In 2007, the nation’s economic growth will soften slightly, inflation will decrease, and the unemployment rate will edge higher, according to the median forecast of the participants at the Federal Reserve Bank of Chicago’s Economic Outlook Symposium.Economic forecasting

Emily Engel

William A. Strauss

English

Research Papers in Economics

Chicago Fed Letter
Economic Outlook Symposium: Summary of 2006 results and
forecasts for 2007
by William A. Strauss, senior economist and economic advisor, and Emily A. Engel, associate economist
In 2007, the nation’s economic growth will soften slightly, inflation will decrease, and the
unemployment rate will edge higher, according to the median forecast of the participants
at the Federal Reserve Bank of Chicago’s Economic Outlook Symposium.
ESSAYS ON ISSUES THE FEDERAL RESERVE BANK FEBRUARY 2007
OF CHICAGO NUMBER 235
2005 2006 2007
(Actual) (Forecast) (Forecast)
Real gross domestic producta 3.1 3.0 2.8
Real personal consumption expendituresa 2.9 3.4 2.8
Real business fixed investmenta 5.6 8.6 5.9
Real residential investmenta 9.0 –10.4 –4.2
Change in private inventoriesb 43.5 38.0 38.6
Net exports of goods and servicesb –636.6 –638.4 –630.1
Real government consumption
expenditures and gross investmenta 1.2 2.4 1.7
Industrial productiona 3.0 4.3 2.6
Car & light truck sales (millions of units)c 16.9 16.6 16.4
Housing starts (millions of units)c 2.07 1.85 1.60
Unemployment rated 4.9 4.6 4.9
Consumer Price Indexa 3.7 3.0 2.5
1-year Treasury rate (constant maturity)d 4.29 5.02 4.80
10-year Treasury rate (constant maturity)d 4.49 4.80 5.00
JPMorgan trade weighted dollar indexa 2.1 –3.4 –0.6
Oil price (dollars per barrel of
West Texas Intermediate) 60.03 60.17 59.05
aFourth quarter over fourth quarter percent change.
bBillions of chained (2000) dollars.
cFourth quarter average.
dPercent.
SOURCES: Actual data from authors’ calculations and Haver Analytics;
median forecast from Economic Outlook Symposium participants.
1. Median forecast of GDP and related items
So how did the U.S. economy perform
over the past year? Real gross domestic
product (GDP) growth was 1.8% in the
fourth quarter of 2005. Growth in this
quarter was held down by a sharp reduc-
tion in energy production following
Hurricanes Katrina and Rita and a sig-
nificant drop in vehicle
sales that followed the
surge in the summer
from “employee pric-
ing” incentive programs
by the Big Three auto-
makers. Without the
drag from these two
events, GDP growth
surged to 5.6% in the
first quarter of 2006.
Growth moderated to
2.6% in the second
quarter and to 2.0%
in the third quarter.
In the second and
third quarters of 2006,
growth would be con-
sidered by our consen-
sus group as below
potential for the U.S.
economy. However,
the weakness was in
large part attributable to the pullback in
the residential sector. This reduction
lowered GDP growth by 0.7 percentage
points and 1.2 percentage points in the
second and third quarters, respectively.
The unemployment rate remained fairly
stable at around 4.7% over the first
three quarters of 2006. Employment
expanded by over 1.8 million jobs be-
tween November 2005 and November
2006. An average of 151,300 jobs were
added each month—an impressive gain.
Inflation edged higher during 2006. The
Personal Consumption Expenditures
Price Index increased 2.0% in the first
quarter, 4.0% in the second quarter, and
2.4% in the third quarter. This was in
large part due to significant increases in
energy prices that peaked in the sum-
mer. West Texas Intermediate oil prices
averaged just over $59 per barrel in
December 2005 and increased to $74 by
July 2006—approximately a 25% increase
over this short period. Oil prices backed
off from these elevated levels, falling
to $59 per barrel by November 2006.
Removing food and energy, core infla-
tion rates were higher during 2006, with
prices rising 2.1%, 2.7%, and 2.2% dur-
ing the first, second, and third quarters
of the year, respectively.
Higher energy prices during the first
half of 2006 put increasing pressure on
consumer spending. Spending on energy
goods and services as a share of total
spending was 5.7% for the first 11 months
of 2005 and rose to average 6.0% for the
comparable period in 2006. Yet, when
viewed from a historical perspective, itWith a slower pace of economic activity and flat oil prices,
