Consumer behavior ; Forecasting ; Gross domestic product

William A. Strauss

English

Research Papers in Economics

ESSAYS ON ISSUES THE FEDERAL RESERVE BANK FEBRUARY 1996
OF CHICAGO NUMBER 102
Chicago Fed Letter
Can the consumer keep
the expansion alive?
While 1995 witnessed the soft land-
ing that had been widely forecast,
the economic outlook for 1996 is for
continued modest growth following
this slowdown.  The Federal Reserve
Bank of Chicago held its Ninth An-
nual Economic Outlook Symposium
on December 8, 1995.  More than 50
economists and analysts from busi-
ness, academia, and government
attended the symposium.  The ses-
sions focused on the question, can
the consumer keep the expansion
alive?  Prior to the symposium, partic-
ipants were invited to submit both
annual and quarterly 1996 forecasts
for many gross domestic product
(GDP) components, as well as several
other economic series.  Thirty-five
individuals provided forecasts, and a
consensus forecast was presented at
the symposium.  This Fed Letter will
review the accuracy of the forecast
for 1995 presented at last year’s sym-
posium and summarize the 1996
Economic Outlook Symposium.
The economy in 1995—forecast
and results
The expectation at last year’s Econom-
ic Outlook Symposium was for growth
in real GDP to average 2.4% for the
fourth quarter of 1994 through the
first three quarters of 1995, a reduction
from the extremely strong 4.4% pace
of the previous four quarters.  Figure 1
shows that while the forecast was accu-
rate as to the downward direction in
the growth rate, the softening was not
as significant as expected.  Real GDP
averaged a fairly strong 3.3% over the
four quarters through the third quar-
ter of 1995.
Among components of real GDP
which were stronger than forecast
were personal consump-
tion expenditures,
business fixed invest-
ment, and change in
business inventories.
However, many of the
other economic series
(both components and
indicators) that are
used to measure
strength in the econo-
my were weaker than
expected, including
residential construc-
tion, net exports, and
government expendi-
tures.  Industrial pro-
duction, which was
forecast to increase by
3.6%, averaged a growth rate of 3.1%
over the four quarters.  Sales of cars
and light trucks, which were expected
to average 15.3 million units, fell
short by nearly half a million units.
The 1995 forecasts were too pessimis-
tic on the unemployment rate, which
was 0.3% lower than forecast.  Many
of the forecasters expected the infla-
tion rate to increase to 3.5% from an
average 2.8% for the previous four
quarters; in fact it averaged 2.7%.
Overall, the forecasters were sur-
prised by the strength in the economy
in 1995, especially in business fixed
investment, and the relative weakness
in the rate of inflation.
Looking ahead to 1996
1996 is generally expected to be an
uneventful year in economic terms.
This is not necessarily a bad thing—
consider that not a single forecaster
is expecting a recession over the
next five quarters.  Figure 2 summa-
rizes what forecasters are expecting
both in 1995 (fourth-quarter num-
bers not known) and in 1996.  The
consensus forecast is for 1995 real
GDP to average 3.2%.  The forecast
for 1996 real GDP is 2.5%.  This de-
cline of 0.7% is based on softening
in the growth rates of personal con-
sumption expenditures, business
fixed investment, and change in
business inventories.  Residential
construction is expected to grow by
2.1% this year.  The other area where
some slight improvement is forecast
to occur in 1996 is net exports, which
are expected to average –$121.6 bil-
lion.  Government is forecast to
match its no-growth performance of
the past year.
Following the slowdown in real GDP,
industrial production is expected to
slow from 3.5% to 2.5% in 1996.  Cars
and light trucks are expected to con-
tinue their relatively modest output
rate of 14.7 million units.  Housing
starts are expected to follow the 1.35
million unit pace that they experi-
enced in 1995.  The unemployment
rate is forecast to rise by one-tenth of a
percent to 5.7%.  Inflation is forecast
to decline by one-tenth of a percent to
2.8% in 1996.  The prime rate is fore-
cast to fall by over 40 basis points next
year.  Finally, the trade-weighted dollar
is expected to rise by 1.5%.
-4
0
4
8
1989 ’90 ’91 ’92 ’93 ’94 ’95
percent change, annual rate
Forecast range
Actual
Source: U.S. Bureau of Economic Analysis,National Income Product Accounts,
Note: The dashed line represents the mean of the consensus forecast.
various years.
1. 1995 forecast of real GDP1994 1995 1996
Real GDP 4.1% 3.2% 2.5%
Personal consumption expenditures 3.5% 2.9% 2.4%
Business fixed investment 13.7% 14.5% 6.8%
Residential construction 8.6% –1.9% 2.1%
Change in business inventories (bil. constant $) $47.8 $37.1 $28.9
Net exports of goods and services (bil. constant $) –$110.0 –$124.2 –$121.6
Government purchases of goods and services –0.8% 0.0% 0.1%
Industrial production 5.3% 3.5% 2.5%
Cars and light-truck sales (millions) 15.1 14.7 14.7
Housing starts (millions) 1.45 1.35 1.34
Unemployment rate 6.1% 5.6% 5.7%
Inflation rate (consumer price index) 2.6% 2.9% 2.8%
Prime rate 7.14% 8.78% 8.35%
