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ESSAYS ON ISSUES THE FEDERAL RESERVE BANK OF CHICAGO FEBRUARY 1998 NUMBER 126 Chicago Fed Letter Where have all the workers gone?—A summary o f the 1998 Economic Outlook Symposium In 1997, the econom y exp an d ed with gusto in the first quarter, rising by nearly 5%, and then m oderated in the secon d an d third quarters, gaining 3.3% and 3.5%, respectively. Observers feared that such high growth was un sustainable without causing the econ omy to overheat an d inflation to rise. However, the year witnessed a down ward trend in both the unemployment rate an d inflation. Still, the lag struc ture between strong econom ic growth an d inflation is not clearly defined and concern about inflation rem ained even as the inflation rate dipped below 2%, its lowest level in over ten years. T he Asian econom ic crisis in O ctober led to increased stock market volatility, strengthen ed the dollar, an d ad d ed a new wrinkle to the U .S. econom ic horizon. Against this backdrop, the Federal Reserve B an k of C h icago held its eleventh annual Econom ic O utlook Sym posium on D ecem ber 5, 1997. M ore than 50 econom ists an d analysts from business, academ ia, an d govern m ent attended the conference. T he focus o f this year’s conference was on the labor market and whether an econ omy operating at full em ploym ent can continue to expan d when it is running out o f workers. This Fed Letter reviews the accuracy o f last year’s conference forecasts an d sum m arizes the 1998 Econom ic O utlook Sym posium . Looking over our shoulders Generally, participants in last year’s sym posium underestimated the strength of the economy. They expected real gross domestic product (GDP) to increase by ju st over 2% in 1997; for the first 1. M edian fo recasts fro m the 1998 Econom ic O utlook Sym posium 1996 1997 1998 Real GDP 2.8% 3.8% Personal co n su m p tio n expenditures 2.6% 3.3% 2.6% 3.0% Business fixed investm ent 9.2% 10.6% 9.2% Residential construction 5.9% 2.3% 2.1% Change in business inventories (bil. constant $) $25.0 $60.5 $38.5 -$176.0 -$114.4 -$145.4 G overnm ent purchases o f goods and services Net e xports o f goods and services (bil. constant $) 0.5% 1.0% 1.1% Industrial p ro d u ctio n 2.8% 4.6% 3.5% Car and lig h t truck sales (m illio ns) 15.0 15.0 14.8 Housing starts (m illio ns) 1.47 1.46 1.41 4.9% U n e m p lo ym e n t rate 5.4% 5.0% In fla tion rate (Consum er Price Index) 2.9% 2.4% 2.4% 8.27% 8.44% 8.70% 3.6% 10.5% 1.0% Prime rate Federal Reserve trad e -w e ig h te d d o lla r Note: Data are actual for 1996 and forecast for 1997 and 1998. 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; and Federal Reserve Bank of Chicago, Economic Outlook Symposium. three quarters, it averaged ju st under 4%. This underestim ation tendency held for m ost o f the subcategories o f GDP. The 5.2% growth rate of industrial production for the first three quarters o f 1997 was m ore than twice the forecast. Light vehicle sales averaged 406,000 m ore units than forecast a year ago. H ousing starts were expected to m oderate to 1.39 million units in 1997 after a very strong year in 1996; instead, 1.46 mil lion annualized units were ad d ed in the first three quarters. T he tradew eighted dollar was anticipated to increase a slight 0.9% during 1997; however, the dollar appreciated near ly 17% for the year. An overestim a tion of 0.4 percentage points occurred for the unem ploym ent rate forecast. T he inflation rate was expected to soften in 1997 to a 2.8% rate, follow ing the 2.9% average o f 1996. Howev er, it ended half a percentage point lower than the forecast at 2.3%. The symposium forecast was more accu rate on interest rates, with the actual rate being only 28 basis points higher than the forecast for 1997. In summary, the econom y expan ded faster, inflation was m ore benign, and unem ploym ent rates were lower than last year’s sym posium forecasts sug gested. With unem ploym ent rates now below 5%, an d in many regions un der 4%, businesses are increasingly becom ing co n cern ed about finding qualified workers. This con cern raised the qu es tion that becam e the them e o f the 1998 Econom ic O utlook Sym posium , “W here have all the workers g o n e?” Looking ahead For 1998, the symposium forecasts show the positive 1997 econom ic conditions continuing, albeit at a much slower pace. Figure 1 sum m arizes expectations for 1997 (fourth quarter num bers not known) an d 1998. M ost forecasters 2. R eal GD P growth