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ESSAYS ON ISSUES

	 THE FEDERAL RESERVE BANK
	 OF CHICAGO

	 AUGUST 2009
	 NUMBER 265a

Chicag­o Fed Letter
Economy to turn the corner in 2010
by William A. Strauss, senior economist and economic advisor, and Emily A. Engel, senior associate economist

According to participants in the Chicago Fed’s annual Automotive Outlook Symposium,
the nation’s economic decline is forecasted to bottom out this year; solid economic
growth is expected in 2010—with inflation staying contained but the unemployment
rate remaining high. Light vehicle sales are predicted to fall sharply this year and
then to improve in 2010.

The Federal Reserve Bank of Chicago

held its sixteenth annual Automotive
Outlook Symposium on June 4–5, 2009,
at its Detroit Branch. More than 90
economists and analysts from business,
academia, and gov1. Median forecast of GDP and related items
ernment attended
the conference. This
	
2008	
2009	
2010
Chicago Fed Letter
	
(Actual)	 (Forecast)	 (Forecast)
reviews last year’s
Real gross domestic product 	
–0.8	
–1.8	
3.2
forecasts for 2008,
Real personal consumption expenditures 	
–1.5	
0.8	
2.3
Real business fixed investment 	
–5.2	
–18.8	
2.0
analyzes the foreReal residential investment 	
–19.4	
–16.8	
5.8
casts for 2009 and
Change in private inventories 	
–25.8	
–10.0	
28.1
Net exports of goods and services 	
–364.5	
–333.8	
–339.2
2010 (see figure 1),
Real government consumption
and summarizes the
expenditures and gross investment 	
3.2	
1.7	
2.9
Industrial production 	
–6.7	
–7.5	
5.4
presentations at this
9.7	
11.3
Car and light truck sales (millions of units)	
13.2	
year’s conference.1
0.53	
0.74
Housing starts (millions of units)	
0.90	
a

a

a

a

b

b

a

a

Unemployment ratec	
6.9	
Consumer Price Indexa	
1.5	
c
One-year Treasury rate (constant maturity) 	 0.99	
Ten-year Treasury rate (constant maturity)c	 3.25	
JPMorgan Trade-Weighted Dollar Indexa	
9.2	
Oil price (dollars per barrel of
c
West Texas Intermediate) 	
58.37	

9.9	
–0.5	
0.71	
3.02	
3.9	

9.5
1.6
1.30	
3.75
0.9

The U.S. economy’s
output peaked in
December 2007; the
U.S. entered a reces56.00	
65.50
sion in January 2008.
Percentage change, fourth quarter over fourth quarter.
Billions of chained (2000) dollars in the fourth quarter at a seasonally adjusted annual rate.
However, for the first
Fourth quarter average.
eight months of 2008,
Note: These values reflect forecasts made in May 2009.
Sources: Actual data from authors’ calculations and Haver Analytics; median forecast from
conditions were relaAutomotive Outlook Symposium participants.
tively flat (in fact,
gross domestic product, or GDP, rose 2.2% in the first half
of 2008, compared with the first half of
2007). It was not until the financial crisis
began in September 2008 that economic
activity began to decline, falling in the
third quarter 0.5% (seasonally adjusted
annual rate, or SAAR) from the second
a
b
c

quarter. Output fell by a more significant
6.3% in the fourth quarter of 2008 and
by 5.5% in the first quarter of 2009.
The dramatic decline in lending activity
that began in September 2008 brought
an already elevated risk to the economic outlook to a tipping point. For instance, borrowing costs from the risky
high-yield corporate bond market rose
from around 8% in the middle of 2007
to 11.5% at the end of August 2008. By
the end of September, this interest rate
rose to nearly 14%; then it moved up
to nearly 19% by the end of October;
and then it increased to more than 21%
at the end of November. Between June
2007 and August 2008, this rate rose
350 basis points, but the credit crisis in
September caused the rate to increase
an additional 1,000 basis points in just
three months.
Prior to September 2008, it was a challenge to find parts of the real economy
that were being materially affected by
the turmoil in the financial markets. The
dichotomy between the performance of
Wall Street firms and Main Street firms
was often mentioned. However, because
of the financial crisis in September, nonfinancial firms and individuals began
to experience reductions of available
credit. As an illustration, the economy
began shedding jobs in January 2008,
but for the first eight months of 2008,

losses averaged 137,400 jobs per month.
During the following ten months, job
losses averaged 536,100 jobs per month.
With job losses, consumer spending began to retrench, falling 3.8% and 4.3%
in the third and fourth quarters of 2008,
respectively, and then rising 1.4% in the
first quarter of this year. For the first three
quarters of 2008, light vehicle sales (car
and light truck sales) averaged 14.1 million units (SAAR)—12.8% below the
comparable year-earlier period. However,
between October 2008 and June 2009,
sales fell to 9.8 million units (SAAR)—
35% below the comparable period
in 2007–08.

