Economic conditions ; Economic development

Avinash Kaza

William A. Strauss

English

Research Papers in Economics

Chicago Fed Letter
SPECIAL ISSUE THE FEDERAL RESERVE BANK FEBRUARY 2004
OF CHICAGO NUMBER 199a
Expansion picks up steam
William Strauss, senior economist and economic advisor, and Avinash Kaza, associate economist
While the U.S. economy has been expanding for the past two years, it hasn't felt all
that robust. What can we expect in 2004? Can the acceleration in economic growth
that followed the end of major fighting in Iraq be sustained? A recent Chicago Fed
symposium brought economists from academia and business together to discuss the
outlook for 2004.
After suffering through a mild reces-
sion during most of 2001, the U.S.
economy has been expanding for the
past two years. Yet when one looks
back over this period, it feels like the
economy has continued to struggle
and has not per-
formed as well as it
should. In fact while
output rose in each
of the past eight quar-
ters, employment de-
clined in all but one
of them. Furthermore,
the manufacturing
sector has struggled
during this two-year
expansion. Industrial
output was virtually
unchanged in the
third quarter of 2003
compared with its lev-
el two years earlier.
Still, the economy
has performed im-
pressively in light of
all of the negative
economic shocks it has experienced
over the past three years: the stock
market collapse, oil and natural gas
price hikes, the September 11, 2001,
attacks, a war in Afghanistan, corpo-
rate governance scandals, and a war
with Iraq.
As 2002 drew to a close and 2003 be-
gan, it appeared increasingly likely
that the U.S. would go to war with
Iraq. This caused businesses to hold
off on making spending decisions un-
til the situation with Iraq was resolved.
The U.S. economy (measured as gross
domestic product or GDP) expanded
by a meager 1.4% in both the fourth
quarter of 2002 and the first quarter
of 2003, respectively. With the conclu-
sion of major fighting in Iraq occurring
in April, the delayed business deci-
sions were exercised and the economy
expanded by 3.3% in the second quar-
ter. With no apparent major negative
economic event occurring since April,
the economy truly began to move for-
ward—it grew by 8.2% in the third
quarter of 2003, the strongest rate of
growth in nearly 20 years. By the end
of 2003, the economy’s expansion ap-
peared to be gaining traction. We have
even seen some improvement in the
employment data since August 2003.
Against this backdrop, the Federal
Reserve Bank of Chicago held its seven-
teenth Economic Outlook Symposium
on December 12, 2003. More than 90
economists and analysts from business,
academia, and government attended
the conference. This Chicago Fed Letter
reviews last year’s forecasts for 2003
and summarizes the presentations at
1. Forecasts from Annual Economic Outlook Symposium
2002 2003 2004
(Actual) (Forecast) (Forecast)
Real gross domestic producta 2.4 3.0 4.1
Real personal consumption expendituresa 3.1 3.1 3.6
Real business fixed investmenta –5.7 2.4 9.3
Real residential investmenta 3.9 8.6 2.1
Change in private inventoriesb 5.2 –8.8 35.0
Net exports of goods and servicesb –488.6 –529.2 –550.6
Real government consumption
expenditures and gross investmenta 4.4 3.3 2.6
Industrial productiona –0.6 –0.3 3.7
Auto & light truck sales (millions of units) 16.7 16.6 16.8
Housing starts (millions of units) 1.71 1.79 1.71
Unemployment ratec 5.8 6.0 5.8
Inflation rate (Consumer Price Index)a 1.6 2.3 2.2
1-year Treasury rate (constant maturity)c 2.00 1.24 1.71
10-year Treasury rate (constant maturity)c 4.61 4.03 4.69
J. P. Morgan Trade Weighted Dollar Indexa –0.4 –6.2 –1.3
Oil price (dollars per barrel)d 26.10 30.52 27.72
aPercent change from previous year; bbillions of chained (1996) dollars; cpercent; dWest
Texas Intermediate.
SOURCES: Actual data from Haver Analytics; median forecasts from Economic Outlook
Symposium participants.this year’s conference (see figure 1).
We begin with an overview of the econ-
omy’s performance in 2003 and the
consensus forecasts for the year ahead.
Last year’s forecasters were anticipat-
ing that the economy in 2003 would
begin with growth below potential (a
growth rate associated with a stable
unemployment rate and no inflation-
ary pressures) for the first half of the
year and then rising as the year pro-
gressed to just slightly faster than po-
tential growth. The economy started
off slower than forecasted as the un-
certainty associated with the impend-
ing war dampened business activity.
However, it continued to improve in
the second quarter, rising 3.3%, just
above the forecasted rate. Then, the
economy shifted into high gear in the
third quarter, growing by over 8%. The