Federal Reserve trade-weighted dollar –2.0% –6.4% 1.5%
Note: Data are actual for 1994 and forecast for 1995 and 1996.
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.
employment growth, consumer debt
loads, and prices of autos are factors
that will determine this trend.  In the
event that the federal budget talks
drag on with no significant easing
from the Federal Reserve, rising inter-
est rates could bring consumption to
a lower level than anticipated.
An economist from a major home
appliance manufacturer indicated
that sales for the core group of appli-
ances (i.e., washers, dryers, refrigera-
tors, ovens, ranges, dishwashers, and
freezers), which tend to move with
the business cycle, are holding steady
at about 31 million units per year.
This economist believes appliance
producers will try to pass-through
some price increases during 1996,
but that they will not be successful.
Competition from within the indus-
try will hold prices down.  Very little
growth is expected in home appli-
ance sales in 1996.  One issue that
bears watching is the level of con-
sumer debt.  Should the consumer
debt service burden continue to rise,
it may also have a dampening effect
on economic growth.
The investment sector remains
relatively strong
While the investment component of
GDP is expected to increase by only
half as much in1996 as in the past
year, it still represents a key driver to
the economy.  Like consumer dura-
bles, investment is an extremely
volatile component of GDP, and the
Forecast range
-4
0
4
8
1990 ’91 ’92 ’93 ’94 ’95 ’96
percent change, annual rate
Actual
Source: U.S. Bureau of Economic Analysis.
Note: The dashed line represents the mean of the consensus forecast.
Figure 3 shows that the consensus
forecast for quarterly GDP is for a
fairly weak fourth quarter 1995 with
growth in real GDP of 2%, increasing
and holding steady at around 2.5%
in 1996.  Personal consumption ex-
penditures, business fixed invest-
ment, residential construction, and
change in business inventories all
display patterns of softening in their
growth rates as 1996 progresses.
Only net exports are expected to
strengthen going into 1997.
Looking at the quarterly patterns for
the other economic series, both in-
dustrial production and the trade-
weighted dollar are expected to grow
at the same pace as they have recent-
ly.  Cars and light-truck sales and the
unemployment rate are expected to
hold relatively steady at current lev-
els.  The prime rate and housing
starts are expected to decline over
the forecast horizon.  Figure 4 illus-
trates that a slight pickup in inflation
is anticipated during 1996.
The consumer sector holds its ground
The personal consumption expendi-
tures component comprises over
two-thirds of GDP.  Knowing how
the durables sector, which is the
most volatile part of consumer ex-
penditures, will perform in 1996 is
key to understanding whether the
consumer will keep the economic
expansion alive.  An economist from
a Big 3 auto manufacturer indicated
that the consensus forecast of 2.5%
growth in real GDP leaves little
room for growth in the auto market.
This economist projected light-vehi-
cle sales of 14.9 million units in
1996, up only 1% from 1995 levels.
Expectations are for the Federal
Reserve to ease monetary policy
soon, but growth in consumption
may still be at an even lower rate
than GDP growth.
One potential positive
effect on auto sales in
1996 is that the strong
sales of the late 1980s
may generate some
new sales as owners
consider replacing
those seven- to ten-
year-old vehicles.
However, improve-
ments in durability
may dampen replace-
ment demand, and
the bulk of the growth
in auto sales is likely
to be trend-driven.
Population growth,
household formation,
2. Mean forecasts from the 1996 Economic Outlook Symposium
3. 1996 forecast of real GDP1990 ’91 ’92 ’93 ’94 ’96
Note: The dashed line represents the mean of the consensus forecast.
Source: U.S. Department of Labor, Bureau of Labor Statistics.
0
3
6
9
percent change in the CPI, annual rate
Actual
Forecast range
’95
heavy-duty truck segment is arguably
its most erratic performer.  An ana-
lyst from a heavy-duty truck research
company forecasts a soft landing for
the U.S. economy.  At this time, two-
thirds of all manufactured goods are
hauled by truck.  Trucks continue to
gain share of the freight market be-
cause the manufactured goods that
are transported by truck are experi-
encing growth.  However, for 1996,
slow growth in industrial production
is expected to lead to an 18% decline
in sales and a 22% decline in pro-
duction of Class 8 heavy-duty trucks.
While the backlog-to-build ratio
reached nearly 14 months during
1994, it has more recently slipped to
just over six months.  The current
level is relatively good, when histori-
cally the ratio has been under four
months.  Due to the waning of pent-
up demand for heavy-duty trucks after
two record production years in 1994
and 1995, the industry may be facing a
very tough year in 1996.  However,
forecast production levels for 1996
should still make it the fourth-best
year in the industry’s history.
A representative from a machine-tool
association announced that during
1995 the U.S. returned to being the
