year. Instead, rates fell for m ost o f the year an d the fourth quarter prim e rate was 100 basis points lower than forecast, at 7.75%. In summary, the econom y expan ded faster, inflation was significantly lower, an d unem ploy m ent rates were lower than last year’s sym posium forecast suggested. Looking ahead to 1999 For 1999, the symposium forecasts show the econom y’s growth slowing in the first h alf o f the year an d then e xp an d ing at a faster pace as the year draws to a close. Figure 1 sum m arizes full-year forecasts for 1998 an d 1999. M ost fo re casters believe that the growth rates ex perien ced in 1998 are unsustainable an d that real growth will be lower in 1999 for alm ost every subcategory of GDP. T he typical forecasts are fo r real GDP growth o f 3.6% in 1998 an d 2.1% in 1999. Analysts expect concerns about financial an d in tern ation al conditions to reduce con sum er spen din g from 1998’s very strong level o f nearly 5% to ju st un der 3%. Business fixed invest m ent growth is an ticipated to be m ore than halved from 11.4% during 1998 to ju st over 5% in 1999. R esidential construction, which is expected to post a very strong gain fo r 1998, is forecast to increase by ju st 0.8% during 1999. With con tin u ed econom ic weakness abroad, analysts expect the trade deficit to continue to grow in 1999, although at 1. Actual 1997 and m edian fo recasts o f GD P and related item s 19 97 19 98 (A c tu a l) (F o r e c a s t) 1999 (F o re c a s t) Real gross domestic product 3.9 3.6 2.1 Real personal consumption expenditures81 3.4 4.7 2.8 Real fixed investment, nonresidential8 10.7 11.4 5.1 Real fixed investment, residential81 Change in business inventories6 2.5 63.2 9.4 59.3 0.8 46.6 -1 3 6 .1 -2 4 6 .5 -3 0 0 .0 Net exports of goods and services6 Real government consumption expenditures and gross investmentsa 1.3 0.8 1.6 Industrial productiona 5.0 3.1 1.9 Auto & light truck sales ( m ill io n s o f u n its ) 15.0 15.4 14.8 Housing starts ( m ill io n s Unemployment ratec o f u n its ) 1.48 5.0 1.60 4.5 1.50 4.8 Inflation rate (Consumer Price Index)a 1-year Treasury rate ( c o n s t a n t m a tu r ity ) c 10-year Treasury rate ( c o n s t a n t m a t u r i t y ) ' J. P. Morgan trade-weighted dollar indexa 2.3 1.6 2.0 5.63 5.02 4.57 6.35 8.0 5.29 3.0 5.00 -3 .2 aPercent change from previous year. bBillions of chained (1992) dollars. cPercent. Note: Data as of December 4, 1998. a slower pace than in 1998. T he govern m ent sector is expected to show slight ly stronger growth, at 1.6% versus 0.8% in 1998. With relatively slower growth in real GDP, analysts expect industrial pro duction growth to slow from 3.1% an ticipated for 1998 to 1.9% forecast in 1999. After an oth er solid year in 1998, the light vehicle m arket is expected to sell 600,000 fewer units in 1999. H ousing starts are forecast to m oderate to a still robust 1.5 million unit pace. Analysts forecast the 1999 unem ploy m ent rate to average three-tenths o f a percen tage point above the 1998 rate. T he rate o f inflation is forecast to in crease slightly from 1.6% to 2.0%. Oneyear Treasury rates are expected to be 45 basis points lower and ten-year rates 29 basis points lower, on average, in 1999 than in 1998. Finally, the tradew eighted dollar is an ticipated to fall by 3.2%. In term s o f the quarterly pattern for real GDP growth, the forecast g ro u p is expectin g a downward trend th rough the secon d quarter o f 1999, with 1.8% growth in the first quarter slowing to 1.6% in the second. They anticipate a slight increase th rough the secon d half, to 2.3% in the third quarter and 2.6% in the fourth quarter (see figure 2). This pattern is reflected in the growth outlook fo r person al co n sum p tion expen ditures, business fixed in vestment, residential investm ent, an d governm ent spending. Som e weaken ing is expected in ch an ge in business inventories an d net exports. T he quarterly pattern for industrial produ ction growth is expected to be sim ilar to the overall pattern o f GDP growth. T he quarterly patterns for light vehicle sales an d housing starts are also similar to the pattern for real GDP, but the growth trough occurs in the third quarter. T he unem ploym ent rate an d inflation rate are an ticipated to rise over the fo ur quarters o f 1999. T he one-year Treasury rate is forecast to bottom out at 4.41% in the first quarter an d rise for the rem ain der of the year, reaching 4.55% in the fourth quarter. T he ten-year Treasury rate is expected to fall to 4.80% in the sec on d quarter an d rise to 5.07% in the fourth quarter. Outlook for ligh t vehicle sales A ch ief econ om ist from an autom otive m an ufacturer expects vehicle sales to continue positive but at lower levels in 1999 an d 2000. This econom ist does not see any signs o f con