forecasted decline in the unemploy-
ment rate did not occur as labor mar-
kets continued to struggle throughout
the year. A slight rebuild in inventories
was expected but inventories contin-
ued to be cut, leading to a substantial
plunge in the inventory to GDP ratio.
Industrial production was expected to
rise during 2003 but, after a slight gain
in the first quarter, fell sharply in the
second, although it rose in the third
quarter. The vehicle sector was fore-
casted to sell 16.5 million units, just
below what occurred. Housing starts
were expected to be fairly flat during
2003, but continued to perform much
better than predicted. This is ex-
plained in part by a lower actual path
for the ten-year Treasury rate. While
generating a volatile pattern, inflation
was close to what was forecasted.
Real GDP is expected to have increased
by 3.0% in 2003 and then rise to a
strong 4.1% in 2004, largely reflecting
a significant improvement in the busi-
ness sector. Business fixed investment
is forecasted to increase from a 2.4%
gain in 2003 to 9.3% in 2004. Invento-
ries are predicted to rise by $35 billion,
an improvement from the anticipated
$8.8 billion decline in 2003, but this
would still lead to a continued decline
in the inventory to GDP ratio. Indus-
trial production, which is expected to
fall 0.3% in 2003, should increase 3.7%
in 2004, a slower pace than the overall
economy, consistent with a fall in the
inventory ratio.
The forecasters expect spending in
the consumer sector, which has been
the most solid performer over the past
few years, to improve in 2004, rising
from 3.1% growth in 2003 to 3.6%.
Some of this is expected to reflect a
slightly better selling rate for light ve-
hicles, which are forecasted to improve
from 16.6 million units in 2003 to 16.8
million units in 2004. The improve-
ment in the consumer sector should
be supported by an improving labor
market, with the unemployment rate
anticipated to average 5.8% in 2004,
0.2 percentage points lower than in
2003. Residential construction growth
is forecasted to rise by a much slower
pace of only 2.1% in 2004 after a very
strong 8.6% rate in 2003. The consen-
sus group estimates that housing starts
will slow to 1.71 million units in 2004,
about 800,000 units lower than in
2003. A predicted increase in interest
rates will play a role in slowing the
housing market. Forecasters expect
the ten-year Treasury rate to average
4.69% in 2004, 66 basis points higher
than in 2003.
Government spending is anticipated
to rise by 2.6% in 2004, a slower pace
than in 2003. The international trade
deficit is expected to increase some-
what, rising from $529.2 billion to
$550.6 billion.
Inflation is expected to remain relative-
ly unchanged at 2.2% in 2004, with oil
prices falling from an average $30.52 a
barrel in 2003 to $27.72 in 2004.
Forecasts for consumer spending
and banking
According to Carl Tannenbaum, senior
vice president and chief economist of
LaSalle Banks/ABN AMRO, consumer
spending is expected to be strong in
2004, although some risks may persist
in the economy. Over the past few years,
consumer spending and retail sales
have remained strong as consumers
kept spending through the downturn.
Some of the more recent stimulus for
this spending has been reduced—e.g.,
interest rates are now trending upward
and the tax cuts have been completed.
However, Tannenbaum does not fore-
see a major cutback in spending. For
example, some people’s withholding
schedules did not change, meaning
they will experience the tax cut in
2004 in the form of a refund. Moreover,
even the slightly higher interest rates
this year remain low by historical stan-
dards, so housing remains affordable.
Some of the determinants of consum-
er spending are mixed. For example,
consumer confidence is improving, as
is the stock market. However, there
are fears that the stock market has ris-
en too rapidly and may be approach-
ing another bubble. Furthermore,
wage growth and employment have
not picked up significantly.
Despite these mixed factors, Tannen-
baum forecasts continued strength in
consumer spending. Consumers are
not so overburdened with debt that
they are likely to reduce their spend-
ing drastically in the near future.
Vehicle sales outlook
Ellen Hughes-Cromwick, senior econ-
omist at Ford Motor Company, spoke
about her forecast for vehicle sales.
She believes the overall economy is
strengthening, and the improving
macroeconomic environment will
help vehicle sales remain strong.
Historical data on global vehicle sales
shows that average annual growth of
vehicle sales globally fell by half be-
tween the periods 1990–99 and 1999–
2003. Despite this, the U.S. vehicle
market is still strong. Some other
trends include enormous pricing pres-