percent change, annual rate ■ h 1 Forecast range Actual A J A, t v \ J ____ i ■ ■ ■ ■ ■ ■ ■ i ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ i ■ ■ ■ ■ 1992 ’93 ’94 ’95 ’96 ’97 Sources: U.S. Bureau o f E conom ic A nalysis. Dashed line represents Federal Reserve Bank o f Chicago, E conom ic O u tlo o k S ym p o siu m m edian forecast. believed that the growth rates exp eri en ced in 1997 are unsustainable and that real output growth during 1998 will be lower than in 1997 for every subcategory o f GDP. T he typical fore caster is expecting real GDP growth to be 3.8% in 1997 an d 2.6% in 1998. Given the situation in Asia, it is not surprising that one o f m ost dram atic changes anticipated during 1998 is on the international front, with net ex ports forecast to decline from -$145.4 billion in 1997 to -$176.0 billion in 1998. Only the governm ent sector is expected to grow in 1998 at rates sim ilar to 1997. In term s o f the quarterly pattern for real GDP, the forecast group is expect ing a downward trend. In the first quarter, real GDP growth is forecast at 2.8%, m oderating steadily to 2.2% by the fourth quarter o f 1998 (see figure 2). This downward pattern is reflected in the growth outlook for person al consum ption expenditures, business fixed investment, an d resi dential investment. Som e weakening is expected for change in business inventories an d net exports. Govern m ent spen din g growth is forecast to rem ain fairly flat over the four quarters o f 1998. T he quarterly patterns for the other series forecasts— industrial p rod u c tion growth, car an d light truck sales, an d housing starts— are expected to decline over the forecast horizon. The unem ploym ent rate (see figure 3), inflation, and the prim e rate are antic ipated to rise over the four quarters of 1998. Finally, the growth rate for the trade-weighted dollar should show a fairly flat pattern in 1998. Below, we sum marize the dis cussion o f tight labor markets and forecasts for individual sectors. D ealing with tight labor m arkets A chief executive officer (CEO ) from a tem po ■ ■ ■ ■_______ rary help firm said that ’98 while jo b s are being created at a fast pace, there are major discrep ancies between jo b s an d individuals available to fill them , both in term s o f geography and education. The speaker proposed several solutions to the tight labor force problem : 1) O utsourcing o f positions to tem porary help agencies to reduce the cost o f mis-hiring, one of the more sig nificant costs that com panies incur. 2) T raining o f em ployees to keep their skills current. Corporate training has been one of the areas most affected by cost cutting. 3) Bringing retirees back into the work force. 4) U sing exp an d ed hiring sources, such as the Internet, networking through new hires, looking at individuals ju st out o f high school who are not sure what jo b they want to hold, or creating alli ances with correspon dence schools. 5) R educing turnover through a com bination o f nonm onetary and m onetary incentives. 6) Preparing students better for the working world. Finally, the speaker asked whether, in a full em ploym ent environm ent, cur rently unem ployed individuals are in fact em ployable. Do they even have basic jo b skills? What can be done about this portion o f the unem ploy m ent group? A ccording to the CEO, the labor m arkets will continue to be very tight an d the gap will persist between what em ployers want an d what is available. O utlook fo r individual sectors Consumer—T he econom ic outlook from the consum er side was discussed by an econom ist who has worked with consum er surveys extensively for many years. C onsum ers typically decide to stop spen din g only if som e m ajor econom ic or political event changes the economic horizon and, at this time, they generally expect the current expan sion to last anoth er five years. T he consum er has not been this opti mistic about conditions since 1965. Indicative that consum ers expect low rates o f inflation to continue is that the inflationary mentality that they should buy now before prices go up no longer exists. There does not appear to be any significant pent-up dem and, so consum ers now feel they can shop elsewhere if prices are high. This view has placed increased competitive pressures on som e producers, m aking it difficult to pass on higher m anufac turing costs to consum ers. B ased on the surveys, consum ers are not as con cern ed about becom ing un em ployed as they were a short tim e ago and, as a