from 16.1 million in 2007 to 15.2 million
in 2008. The actual drop was much
greater, with light vehicle sales falling
to 13.2 million in 2008. The housing
sector was predicted to be quite weak
in 2008, and the actual results were just
a bit weaker than expected. Housing
starts were forecasted to fall to 0.97 million units in 2008, but actually fell to
0.90 million units. Similarly, residential
investment was predicted to decline by
16.3%, but actually fell by 19.4%.
Outlook for 2009 and 2010

The forecast for 2009 is for economic
growth to fall during the first half of

Light vehicle sales are predicted at 9.7 million units in 2009
and 11.3 million units in 2010.
In order to combat the weakness in the
economy, the Federal Reserve began
lowering short-term interest rates in
September 2007. The federal funds
rate was reduced from 5.25% to nearly
0% by the end of 2008. In addition, the
Federal Reserve increased the term
lengths of some of its lending and provided loans to specific stressed markets.
Forecasts versus results

At last year’s symposium, participants
forecasted an anemic 1.2% rate of growth
for the economy in 2008, but the previously mentioned financial crisis led
to real GDP falling 0.8%. The unemployment rate was forecasted to rise to 5.4%
by the end of 2008—much lower than
the 6.9% that the unemployment rate
averaged in the final quarter of last year.
Inflation, as measured by the Consumer
Price Index (CPI), was predicted to
average 3.9%—off significantly from
the actual 1.5% increase in prices that
occurred during 2008. In large part the
inflation forecast was wrong because of
a substantial miss on energy prices: Oil
prices were anticipated to average
around $105 per barrel in the fourth
quarter of 2008, but oil prices plunged
to average below $60 per barrel in the
final quarter of last year. Light vehicle
sales were expected to fall substantially,

the year. But it is predicted to rise fractionally, by 0.2%, in the third quarter of
2009 and then faster in the final quarter,
by 1.7%. For the year as a whole, real
GDP is predicted to fall by 1.8%. The
economy is then forecasted to rise by
3.2% in 2010. While this slightly-abovetrend rate would be the best growth
rate since 2003, it would be considered
relatively restrained compared with the
historical performance of the economy
following a sharp contraction in GDP.
With the economy struggling, the unemployment rate is expected to rise to
9.9% by the fourth quarter of 2009 and
then edge just a bit lower to 9.5% by the
final quarter of 2010. Inflation, as measured by the CPI, is expected to turn
negative in 2009, declining by 0.5%; and
then it is anticipated to rise next year
by 1.6%. This pattern is being largely
driven by the movement of oil prices,
which are predicted to average $56 per
barrel in the final quarter of this year
and about $66 per barrel at the end of
2010. Personal consumption expenditures are forecasted to expand by a tepid
rate, 0.8%, in 2009 and then rise by a
slow rate, 2.3%, in 2010. Light vehicle
sales are expected to fall to 9.7 million
units this year and then improve to
11.3 million units next year. Business
fixed investment is expected to fall by

a substantial 18.8% in 2009 and then rise
by 2.0% in 2010. Industrial production
is forecasted to decrease by 7.5% this
year and then rise to a strong 5.4%
next year.
The housing sector is forecasted to bottom out this year. Residential investment
is predicted to fall by an additional 16.8%
this year, a little less of a drag than in
2008. The quarterly pattern of the forecast implies that the consensus group
expects the housing market to stabilize
in the final quarter of this year. Housing
starts are anticipated to reach the bottom in the second quarter of this year,
at 0.50 million starts (SAAR). Residential investment is then expected to rise
5.8% next year. Housing starts are predicted to rise from 0.53 million units
this year to 0.74 million units in 2010.
The long-term interest rate (ten-year
Treasury rate) is forecasted to decrease
23 basis points in 2009 and then rise
73 basis points in 2010. The short-term
interest rate (one-year Treasury rate) is
expected to decline 28 basis points this
year and then rise 59 basis points next
year. The trade-weighted U.S. dollar is
predicted to rise 3.9% this year and then
rise 0.9% in 2010. The trade deficit (net
exports of goods and services) is predicted to continue to improve this year
and then deteriorate slightly in 2010.
Auto sector outlook