inflation is forecasted to moderate in 2007.
was still below the rate it has averaged
since 1960, 6.4%.
The housing sector experienced a sharp
pullback in activity during 2006. The
months’ supply of new single-family
homes (the number of months it would
take to sell the current supply of new
single-family homes at the current selling
rate) averaged 4.1 months from 1997
to 2005. It averaged 4.4 months in 2005,
and then rose to average 6.4 months in
the first 11 months of 2006. This buildup
in inventories led to a substantial cut-
back in new construction. Housing
starts fell from an annual rate of over
2.0 million units at the beginning of
2006 to just below 1.6 million units by
November. After edging lower by 0.3%
in the first quarter, residential investment
fell sharply by 11.1% in the second quar-
ter and by 18.6% in the third quarter.
The weakness in housing ended the
dramatic increases in residential home
prices. After rising 10.9% in 2005, house
prices rose at much slower rates as the
year progressed, gaining 8.3%, 5.0%,
and 1.5% during the first, second, and
third quarters of the year, respectively.
Consumer credit conditions appear to
be weathering this downturn. While
the residential real estate loan delin-
quency rate has edged higher, it remains
low. The mortgage foreclosure rate has
remained flat.
Economic Outlook Symposium on
December 1, 2006. A severe winter storm
swept into Chicago on the day of the
symposium, yet more than 60 economists
and analysts from business, academia,
and government attended the confer-
ence. This Chicago Fed Letter reviews the
previous year’s forecasts for 2006 and
summarizes the presentations at the
2006 conference (see figure 1).
Performance versus the forecasts
In 2005, forecasters were anticipating
that the economy would grow near po-
tential in 2006 (a growth rate associated
with a stable unemployment rate and
no inflationary pressures). GDP growth
started off a bit faster than forecasted,
rising 5.6% in the first quarter compared
with the 3.5% predicted. Second quar-
ter output was expected to increase by
3.4%, but it grew by 2.6%. Third quar-
ter GDP expanded by 2.0%, slower than
the 3.0% forecasted. The unemployment
rate was forecasted to remain fairly stable
at around 5.0%. The year started off
with a more marked reduction in the
unemployment rate: It fell to 4.7% in
the first quarter and ended the year
averaging 4.5% in the fourth quarter.
In general, the consensus forecast was
fairly accurate, with the exception of a
few sectors. West Texas Intermediate
oil prices were forecasted to average
to the consensus forecast, the industrial
sector should have expanded by an av-
erage of 3.3% for the first three quarters
of the year. However, industrial produc-
tion rose more robustly, increasing by
5.2%, 6.5%, and 3.9% for the first, sec-
ond, and third quarters of 2006, respec-
tively. Light vehicle sales were forecasted
to average 16.8 million units during
2006, higher than the 16.5 million units
that were sold.
Economic outlook for 2007
According to the consensus group, real
GDP is expected to have increased by
3.0% in 2006 and then rise 2.8% in
2007—a rate that the consensus group
regards as a bit below potential. While
virtually all sectors are predicted to ex-
perience more moderate performance,
the housing sector is expected to have
the most significant reduction in activi-
ty. Housing starts are forecasted to av-
erage 1.60 million units in 2007 after
averaging 1.85 million units in 2006.
This is predicted to lead to continued
reductions in residential investment
during 2007. After falling by 10.4% in
2006, residential investment is forecast-
ed to decline 4.2% in 2007.
The inverted yield curve is predicted to
correct itself, although it should still be
relatively flat. Forecasters expect the
ten-year Treasury rate to rise 20 basis
points to 5.0% by the final quarter of
2007. They also expect a 22-basis-point
reduction in the one-year Treasury rate
to 4.8% by the end of 2007.
Spending growth in the consumer sec-
tor is predicted to expand at a slower
pace in 2007, edging down from 3.4%
growth in 2006 to 2.8%. The easing on
spending growth is expected to translate
into a slight decline in light vehicle sales,
which are forecasted at 16.4 million
units in 2007.
The business sector is expected to have
another solid year, with growth in busi-