result, they are m ore willing to ask for wage increases. Autos—An econom ist from an auto produ cer expects light vehicle sales (seasonally adjusted annual rate) to be 14.7 m illion to 15.2 m illion units, which is in the range o f the con sen sus forecast of 14.8 million units. This econom ist felt that there does not ap p ear to be a large am oun t o f pentup dem and. Feeling con fiden t about the economy, consum ers have con tinued to m ake large purchases, such as vehicles, in the past year. The econom ist expects core inflation to be un der 2% in 1998 an d interest rates to be stable, which should lead to good retail sales and vehicle sales. The risks to dom estic vehicle produ cer sales are con tin ued com petition from E u ropean producers and increased com petition from Asian producers, in particular Japan and South Korea. Having lost sales in the Far East due to the Asian econom ic crisis, Japan an d South Korea will probably try to ship m ore product to the U.S. to keep their production levels up. This increased com petition will lead to even lower vehicle prices for consum ers in 1998. With reduced production an d consum ption dem an d in Asia, this economist expects crude oil prices to be down by 20% in 1998. This is the consultant felt that wages in this in dustry do not accu rately represent the total compensation that employees receive. Front-end or perfor mance-based bonuses, as well as profit sharing plans, add to total com pensation. Banking—The con cern over rising con sum er credit card debt was discussed by an econom ist from a Sources: U.S. D e partm ent o f L a b o r, Bureau o f Lab or S tatistics. large com m ercial Dashed lin e represents Federal Reserve Bank o f C hicago, E conom ic O utlo o k S ym p o s iu m m edian fo re c a s t. bank. D espite improv ing econom ic conditions, debt levels good news for light truck sales, as these have increased to record levels. vehicles tend to be less fuel efficient However, the speaker felt that co n than passenger cars. sum ers are getting smarter about m anaging debt. M ore aggressive Home building—An executive who credit card m arketing by issuers ex represents the hom e building industry plains part of the debt buildup. In ad presented a very favorable outlook dition, consum ers are feeling m ore for the housing industry in 1998. confident an d are m ore willing to Com petition has increased for hom e extend their credit obligations. builders with m ore builders com pet ing for m arket share. It has been quite In 1998, the banking industry faces a buyers’ m arket with incentives being som e challenges. While short-term offered by builders. Builders are not interest rates have rem ain ed fairly having trouble finding labor, and wages steady, long-term interest rates have have not increased significantly over com e down since the m iddle of the past year. With the strong sales 1997, leadin g to a flattening o f the pace of the past several years, there yield curve. This will hurt the profit does not appear to be any pent-up m argins o f banks, which m ake their dem and in the housing market. This m oney by borrow ing short an d len d executive expects housing starts to ing long. Consolidation in the bank ease to 1.39 million units in 1998. The ing industry will continue. There are consensus forecast for 1998 is slightly 25% fewer banks in the U.S. now m ore optimistic at 1.41 million units. than in 1990. Steel—A consultant to the steel indus Heavy equipment—A ccording to a try said that many m ajor projects will director o f the economics department be undertaken in 1998 an d that given of a heavy equipm ent manufacturer, the am oun t o f steel bein g shipped, the industry is heavily reliant on how the construction num bers being well the construction industry does reported are too low. Steel con sum p during 1998. T he industry is current tion is projected to increase nearly ly in an upsurge. While tightness in 2% in 1998. Engine an d parts plants the labor m arket continues to be a and assembly plants in the automotive concern, this industry has been less industry are the m ost active sectors for affected than other industries. Pro investm ent in this industry. T here ductivity gains have allowed the do not ap p ear to be any capacity con speaker’s company to reduce employ straints, with the possible exception ment, while increasing both sales and o f high-perform ance products. Com shipments. For new hires at this com pensation is generally high in the pany, there were 25 applicants for