sum er retrenchm ent due to high debt levels an d suggested that given the appreci ation in hom e values, consum ers feel richer an d this wealth effect has kept con sum er spen din g strong. For N orth A m erica, the econom ist anticipates a d rop from above trend growth in 1998 to slightly below trend growth in 1999. Strong dom estic dem and should offset som e o f the im pact o f the em erging m arket crises. South Am erica has been heavily affected by the financial turmoil in Asia an d Russia. E u rope is less dep en d en t on trade with Asia and E u ro pean econ om ic growth should be close to trend in 1999. Em erging m arkets in Asia will experien ce an oth er down year. Sales o f U.S. new vehicles, which have been above trend since 1994, are ex pected to be lower in 1999 at 14.5 m il lion units. Overall, U.S. new vehicle sales growth is forecast to be close to tren d in 1999 at 2.1% versus 3.6% in 1998. Vehicle ow nership p er h ou se hold continues to grow, and light trucks are rapidly ap p roach in g 50% o f new vehicle sales, su pported by falling oil prices. T he extrem ely com petitive pricing environm ent is likely to co n tinue in 1999. New vehicle transaction prices are forecast to decline by 1% in nom inal term s an d used vehicle prices to continue to im prove. Housing sector outlook A m ajor housing group association spokesperson offered a very strong out look for the sector in 1998 with slower growth in 1999, supported by low inter est rates, high hom e ownership rates, high consum er confidence, and modest inflation. Growing sales to immigrants an d rising ownership rates am on g an aging population should also lead to higher hom e sales. R etail forecast A specialist from the retail industry pain ted a favorable picture o f retail sales in 1999. C on su m er spen din g during 1998 h ad been the best since 1994, based on total con sum er exp en ditures on a year-over-year basis, with both g o o d s an d services doin g well. C onsum ers are feelin g confident. D urable goo d s sales have soared and nondurables have recovered from their weakness in 1997. T otal furniture and household equipm ent, furniture, kitch en an d household appliances, and most notably total video, audio, com put ers, and m usical instrum ents are all doing well com pared with 1997. All toy categories ap p ear be doing well, with do-it yourself toys lead in g the pack. A pparel b egan 1998 very strong, but w eakened as the year cam e to a close. Overall, analysts expect the holiday selling season to be relatively g oo d and positive retail sales to continue into 1999. Inflation is not seen as a p ro b lem fo r d urable g o o d s sales. Capacity constraint problem s exist mostly on the West Coast, but m ajor com pan ies have sh ip p ed inventory from the East C oast to resolve these problem s. Price is considered the m ost im portant issue for consum ers, an d it is influencing where they sp en d their money. Financial sector outlook A ch ief econom ist fo r a financial ser vices firm described econ om ic fu n d a m entals as solid, including con sum er spen din g, hom e sales, Midwest em ploym ent growth, an d the Chicago Fed Midwest M anufacturing Index. M onetary policy signals, such as the fed funds rates, m oney growth, bank credit reserves, an d the yield curve, do not a p p ea r to be signaling a reces sion. A lthough corporate profits are declining, which may be a lead in g in dicator o f a future recession, the im pact on the econom y would probably not be felt until 2000. T he econom ist cited substantial increases in interest spreads in Sep tem b er an d Octob e r 1998 as an oth er potential cause for con cern. However, the econom ist notes that banks are becom in g m ore cautious in len d ing practices; credit strains at banks rem ain low and, th erefore, do not represen t a m ajor threat to the stability o f the financial system. growth of 3%, low inflation, lower profits an d cash flows, a m ixed outlook for m ining (with sales flat or slightly u p ), a sharp downturn in agricultural equip m ent, an d flat construction spending. Highways an d public buildin g should be up, with h ousin g staying flat. T hese forecasts are pretty m uch in line with the consensus forecast discussed earli er. Overall, the econom ist does not see any growth for the industry in 1999. However, given that 1998 sales were strong, this econom ist suggests holding to those levels for 1999 would be fine. Outlook for the steel industry A consultant from the steel industry said the industry is suf ferin g the negative effects o f the eco nom ic crisis in South east Asia and oth er parts o f the world. T he consult ant cited healthy gross dom estic pur chases as a signal that consum ers are doing well in the current environ ment. Favorable projects for construc tion