Ted Chu, lead economist, General
Motors Corporation, delivered the economic and auto industry outlook, with
a focus on the Detroit Three.2 On the
economic front, Chu said, many of the
recent “worst fears,” such as a complete
market meltdown or rising protectionism, never materialized. He added that,
while he sees no strong economic recovery in the near future, there are some
monthly data series—e.g., retail sales and
industrial production—that are starting
to stabilize. On the automotive side, Chu
said that total vehicle sales in the U.S.
are predicted to rise above 16 million
units by the end of 2012. Chu turned his
attention to China’s automotive market,
pointing out that China’s volume (numbers of cars produced) overtook that of
the U.S. sooner than he had expected.

This happened mostly because of the
recent drop in U.S. auto sales. Chu explained that once the pace of sales in
the U.S. accelerates, China will again
trail behind the U.S. in industry volume
for a short period, after which it will
permanently outpace the U.S.
Kenny Vieth, partner, Americas Commercial Transportation Research
Company, presented the outlook on
the medium- and heavy-duty truck industry. Vieth explained that with the
weak economy, the U.S. is not generating as much commercial freight to haul
in 2009 as last year. Given the current
volume of freight, there is an excess capacity of heavy-duty trucks of approximately 6% (about 200,000).
Vieth also spoke about the upcoming
U.S. Environmental Protection Agency’s
(EPA) emissions mandate, which will
take effect in 2010. These new emissions
regulations for trucks had been expected
to speed up the normal cyclical process
of buying trucks in 2009. However, strong
“prepurchases” of trucks that meet the
current EPA standards (but not the 2010
standards) have not materialized because of the economic downturn. This
lack of prepurchases sharply contrasts
with the patterns of prepurchases that
were witnessed shortly before the 2002
and 2007 EPA emissions mandates.
Another factor affecting the trucking
industry, Vieth noted, is the tightening
of supply chains among the companies
whose freight it hauls. On account of the
higher fuel prices in 2008, most truckers
increased the product they carried per
load. This caused some companies to
reexamine their bulky packaging, creating a packaging revolution. Three
examples of this new packaging style are
square milk containers, flat products
(instead of inflated ones), and concentrated products (which have had water
removed). Companies have also tightened their supply chains by producing
closer to their end markets. These strategies result in truckers driving fewer miles.
According to Vieth, there is a strong
correlation between the trucking market
and the housing market. So, while there
will always be a demand for trucking,
he said, the trucking market will not

fully recover until the housing market
returns to approximately 1.5 million
starts per year.
David Andrea, vice president, Original
Equipment Suppliers Association
(OESA), presented the outlook on the
auto parts suppliers, with a focus on restructuring efforts throughout the sector.
Overall, most suppliers, especially smaller
firms, are hurting. There is uncertainty
surrounding original equipment manufacturers’ future production schedules;
recently, monthly supplier receivables
have stabilized, but they continue to be
a source of concern; and suppliers continue to battle low cash flows, low working
capital, and longer than normal periods
of work stoppage. However, Andrea explained that many suppliers, according
to the OESA’s Supplier Financial Health
Survey in May 2009, have restructured
their businesses, so they should be able
to break even at the lower volumes that
are expected in the next couple of years.
Andrea forecasted North American lightduty production to be at 7.95 million
units in 2009 and 9.67 million units in
2010. He said he expected it to finally
break the 10-million-unit mark in 2011,
with 11.85 million units anticipated
that year.
Paul Taylor, chief economist, National
Automobile Dealers Association, presented the light vehicle sales outlook
from the dealers’ perspective. Even with
the recent increases in automakers’ financial incentives for consumers to purchase new vehicles, Taylor forecasted
10 million to 12 million light vehicle
sales for 2009—down from the already
low 13.2 million units in 2008. Taylor
said that the drop in new vehicle sales
can be partially attributed to falling home
equity values. Even though consumers
are not borrowing against their home
equity, they perceive the equity in their
homes as a gauge of how well they are
doing overall.
With high fuel prices and the weak economy, all car segments showed negative
growth in 2008. However, sales of both
small cars and CUVs (crossover utility
vehicles, or utility vehicles built on passenger car platforms) experienced smaller declines. This trend has continued