top consumer of machine tools in
the world.  Research and develop-
ment expenditure in the machine-
tool industry is the highest of any
manufacturing industry.  This analyst
is cautiously optimistic regarding
domestic sales and
production in 1996.
The growth potential
for this industry dur-
ing 1996 is limited by
the relatively slow
growth forecast for the
economy; however,
export markets should
provide growth oppor-
tunities.  Sales to Chi-
na have been very
encouraging and South
America is expected to
provide $9 billion in
machine-tool orders
over the next five years.
While orders are esti-
mated to have risen by
10% during 1995, they are forecast to
grow by only 5% in 1996.
Basic materials industries are at the
leading edge
A consultant to the steel industry
expects steel shipments to be up a
modest 2% to 3% in 1996.  Roughly
75% of all steel goes into construction
and producer durable equipment.
The other 25% goes into consumer
durable equipment.  Imports of
steel continue to decline.  A shift in
the types of steel being produced is
anticipated, away from sheet steel,
which is used in the auto and appli-
ance industries, toward structural
steel, which is used for plant and
equipment applications.  The pro-
portion of domestic steel used in
auto production is expected to in-
crease in 1996 as the share of do-
mestically produced autos contin-
ues to increase.  Continued strong
plant and equipment expenditures
during 1996 should also help the
steel industry.
An analyst from a paper manufactur-
er stated that there is almost a one-
to-one correspondence between
paper production growth and real
GDP growth.  The analyst forecasts
paper and paperboard production
to grow by 2.5% in 1996.  As paper
prices have risen dramatically over
the last year, consumers are shifting to
lower grades of paper and considering
ways of using the product more effi-
ciently.  The industry is now begin-
ning to deal with the problem of
overcapacity; it had been operating
at over 100% levels.  As a result,
downward pressure on paper prices
is anticipated.
Conclusion
The soft landing forecast for 1995
turned out to be bumpier than ex-
pected but generally on target.
A trend-driven growth rate from this
lower level of GDP growth is forecast
for 1996, and most likely the quarter-
ly path will be far less smooth than
indicated in the consensus forecast.
Nevertheless, the symposium found
widespread support for slow but posi-
tive economic growth in the year
ahead.  If accurate, this moderate
growth rate may mean some very
good news on the inflation front, as
price pressures from the economy
will be very slight.
—William A. Strauss
Senior Economist
Michael H. Moskow, President; William C.
Hunter, Senior Vice President and Director of
Research;  Douglas Evanoff, Assistant Vice President,
financial studies; Charles Evans and Kenneth
Kuttner, Assistant Vice Presidents, 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, 312-322-5111.
ISSN 0895-0164
4. Inflation rateP
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Sources: The Midwest Manufacturing Index (MMI)
is a composite index of 15 industries, based on
monthly hours worked and kilowatt hours.   IP rep-
resents the Federal Reserve Board industrial pro-
duction index for the U.S. manufacturing sector.
Autos and light trucks are measured in annualized
units, using seasonal adjustments developed by the
Board.  The purchasing managers’ survey data
for the Midwest are weighted averages of the sea-
sonally adjusted production components from the
Chicago, Detroit, and Milwaukee Purchasing Man-
agers’ Association surveys, with assistance from
Bishop Associates, Comerica, and the University of
Wisconsin–Milwaukee.
100
115
130
145
Manufacturing output indexes, 1987=100
MMI
IP
Motor vehicle production
(millions, seasonally adj. annual rate)
Nov. Month ago Year ago
Cars 6.0 6.1 6.5
5.4 5.3 5.4 Light trucks
1992 1994 1995
Manufacturing output indexes
(1987=100)
Nov. Month ago Year ago
MMI 144.1 141.9 139.8
122.7 124.7 124.9 IP
Purchasing managers’ surveys:
net % reporting production growth
Nov. Month ago Year ago
MW 52.1 62.0 67.0
64.5 48.4 45.8 U.S.
1993
Tracking Midwest manufacturing activity
The Midwest Manufacturing Index for November rebounded from its dip in
October, reaching its highest level of the year.  While the Federal Reserve’s pro-
duction index for manufacturing followed a similar pattern, the national index
was flat over the last three months.  Thus, the Midwest appears to be recovering
from the mid-year inventory correction more quickly than the rest of the nation.
The recent pattern in the MMI is consistent with reports from Midwest purchas-
ing managers’ surveys.  Aside from auto-related industries, most surveys for
December were indicating expanding orders and production in the region.
With light-vehicle production virtually flat and auto inventories rising, some
softening in this sector is to be expected and could continue into the first quar-
ter of 1996.

Can the consumer keep the expansion alive?

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Can the consumer keep the expansion alive?

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