and the steel industry include highway an d rapid transit, airports (and related access roads, hangers, an d parkin g g arag es), sch ool bu ild ings, an d m unicipal service projects (i.e., fire departm ents, police d ep art m ents, an d recreation facilities). T he econ om ic outlook fo r 1999 calls fo r slower econom ic growth than in 1998, co u p led with relatively low rates o f inflation an d unem ploym ent. Both light vehicle sales an d housing starts are an ticipated to be down from their 1998 levels, but still at fairly g o o d lev els. If this forecast is realized, 1999 will be the ninth year o f one o f the longestlived econ om ic expan sion s o f the post war era. This consultant anticipates growth in construction in 1999, which should bod e well for the U.S. steel industry. H eavy equipm ent forecast A ccording to a sen ior econ om ist at a heavy equ ipm en t produ cer, this in dustry like the steel industry is facing significant challenges. Low com m odi ty prices are m aking it difficult to sell heavy equ ipm en t outside the U.S., as foreign com pan ies are usin g their m oney to buy equ ipm en t p rodu ced locally. However, growth in 1998 was only slightly down from 1997 levels, an d growth levels for 1999 should be in line with 1998, despite the im pact o f recessions in certain parts o f the world. Equipm en t sales an d profit ability in the steel industry are very cyclical, but have been grow ing at abo u t 10% per year. T he econom ist expects U.S. GDP growth o f 2.0% to 2.5% in 1999, dom estic dem an d Conclusion —W illiam Strauss S en io r econom ist an d econom ic advisor — Keith Motycka Associate econom ist Michael H. Moskow, President; William C. Hunter, Senior Vice President and Director ofResearch; Douglas Evanoff, Vice President, financial studies; Charles Evans, Vice President, macroeconomic policy research; Daniel Sullivan, Vice President, microeconomic policy research; William Testa, Vice President, regional programs; Vance Lancaster, Research Officer; Helen O ’D. Koshy, Editor. Chicago Fed Letter is published monthly by the Research Department o f the Federal Reserve Bank o f Chicago. The views expressed are the authors’ and are not necessarily those o f 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 o f the reprints. Chicago Fed Letter is available without charge from the Public Information Center, Federal Reserve Bank o f Chicago, P.O. Box 834, Chicago, Illinois 60690-0834, tel. 312-322-5111 or fax 312-322-5515. Chicago Fed Letter and other Bank publications are available on the World Wide Web at h ttp :// www.frbchi.org. ISSN 0 8 9 5 - 0 1 6 4 Tracking M idwest m anufacturing activity Motor vehicle production (millions, seasonally adj. annual rate) M anufacturing ou tp u t indexes (1992=100) CFMMI IP 7.4 Nov. Month ago Yearago 128.6 135.9 128.8 136.0 127.3 123.3 ------------------------------------------------------------------------------------------ M otor vehicle production (millions, seasonally adj. annual rate) Dec. Month ago Year ago Cars 5.8 5.8 5.8 Light trucks 6.6 6.7 6.4 Purchasing m anagers’ surveys: n et % re p o rtin g p ro d u c tio n growth Dec. Month ago Year ago MW 54.5 54.2 58.1 U.S. 46.8 48.5 56.1 T he CFMMI d ecreased 0.1% from O ctober to N ovem ber follow ing a revised 1.3% gain in O ctober. T he IP was u n ch an ged in N ovem ber following an in crease o f 0.6% in O ctober. Ligh t truck produ ction d ecreased slightly from 6.7 m illion units in N ovem ber to 6.6 m illion units in D ecem ber, an d car p rod u c tion rem ain ed constant at 5.8 m illion units for N ovem ber an d D ecem ber. T he Midwest purch asin g m an ag ers’ com posite in d ex (a w eighted average o f the Chicago, Detroit, and Milwaukee surveys) for production increased to 54.5% in D ecem ber from 54.2% in N ovem ber. T he p urch asin g m an ag ers’ index d ecreased in Milwaukee, but the in dexes in creased in C hicago an d Detroit. T he national purch asin g m an ag ers’ survey for produ ction declin ed from 48.5% to 46.8% from N ovem ber to D ecem ber. Sources: The Chicago Fed Midwest Manufactur ing Index (CFMMI) is a composite index of 16 industries, based on monthly hours worked and kilowatt hours. IP represents the Federal Re serve Board’s 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 seasonal ly adjusted production components from the Chicago, Detroit, and Milwaukee Purchasing M anagers’ Association surveys, with assistance from Bishop Associates, Comerica, and the University of Wisconsin-Milwaukee. peisenbej eoiAjes ujniey IIIS-ZZE (ZIE) f£8006909 Z m 'O N H IA feO d SIONmi'OOVOlHO a iv d d o v is o d s n a d a o o d v a t^ + diz siouini ‘0§E3TO f£8 xoa O'd J01U9Q uoperajojuj a ijq n j OOVOIHO 4 0 >INVa 3AH3S3H 3VH3Q33 HVIAI S S V lO lS dld cm d o sd d d J0 }} 0 q p 0 h j O § B 0 iq Q
@FedFRASER