Robert H. Schnorbus

William A. Strauss

English

Research Papers in Economics

ESSAYS ON ISSUES THE FEDERAL RESERVE BANK FEBRUARY 1997
OF CHICAGO NUMBER 114
Chicago Fed Letter
1. Median forecasts from the 1997 Economic Outlook Symposium
Building a house for the
21st century
While 1996 started off slowly, the eco-
nomic engine accelerated in the
second quarter of the year, to the
point where many people were very
concerned about the economy over-
heating.  These fears were mollified
in the third quarter as the economy’s
growth matched the slower growth of
the first quarter. In that setting, the
Federal Reserve Bank of Chicago held
its tenth annual Economic Outlook
Symposium on December 6, 1996.
More than 50 economists and analysts
from business, academia, and govern-
ment attended the conference. The
sessions focused on the housing mar-
ket and how its strength during 1996
would affect the economy in 1997.
Prior to the symposium, individuals
were asked to submit both annual and
quarterly 1997 forecasts for many of
the gross domestic product (GDP)
components, as well as several other
economic series. This Fed Letter will
review the accuracy of last year’s
conference forecast for 1996 and
summarize the 1997 Economic Out-
look Symposium.
The economy in 1996—Forecast
and results
It is helpful to look back to the fore-
casts that were made a year ago and
analyze where the forecasts differed
from the actual outcome. One caveat
should be noted. Last year’s forecasts
were made late in 1995, prior to the
new chain-weighted revisions to GDP.
Consequently, the forecasts were based
upon the old fixed-weight measure-
ments. During the 1990s, the new
chain-weighted real GDP averaged
–0.5% lower annualized growth than
the old fixed-weight measured real
GDP. The expectation at last year’s
Economic Outlook Symposium was for
growth in real GDP to average 2.6%
for the fourth quarter of 1995 through
the first three quarters of 1996, a reduc-
tion from the extremely strong 3.7%
pace of the prior four quarters. Cor-
recting for the –0.5% lower growth in
the new data would reduce the fore-
cast to 2.1%.  Actual real GDP has aver-
aged 2.0% growth over the past four
quarters. So the corrected consensus
forecast was fairly accurate last year.
The consensus forecasts of the compo-
nents of GDP were generally higher
than the realized revised components’
actual values. For personal consump-
tion expenditures, change in business
inventories, net exports, and govern-
ment purchases of goods and services,
the degree of overforecast was very
small. However, business fixed invest-
ment was expected to increase by 8.4%
but only grew by 6.5%. This relatively
large difference for business fixed in-
vestment could possibly be due to the
new chain-weighting technique. The
largest forecast error in the GDP com-
ponents occurred for residential fixed
investment, which was anticipated to in-
crease by 1.7% but rose by 3.9%. The
consensus forecast was right on tar-
get for industrial production, while
the unemployment rate, inflation,
and the prime rate were slightly low-
er than the group expected. The con-
sensus was a little low on light vehicle
sales, which turned out to be 300,000
units stronger than expected. The
trade-weighted dollar showed more
strength than the forecasters antici-
pated. Finally, housing starts were
anticipated to increase by 1.36 million
units but in fact rose by 1.46 million
units. This unexpected strength in
the housing sector was a prime reason
that the central topic for the 1997
1995 1996 1997
Real GDP 2.0% 2.3% 2.2%
Personal consumption expenditures 2.3% 2.4% 2.1%
Business fixed investment 9.5% 7.1% 5.9%
Residential construction –2.3% 5.4% 0.5%
Change in business inventories (billions) $33.2 $17.8 $22.7
Net exports of goods and
  services (billions) –$107.6 –$120.4 –$124.6
Government purchases of goods
  and services 0.0% 0.8% 0.6%
Industrial production 3.3% 3.1% 2.7%
Car and light truck sales (millions) 14.7 15.0 14.7
Housing starts (millions) 1.36 1.46 1.38
Unemployment rate 5.6% 5.4% 5.5%
Inflation rate (Consumer Price Index) 2.8% 2.9% 2.8%
Prime rate 8.83% 8.27% 8.16%
Federal Reserve trade-weighted dollar –7.7% 3.5% 0.7%
Note: Data are actual for 1995 and forecast for 1996 and 1997.
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.-3
0
3
6
1991 ’92 ’93 ’94 ’95 ’96 ’97
percent change, annual rate
Actual
Forecast range
Note: The dashed line represents the median of the consensus forecast.
Source: U.S. Bureau of Economic Analysis.
2. 1997 forecast of real GDP
Economic Outlook Symposium was,
following the presidential vision
theme, Building a House for the
21st Century.
Looking forward
In 1997, the forecasters are expect-
ing a fairly boring year. Boring is not
necessarily bad considering that not
a single forecaster is expecting a re-
cession over the next five quarters.
Figure 1 summarizes what the fore-
casters are expecting both in 1996
(fourth quarter numbers not known)
and in 1997. The typical forecaster is
expecting 1996 real GDP growth to
be 2.3%. The forecast for 1997 is for
real GDP growth to be 2.2%. This slight
decline of 0.1% is related to some an-
ticipated softening in the growth rates
of personal consumption expendi-
tures, business fixed investment, net
exports, and government purchases
of goods and services. A more severe
reduction is expected in residential
construction, which is forecast to ease
to 0.5% in 1997 from 1996’s rate of
5.4%. The only GDP component ex-