into 2009, Taylor said. Looking forward,
Taylor said he expected 2010 to be weak
for light vehicle sales, with pent-up vehicle demand showing up in the marketplace in 2011.
Mike Jackson, chairman and CEO,
AutoNation, delivered a presentation
on the new economic realities in the
U.S. and how they affect the auto industry. He discussed several factors affecting auto sales, focusing in particular
on credit availability and gas prices.
A 20% drop in vehicle sales occurred
immediately after the investment bank
Lehman Brothers collapsed on September 15, 2008. One of the causes for this
large drop in sales, Jackson said, was
the general withdrawal of credit in the
wake of that bank’s demise. This lack
of credit availability was seen in the decline in loan acceptances at the finance
company GMAC (General Motors
Acceptance Corporation), as well as at
Chrysler’s and Ford’s finance companies. From December 2007 to December
2008, AutoNation’s loan approvals from
GMAC plunged almost 100%, from
1,527 loans to 9; over the same period,
loan approvals from Chrysler’s finance
company fell 97%, from 823 to 22, while
the decline in loan approvals from Ford’s
finance company was not as extreme
—they fell 24%, from 1,642 to 1,235.
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.
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.
© 2009 Federal Reserve Bank of Chicago
Chicago Fed Letter articles may be reproduced in
whole or in part, provided the articles are not
reproduced or distributed for commercial gain
and provided the source is appropriately credited.
Prior written permission must be obtained for
any other reproduction, distribution, republication, or creation of derivative works of Chicago Fed
Letter articles. To request permission, please contact
Helen Koshy, senior editor, at 312-322-5830 or
email Helen.Koshy@chi.frb.org. Chicago Fed
Letter and other Bank publications are available
at www.chicagofed.org.
ISSN 0895-0164

Jackson also talked about gas prices
and fuel efficiency. Because of U.S.
consumers’ short-term memories with
respect to gas prices, they have once
again shifted toward bigger, less fuelefficient vehicles as gas prices have fallen since reaching $4.00 per gallon in
the summer of 2008. Even though 5%
of the current U.S. population claims
to care about going “green” when buying a vehicle, Jackson said, that is not
enough to shift the majority of the
country’s population into smaller cars.
However, because of the new CAFE
(Corporate Average Fuel Economy)
standards called for by the Obama administration, automakers selling cars
in the U.S. will need to be more concerned with fuel efficiency. One way to
get U.S. consumers (and automakers)
to care more about fuel efficiency,
Jackson explained, is to tax gas like
Europe and Japan. In Europe, gas is
$8.24 per gallon, of which $4.87 is tax
(more than 12 times the amount in

the U.S.); similarly, in Japan one gallon
of gas costs $5.30, of which $2.09 is tax.
Europe has achieved an average of
36 miles per gallon for the vehicles on
its roads, and Japan has reached an average of 31 miles per gallon. Jackson
argued that higher fuel costs have motivated vehicle buyers in Europe and
Japan to choose vehicles with higher
fuel efficiency. He argued that the U.S.
needs to follow their lead, since an average gallon of gas in the U.S. is $2.46,
and only $0.40 of it is tax. Not surprisingly, the U.S. also lags behind Europe
and Japan on fuel efficiency; the U.S.
average is only 21 miles per gallon.
Jackson contended that it does not work
to be pro-energy-independence and profuel-efficiency, as well as pro-cheap-gas.
He said that the U.S. needs to develop
a more comprehensive energy policy.
According to Jackson, the automotive
industry is currently in a catastrophic
situation, but he said he remains optimistic about the future because the

industry’s old business model of high
fixed costs will be destroyed as many
companies restructure.
Conclusion

The participants at this year’s Automotive Outlook Symposium predicted the
recession to end around the middle of
this year. But because of the fallout from
the financial crisis, economic growth
going forward is expected to be muted,
with the unemployment rate remaining
high. Light vehicle sales this year are
forecasted to be the lowest in over 40
years, but some modest improvement is
expected next year.
1

	Some materials presented at the symposium are available at www.chicagofed.org/
news_and_conferences/conferences_
and_events/2009_aos.cfm. The presentations about fuel efficiency on June 4
will be summarized in an upcoming
Chicago Fed Letter.

	 The Detroit Three are Chrysler Group
LLC, Ford Motor Co., and General
Motors Corp.

2


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102