Economic Outlook

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Economic Outlook

• ROBERT FRY
• SENIOR ASSOCIATE ECONOMIST

Fort Wayne Rubber Group Fort Wayne,
Indiana September 8, 2005
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Economics is the science of telling you things
you have known all your life, but in a language
you cant understand.
-- Dick Armey
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US economy has faced series of headwinds.

• 1999 Y2K
• 2000 Bursting of stock market bubble
• 2001 9/11
• 2002 Corporate governance scandals
• 2003 Iraq war
• 2004 - 2005 Record oil prices
• 2005 Hurricane Katrina

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And yet . . .

• 2001 recession mildest on record.
• Unemployment rate lower than average rate in any
  of last three decades.
• Single-family home sales and housing starts at
  record levels.
• Motor vehicle sales at or above 17 million for 6
  straight years.
• Inflation still low by historical standards.

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RIP
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But it stops later than you think it will, and
the reversal is bigger than you
expect. Robert Fry, 1958-
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U.S. economy has been amazingly resilient.

• Consumer spending has remained strong even
  though
• High gasoline prices reduce purchasing power and
  consumer spending, especially for low-income
  households.
• High oil prices pull down stock prices, dampening
  consumer confidence.
• Interest rates have risen and tax cuts have faded
  into the past.
• Housing remains strong.
• Business investment, once the missing piece of
  the recovery, has become a more important engine
  of growth.
• This mid-cycle slowdown has been much milder
  than we expected . . . so far.

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But can it continue to weather the storm?

• The short-term impact of Katrina is decidedly
  negative.
• Price increases associated with supply
  disruptions are much more harmful than those
  associated with strong demand.
• Employment and earnings will take a big immediate
  hit.
• This is much worse that 9/11.
• Longer-term, Katrina could become a positive for
  GDP (but not for standards of living).
• Rebuilding will boost residential and
  nonresidential construction in 2006.
• We thought housing starts had peaked now were
  not so sure.
• Katrina shifts the expected slowdown in growth
  from 2006 to the last four months of 2005, and
  shifts activity from consumer spending to
  construction.

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U.S. manufacturing has slowed, but not much.

• Leading indicators turned down in spring 2004.
• Auto production was cut at GM Ford in early
  2005.
• In some industries, growth is being
  supply-constrained.
• Growth has slowed, but slowdown has been very
  gradual and year-over-year growth remains above
  trend.
• Weaker dollar may be helping U.S. manufacturers
  just starting to show up in trade figures.
• Near-term outlook was improving before Katrina,
  but storm clouds on the horizon got here sooner
  than we expected.

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Forecasting exchange rates has a success rate no
better than that of forecasting the outcome of a
coin toss.
-- Alan Greenspan November 19, 2004
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Real GDP(Annual Change)
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Global growth stabilizing after slowing.

• After expanding rapidly from mid-2003 to early
  2004, global manufacturing slowed in 2004 and
  early 2005.
• Growth slowed in most regions.
• Western Europe hit by strong Euro.
• Eastern Europe slowed significantly.
• Asia more dependent on imported oil than are
  other regions.
• Growth remains strong in China and India.
• Growth has reaccelerated in Eastern Europe.
• There are a few positive signs in Korea, Japan,
  and Western Europe.

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I cant retire yet. I have an interest-only
mortgage.
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Inflation has risen, but may be near its peak.

• Prices of crude and intermediate materials rose
  sharply from 2002 to 2004.
• Initially, prices of finished goods (ex food and
  energy) didnt rise very much.
• Core inflation accelerated in 2004.
• Prices of crude and intermediate materials (ex
  energy) have peaked and turned down.
• Core inflation may have peaked
• Slower growth and peaking inflation should prompt
  Fed to stop raising interest rates.

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The global expansion continues, but risks
intensify.

• Annual growth rates will be down in all regions
  of the world in 2005, but remain near long-term
  trends despite
• Record oil prices
• Higher short-term US interest rates
• Tighter credit policies in China
• A brightening near-term outlook (ex Katrina)
  suggests that global growth remains close to
  trend in 2006.
• But serious risks remain
• Oil and gas prices
• Over-dependence on US and China
• US current account deficit

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