ness fixed investment rising by 5.9% in
2007, although less than the 8.6% in
2006. Industrial production, which is
expected to have risen 4.3% in 2006,
should increase 2.6% in 2007.
Government spending is anticipated to
rise by 1.7% in 2007, a slower pace than
Light vehicle sales averaged 16.5 mil-
lion units during the first 11 months
of 2006—2.2% below the average of
16.9 million units over the comparable
period in 2005. While the past eight years
have been the industry’s highest selling
years, the amount sold has shown no
growth, ranging between 16.5 million and
17.3 million units each year. Yet the Big
Three automakers’ market share fell from
an average of 70.1% in 1998 to 54.3%
for the first 11 months of 2006—a 2.7
percentage point reduction from the
comparable period of 2005.
Against this backdrop, the Federal Re-
serve Bank of Chicago held its twentieth
$59.24 per barrel in the first quarter
and then fall to $55.69 per barrel by
the fourth quarter. In fact, oil prices
averaged over $63 per barrel in the
first quarter and rose to average over
$70 per barrel in the second and third
quarters and eased to $60 per barrel
in the fourth quarter. Housing starts
were expected to average 1.95 million
in the first quarter and fall to average
1.86 million by the third quarter. In
fact, housing starts averaged a stron-
ger 2.12 million starts in the first quar-
ter, but then fell off more sharply than
anticipated, averaging 1.71 million units
in the third quarter of 2006. AccordingMichael H. Moskow, President; Charles L. Evans,
Senior Vice President and Director of Research;  Douglas
Evanoff, Vice President, financial studies; Jonas Fisher,
Economic Advisor and Team Leader, macroeconomic
policy research; Richard Porter, Vice President, payment
studies; Daniel Sullivan, Vice President, microeconomic
policy research;  William Testa, Vice President, regional
programs and Economics Editor; Helen O’D. Koshy,
Kathryn Moran, and Han Y. Choi, Editors; Rita
Molloy and Julia Baker, Production Editors.
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.
© 2007 Federal Reserve Bank of Chicago
Chicago Fed Letter articles may be reproduced in
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and provided the source is appropriately credited.
Prior written permission must be obtained for
any other reproduction, distribution, republica-
tion, or creation of derivative works of Chicago Fed
Letter articles. To request permission, please contact
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Letter and other Bank publications are available
on the Bank’s website at www.chicagofed.org.
ISSN 0895-0164
in 2006. The international trade defi-
cit is expected to decrease somewhat,
falling from $638.4 billion in 2006 to
$630.1 billion in 2007.
Oil prices are expected to remain around
$60 per barrel throughout 2007. With
a slower pace of economic activity and
flat oil prices, inflation is forecasted to
moderate; inflation, as measured by the
Consumer Price Index, is predicted to
rise by 2.5% in 2007.
A shift toward upscale automobiles and
crossover utility vehicles (CUVs) is antic-
ipated, while the number of traditional
sport utility vehicles (SUVs) sold is ex-
pected to decrease.
Despite these predictions, Hughes-
Cromwick said that she had some reser-
vations about the future of the U.S. auto
sector. For example, the U.S. economy
has recently seen the largest gap between
the personal savings rate and gasoline
of people who own homes has increased
to record levels (68% in the current
decade). This ownership rate encom-
passes a broad base of people of all in-
come levels, as the ready availability of
mortgages and relatively low interest
rates have made it much easier for ev-
eryone to own a home. The low effec-
tive mortgage rates may be leading to
the higher levels of housing starts. With
monetary policy having tightened, a slow-
down is expected, but, Fisher concluded,
housing is not expected to be a major
drag on the economy going forward.
Heavy machinery outlook
Donald Johnson, chief economist,
Caterpillar Inc., presented the outlook
on heavy machinery for 2007. The U.S.
economy is in for a weaker year, with
housing, automotives, and trade expect-
ed to slow down somewhat. However,
Johnson pointed to strong growth in
other economies throughout the world
in 2007. Currently, Europe is on the
road to recovery, and the developing