pected to be stronger in 1997 is the
change in business inventories.
With the slight slowing in real GDP
growth, industrial production is ex-
pected to slow from 3.1% to 2.7% in
1997. Car and light truck sales are ex-
pected to ease somewhat from their
fairly strong 15.0 million unit pace to
a relatively modest sales rate of 14.7
million units. Housing starts are ex-
pected to moderate to a 1.38 million
unit pace in 1997 following a very
strong 1.46 million unit
rate in 1996. The un-
employment rate is
forecast to rise by a
tenth of a percent to
5.5%. Inflation is actu-
ally forecast to decline
by a tenth of a percent
to 2.8% in 1997. There
is an expectation that
the prime rate will ex-
perience a slight de-
cline, falling by 11 basis
points next year. Final-
ly, the trade-weighted
dollar is expected to
rise by 0.7%.
In terms of the quarter-
ly pattern for GDP, the forecast group
is expecting a fairly flat quarterly out-
look. GDP is anticipated to grow by
2.0% in each of the next three quar-
ters, starting with the fourth quarter
of 1996, and then by 2.1% for the last
two quarters of 1997 (see figure 2).
This flat growth pattern for 1997 is
reflected in the growth outlook for
personal consumption expenditures,
business fixed investment, residential
investment, and government purchases
of goods and services. Some weaken-
ing is anticipated in change in business
inventories as the year progresses. Net
exports are anticipated to improve
over the course of 1997.
The quarterly patterns for the other
series forecast—industrial production,
inflation, the prime rate, and the
trade-weighted dollar—are expected
to grow at the same pace that they
have been experiencing recently.
Car and light truck sales and housing
starts (see figure 3) are expected to
decline over the forecast horizon,
while there is a slight pickup antici-
pated in the unemployment rate as
1997 draws to a close.
The macroeconomic outlook
An economist from the Economic
Cycle Research Institute, Inc., argued
that while consensus forecasts do a
fairly good job during a time of expan-
sion or contraction, they do a terrible
job at predicting a turning point in
the economy. So using consensus
forecasts alone will not allow one to
properly anticipate a change in the
direction of the economy. According
to the work done at the Institute, the
current pattern of information is con-
sistent with the beginning of a reces-
sion. However, this is best interpreted
not as a prediction but as a note of
caution. The prediction by this econ-
omist is that the economy is entering
a period of slower growth and is more
vulnerable to some exogenous shock
that could push it into a recession.
The Institute expects inflation to be
benign over the coming year. This
economist concluded with an out-
look for international growth. The
economies of Japan and France are
expected to experience anemic
growth. Germany’s economy is ex-
pected to fare somewhat better, but
not much. The United Kingdom and
Canada are forecast to have reason-
able growth. The economic recover-
ies abroad are considered fragile and
will be heavily dependent on economic
conditions in the United States.
A chief economist from an investment
firm believes that the economy will
most likely continue to expand, but
that there is risk of a recession. Real
disposable income growth should be
able to sustain continued consumer
spending. Debt service payments as a
percent of disposable income are
high and rising. There is a risk to the
forecast that consumer delinquencies
will increase and cause lenders to cut
back on lending, leading to an eco-
nomic slowdown. The housing market
should continue to do well in 1997
for several reasons. Out of pocket ex-
penses for housing have been declin-
ing as a share of household income.
Consumer confidence levels are very
high, consistent with a good housing
market. Credit quality spreads, which
often widen when recession/credit
quality problems begin to surface,
have not widened. Corporate balance
sheets remain solid. This investment
economist was concerned about the
quality spreads for foreign bonds.
Interest rates for Russia and South-
east Asia are viewed as being too low,
not reflecting the true risk of the in-
vestment. Meanwhile Latin America
probably is facing interest rates that
are too high due to overestimated
investment risk.Michael H. Moskow, President; William C. Hunter,
Senior Vice President and Director of Research;
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;  Anne Weaver, Manager, administration;
Helen O’D. Koshy, Editor.
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.  Articles may be
reprinted if the source is credited and the
Research Department is provided with copies
of the reprints.
Chicago Fed Letter is available without charge
from the Public Information Center, Federal
Reserve Bank of Chicago, P.O. Box 834,
Chicago, Illinois 60690-0834, tel. 312-322-5111
or fax 312-322-5515.  Chicago Fed Letter is also
available on the World Wide Web at http:/ /
www.frbchi.org.
ISSN 0895-0164
0.8
1.0
1.2
1.4
1.6
1991 ’92 ’93 ’94 ’95 ’96 ’97
millions of units
Actual
Forecast range
Note: The dashed line represents the median of the consensus forecast.
Source: U.S. Department of Commerce, Department of the Census.
3. 1997 forecast of housing starts
A consultant to consumer industries
expects the current expansion to con-
tinue through 1997, although there is
less of a recession cushion than in past
cycles. The level of growth in service
spending by consumers is much lower