steel industry, m aking it relatively every open in g and, o f those hired, easy to attract workers. Furtherm ore, m ore than 70% had college degrees. T he N orth A m erican m arket for heavy duty equ ipm en t is very m ature and any expan sion in this m arket in 1998 an d beyond will be from foreign de m and. T he environm ent for m achine sales for both the agriculture an d con struction industries during 1998 is very favorable. T he heavy equipm ent industry does well as lon g as housing starts rem ain above a 1.3 m illion unit pace. As lon g as the econom y d o e sn ’t go into a recession an d as lon g as in terest rates rem ain som ew hat stable, the speaker believes that the outlook for the industry will rem ain bright. C onclusion T he econom ic outlook for 1998 calls for slower econom ic growth than in 1997, coupled with a continued low rate o f inflation an d a low unem ploy m ent rate. Both light vehicle sales and housing starts are anticipated to be down slightly from their 1997 levels, but still at fairly high rates. If these forecasts are realized, 1998 will be an other in a series o f very g oo d years for the U.S. economy. —William Strauss Sen ior econom ist Keith Motycka Associate econom ist Michael H. Moskow, President; William C. Hunter, Senior Vice President and Director ofResearch; Douglas Evanoff, Assistant Vice President, financial studies; Charles Evans, Assistant Vice President, macroeconomic policy research; Daniel Sullivan, Assistant Vice President, microeconomic policy research; William Testa, Assistant Vice President, regional programs; Vance Lancaster, Administrative 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. T h e views expressed are the auth ors’ and are not necessarily those of the Federal Reserve Bank o f Chicago or the Federal Reserve System. Articles may be rep rin ted if the source is credited an d the Research Department is provided with copies o f the reprints. Chicago Fed Letter is available without charge from the Public Inform ation 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 http://w w w.frbchi.org. ISSN 0 8 9 5 - 0 1 6 4 T racking M idwest m anufacturing activity Manufacturing output indexes, 1992=100 132 Manufacturing output indexes (1992=100) Nov. Month ago Year ago CFMMI 125.5 124.6 118.8 IP 130.2 129.0 122.5 122 Motor vehicle production (millions, seasonally adj. annual rate) Nov. Month ago Year ago Cars 6.1 5.9 6.3 Light trucks 6.6 6.2 5.6 112 Purchasing managers' surveys: net % reporting production growth Dec. Month ago Year ago MW 58.6 63.7 58.4 U.S. 55.4 58.6 58.5 102 ____________________________________________________________________________________I__ I__ I__ I__ I__I__ I__ I__ I__ I__I__ I__I__ I__ I__ I__ I__I__ I__ I__ I__ I__I__ I__I__ I__ I__ I__ I__I__ I__ I__ I__ I__I__ I__I__ I__ I__ I__ I__I__ I__ I__ I__ I__I__ L 1994 1995 The CFMMI reached a record high o f 125.5 in November. The index gained 0.7% for the month, following a strong 1.1% increase in October. T he Federal Reserve B o ard ’s IP for m anufacturing also set a record high o f 130.2 in Novem ber, gaining 1.0% for the m onth following a 0.6% increase in October. The Midwest purchasing m anagers’ composite index for production decreased to 58.6% in Decem ber from 63.7% in November. Purchasing m anagers’ indexes de creased for the Chicago, Detroit, and Milwaukee surveys. The national purchasing m anagers’ composite index decreased from 58.6% in November to 55.4% in De cember. Total motor vehicle production increased from 12.1 million units in Oc tober to 12.7 million units in November. Light truck production increased from 6.2 to 6.6 million units and car production increased from 5.9 to 6.1 million units. 1996 1997 Sources: The Chicago Fed Midwest Manufacturing Index (CFMMI) is a composite index of 16 industries, based on monthly hours worked and kilowatt hours. IP represents the Federal Reserve Board’s Indus trial Production Index for the U.S. manufacturing sector. Autos and light trucks are measured in an nualized units, using seasonal adjustments devel oped 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 Purchas ing Managers’ Association surveys, with assistance from Bishop Associates, Comerica, and the Uni versity of Wisconsin-Milwaukee. peisenboj odiajos TITS ZZe (ZIE) 1E80 06909 siouini ‘0§E3TO ZMl 'ON HIAIdTd SION I-!-! I 'OOV3IH3 aivd aovisod s n adaoodva t? + diz 1IVIAI S SV lO lS d ld Q T ldO S T dd f£8 xog'O'd J 01U9Q uopetuiojuj aijqnj OOVOIHO TO w v a 3AHTSTH TVHTQTT J0 } } 0 q p 0 t j O § B 0 iq Q