sure and a growth in demand for pre-
mium content in vehicles. Real vehicle
prices have fallen over the past few
years, with a 4% decline from 2002 to
2003, reflecting competitive pressures.
Also, as the nation becomes wealthier,
U.S. consumers are purchasing more
premium vehicles. The average vehicle
transaction price has risen approxi-
mately 15% since 2000, and the premi-
um brand share increased from about
6% in 1995 to 10.6% in 2003. With in-
creased competition and economicMichael H. Moskow, President; Charles L. Evans,
Senior Vice President and Director of Research;
Douglas Evanoff, Vice President, financial studies;
David Marshall, Vice President, macroeconomic policy
research; Daniel Sullivan, Vice President, microeco-
nomic policy research;  William Testa, Vice President,
regional programs and Economics Editor; Helen O’D.
Koshy, Editor; Kathryn Moran, Associate 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 and other Bank publications
are available on the World Wide Web at http://
www.chicagofed.org.
ISSN 0895-0164
growth in the U.S., both of these trends
are expected to continue.
Some issues about the auto industry
include the sizable excess capacity and
the strengthening of the yen. Global
excess capacity was estimated at 12
million units in 2002, and the yen’s
strengthening already appears to have re-
duced U.S. vehicle imports from Japan.
Despite these factors, the North Amer-
ican market is expected to do well in
2004. Canada’s macroeconomic envi-
ronment has been moderately strong,
and this is expected to contribute to
good auto sales in Canada. Mexico’s
economy has been weak, and sales
have flattened. However, vehicle sales
in Mexico are expected to increase by
2005. With the U.S. market expected
to continue to be strong, 2004 is likely
to be a good year for North American
vehicle sales overall.
Steel sector forecast
Robert DiCianni, manager of market-
ing at Ispat Inland, began his outlook
with a quote from Alan Greenspan:
“Uncertainty is not just an important
feature of the [current] landscape; it
is the defining characteristic of [this]
landscape.” This view was echoed by
nearly all of the speakers at the sympo-
sium, many of whom highlighted geo-
political concerns, in particular, as a
source of uncertainty.
DiCianni attributed the steel price in-
creases in early 2002, especially in hot-
rolled steel, to a major steel firm, LTV,
stopping production in December
2001, rather than to the steel tariff im-
posed by President Bush. Prices have
declined recently, but an increase is ex-
pected in 2004. With recent declines in
inventory, there is an impetus for re-
building inventory in 2004.
Many of the users of steel, such as the
auto, appliance, and residential invest-
ment industries, did not reduce de-
mand significantly in 2002 and 2003 as
consumers of these goods continued to
spend, despite the economic downturn.
While non-residential construction
spending experienced a slight dip be-
tween 2002 and 2003, it is expected to
pick up in 2004.
The removal of the steel tariff is not
expected to increase imports signifi-
cantly, because China, which accounts
for most of the increase in world con-
sumption, remains a more attractive
market than the U.S. There have been
increasing demand and higher prices in
China relative to the U.S. Indeed, U.S.
steel consumption has fallen since 2000.
Other trends include increased consoli-
dation in the industry, with some sec-
tors such as electric machinery moving
offshore almost completely. Some risks
include Chinese growth stalling or U.S.
manufacturing not recovering. Howev-
er, the outlook is for a slight recovery in
demand as the economy improves.
Fiscal policy
Rudolph Penner, a former director of
the Congressional Budget Office and
currently a senior fellow at the Urban
Institute, provided his thoughts on
U.S. fiscal policy. He began with a his-
torical perspective, saying this current
period of fiscal stimulus has been the
largest in over a half-century. The tax
cuts have been large, as have spending
increases. For example, discretionary
spending increased 11% in 2002 and
16% in 2003.
In Penner’s view, the efficiency of the
stimulus, i.e., the return for each dol-
lar, is low for several reasons. First,
much of the stimulus went abroad, es-
pecially to reconstruction spending in
Afghanistan and Iraq. Second, the
most recent tax cut on dividends was
on the supply side. Third, the tax cuts
were so confusing that the average tax-
payer does not understand the actual
benefit. Finally, he argued that much of
the tax cut was used to pay down debt
rather than for additional spending.
While the fiscal policies may not have
been efficient, they did help stabilize