than prior expansions as a result of
demographics. The result is that the
service spending cushion has shrunk
to around 2%. Overall, consumer
spending is clearly growing in a range
that is consistent with continued ex-
pansion. The strong housing market
in 1996 has provided good durable
spending growth. This consultant be-
lieves that the strength from the con-
sumer side for continued expansion
has to come from nondurable spend-
ing. Currently, nondurable spending
growth is rebounding, but not too
strongly. Consumer spending on light
vehicles is not out of line with past ex-
pansions. While consumer spending
on furniture and household applianc-
es is fairly moderate, the force behind
durable spending is computer, video,
and audio spending. Apparel has done
well and should continue to add to
growth in 1997. Credit growth has been
slowing and will not be the boost to the
consumer that it has been. Despite
many newspaper reports, real dispos-
able income growth can support contin-
ued consumer expenditures.
An economist from a government
lending institution presented the
long-term outlook for housing and
mortgage finance markets. The year
1996 was one of the best in the hous-
ing industry’s history. Existing homes
sales will set a record,
and new home sales
were good. Home ap-
preciation during this
past year has been the
best of the 1990s. The
outlook for the future is
mixed for the housing
industry. Certain demo-
graphics do not work
in the favor of housing.
Individuals in the 25 to
44 year-old category,
prime first-time home
buyers, are expected to
fall by 5% in the first
decade of the next cen-
tury, so there will be less
need for homes. However, the esti-
mated population growth for the
1990s has been revised to over 25
million people, the largest decade
increase since the 1950s.
While population growth is up, house-
hold formation in the second half of
the 1990s is expected to reach the
lowest levels in the last quarter of a
century. Household formations are the
driving force behind the demand for
housing. Immigration to some extent
can be viewed as a white knight for
the housing industry. The number of
individuals legally emigrating to the
U.S. during the 1990s is expected to
be the largest number in this century.
Statistics show that after 15 years in
the U.S., immigrants have the same
home ownership rates as the general
population, and after 20 years immi-
grant ownership rates are actually
higher than among the general pop-
ulation. There was a large influx of
immigrants approximately 15 years
ago, so the impact of this group on
the housing market should begin to
be felt.
Looking at home ownership by age
category over time, two points stand
out. The first is that home ownership
rates increase with age. The second
point is that for all groups under the
age of 65, home ownership rates have
either stayed the same over time or
have fallen. Home ownership rates
fell from around 65.5% in the early
1980s to around 64% by 1985 and
had been holding steady at 64%
though 1994. Since 1994, home
ownership rates have risen to nearly
their previous level of 65.5%. Thus, the
outlook for housing is generally posi-
tive, with the majority of anticipated as-
sistance coming from immigrants.
Conclusion
After heating up in the second quar-
ter of 1996, economic growth slowed
in the third quarter. The forecasting
participants are expecting slightly
slower growth in real GDP in 1997
than occurred in 1996. There was
very widespread support for contin-
ued slow growth. The range limits of
the forecasts (eliminating the two
extreme high and low values) were
1.4% and 2.6%. This slow economic
growth will be good news for infla-
tion watchers, as price pressures on
the economy are not expected to be
very strong.
—William A. Strauss
Senior economist
Robert H. Schnorbus
Assistant vice president and
senior economist105
115
125
135
Manufacturing output indexes, 1987=100
CFMMI
IP Motor vehicle production
(millions, seasonally adj. annual rate)
Nov. Month ago Year ago
Cars 6.3 5.5 6.1
5.3 5.4 5.6 Light trucks
1993 1995 1996
Manufacturing output indexes
(1987=100)
Nov. Month ago Year ago
CFMMI 129.5 129.5 125.6
124.5 129.4 130.4 IP
Purchasing managers’ surveys:
net % reporting production growth
Dec. Month ago Year ago
MW 58.0 60.2 54.8
46.9 57.5 58.4 U.S.
1994
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Tracking Midwest manufacturing activity
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.
The CFMMI was flat in November, in contrast to a fairly strong gain in the
nation. Declines in its machinery sector were offset by gains in its resource sector
(primarily in food processing and petroleum products). The region’s auto and
steel sectors were flat, despite an increase in auto assemblies in the region and
the nation, following the production rebound from the GM strike. Reporting
problems with electrical power data used to generate the auto component of
the regional index may result in an upward revision next month.
The composite index for production, according to the Midwest purchasing
managers’ surveys, was 58 in December, consistent with expanding activity.
However, the pace of production activity in the region appears to have slowed
from its October rate, in contrast to the nation which showed a modest pickup.

Building a house for the 21st century

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Building a house for the 21st century

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