countries are staying strong.
For 2007, Caterpillar Inc. is forecasting
a slight increase of up to 5% for its own
sales. This is because dealers are ex-
pected to reduce their inventories in
Residential investment as a share of GDP has reached levels
that have not been seen for about 50 years.
Consumer and banking outlook
Carl Tannenbaum, chief economist,
LaSalle Bank/ABN AMRO, said that, on
the consumer side, the housing correc-
tion continues, with existing home prices
dropping, home equity withdrawals falling
from previous high levels, and home eq-
uity loans flattening out. Credit card de-
linquencies are also creeping back up
from the recently low levels. However, gas-
oline prices have dropped from unusually
high levels, and the economy is currently
seeing one of the strongest job markets.
On the banking side, some deterioration
in the Midwest has been seen in credit
quality, especially in the state of Michigan.
We are in a period of a flat yield curve,
Tannenbaum explained, but it is not
necessarily an indicator of a recession.
Commercial and industrial loans (in the
billions of dollars) are higher than they
have been in recent years, and they have
helped make 2006 a strong year for banks.
Credit spreads are narrowing between
corporate bonds and ten-year Treasuries,
which means that, in general, participants
are assessing less risk in the market.
Auto outlook
Ellen Hughes-Cromwick, director and
chief economist, Ford Motor Company,
presented the vehicle industry and sales
outlook for 2007. She expected the auto
sector to remain firm, though U.S. light
vehicle sales are predicted to edge lower.
This projection is based on the positive
global economic and industrial condi-
tions that the market has recently seen.
prices. Indeed, since mid-2005, the three-
month moving average of personal sav-
ings has been negative, while gasoline
and fuel oil spending has exceeded 3%
of consumer incomes.
Steel outlook
Robert DiCianni, marketing manager,
Mittal Steel USA, presented his outlook
on the steel industry for 2007. While
the 2007 forecast for the economy as a
whole anticipates a slight decrease in
growth, it is falling from a strong year
in 2006 and a very strong year in 2005.
With this expected slower pace of growth,
housing is anticipated to taper off from
record levels, accompanied by a slight
decrease in inventories. DiCianni said
he expected automotive production to
continue at a steady rate. However, with
the number of imported vehicles in-
creasing, the U.S. manufacturers may
be using less steel in 2007. On the oth-
er hand, the nonresidential construc-
tion sector—one of the largest users of
steel—is expected to stay strong, as well
as the manufacturing sector.
Housing outlook 
Jonas Fisher, economic advisor and team
leader of the macroeconomics group
at the Federal Reserve Bank of Chicago,
discussed his paper, “The great turn-
of-the-century housing boom.”1 Over the
past decade, residential investment as
a share of GDP has reached levels that
have not been seen for about 50 years.
Also, during this period, the numberresponse to new truck emission stan-
dards and waning market demand in
North America. However, this weakness
in demand is expected to be offset by
demand in other countries. Addition-
ally, some growth is expected from the
mining sector, which is responding to
growing demand (and rising prices)
for metal; this should boost sales of
trucks used at mine sites.
Conclusion
The year 2006 was challenged by a sharp
slowdown in housing and large increases
in energy prices. Housing and energy
prices are expected to add less drag to
the economy in 2007. The outlook for
2007 is for GDP growth to moderate
further; growth is expected to stay be-
low potential for the U.S. economy.
1 Jonas D. M. Fisher and Saad Quayyum,
2006, “The great turn-of-the-century hous-
ing boom,” Economic Perspectives, Federal
Reserve Bank of Chicago, Vol. 30, No. 3,
Third Quarter, pp. 29–44.
The unemployment rate is predicted to
edge higher, remaining near a rate con-
sidered to be full employment. Infla-
tion is expected to moderate in 2007.

Economic Outlook Symposium: summary of 2006 results and forecasts for 2007

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Economic Outlook Symposium: summary of 2006 results and forecasts for 2007

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