the economy due to the sheer volume
of tax cuts and increased spending.
Moreover, the fiscal stimulus was well
timed, even if it was not intended to
address the recession.
Penner also mentioned several similar-
ities between the current deficits and
those of the 1980s. First, the trend is
similar. There was a mild deficit in the
late 1970s and a mild surplus in the
late 1990s, but then the fiscal situation
deteriorated rather sharply. The sec-
ond similarity is related to the first;
the rapid fiscal deterioration was com-
pletely unexpected and caught every-
one by surprise.
The government’s fiscal policy does
not bear full responsibility for the fis-
cal deterioration. The slowdown of the
economy and especially the collapse of
the stock market played a major role
in the reversal from a surplus to a defi-
cit as income tax revenue and capital
gains revenue declined.
Penner argued that today’s deficits are
much more worrisome than those of
the 1980s because the baby boomers
are approaching retirement age. He
expressed concern about Social Secu-
rity finances and the possibility of a
budget crisis that will necessitate the
overhaul of the Social Security system.
Machinery outlook
Frank Manfredi, from Manfredi & As-
sociates, said farm equipment in the
U.S. experienced a strong year in
2003, with sales of some products up
28%. Much of this growth comes from
tractor sales not to corporate farms
but to consumers, due to a recent
trend of individuals purchasing large
estates and using tractors to maintain
their property. The macroeconomic
environment, with increases in thestock market and low interest rates,
has contributed to this phenomenon.
Sales of larger tractors to farmers
dropped in 1998–99, coinciding with a
downturn in the farm sector, and have
never really recovered. However, a
slight improvement is forecasted in
2004, with low stocks and a mild rise
in commodity prices expected to help
farmers. Farm equipment sales are ex-
pected to do well in 2004, although
not as well as in 2003.
Construction machinery is another
major sector of the machinery indus-
try. Construction machinery growth in
2003 was 7.5%, although there was a
lot of variation among individual
products. One of the major trends in
the construction machinery sector is
the growth of rentals. The vast majori-
ty of manufacturers sell directly to
rental companies.
One of the major products of con-
struction machinery is earthmoving
equipment, which is strongly correlat-
ed with housing starts. Residential
construction has enormous ripple ef-
fects for the construction machinery
sector, with increased construction of
schools, strip malls, and other com-
mercial development projects that are
correlated with residential growth.
The extremely strong housing starts
market has helped the construction
machinery sector and this is expected
to continue in 2004, with construction
machinery growth forecasted at 8.9%.
International trade: Winners and
losers
Trade between the U.S. and the world
has increased 127% since 1990, with
increases in nearly every industry.
Laura Spingola, president of Trade
Resources Ltd., discussed the winners
and losers in the U.S. (using the har-
monized classification system).
Sectors that experienced major growth
in exports include tobacco, perfume
and cosmetics, plastics, wood, paper,
textiles, machinery, and vehicles. There
was large import growth in many sec-
tors, including oil, plastics, wood, tex-
tiles, machinery, vehicles, and iron
and steel.
Since industries that increased their
exports may have also increased their
imports, it is important to examine net
exports to see which industries bene-
fited and lost from international
trade. Spingola classified those indus-
tries with a mean of over $1 billion in
net exports per year since 1990 as win-
ners and those with less than $1 bil-
lion in net exports per year since 1990
as losers.
Some of the sector winners in trade
were cereals, miscellaneous chemi-
cals, plastics, aircraft and spacecraft,
and optical, medical, and surgical in-
struments. The losers include oil, knit
apparel, woven apparel, footwear, iron
and steel, machinery, and vehicles.
Conclusion
The economic expansion will contin-
ue into 2004, when the U.S. economy
is expected to have its best year since
1999. With growth above potential,
the unemployment rate is expected to
decline each quarter, reaching 5.7%
by the end of the year. Prices are ex-
pected to remain stable, and the busi-
ness sector is forecasted to have its
best year since 1998.

Expansion picks up steam

http://www.chicagofed.org/digital_assets/publications/chicago_fed_letter/2004/cflfebruary2004_199a.pdf

Expansion picks up steam

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics