Prior to last summer’s catastrophic hurricanes, the U.S. economy seemed headed on a healthy and predictable course. Now, the future of the economy is less certain and a lot more complicated.
Most economists are adjusting their estimates downward for future economic growth. Others are conflicted as to whether the obvious economic losses from wind damage and flooding in the Gulf Region will be largely offset by both public and private rebuilding efforts. Inflation, largely tame for several years, has re-emerged as an issue. Reflecting this concern, the Federal Reserve has shown no signs of changing course with its rate increases. National unemployment, which had fallen to a pre-9/11 low, is sure to increase at least slightly in the coming months. Michigan’s economy and employment rate will continue to be hampered by struggles at the automakers and other manufacturing companies.
The Fed’s Alan Greenspan may be facing his own post-Katrina “conundrum” of a simultaneous slowdown in growth and a rise in inflation. He does not want to raise rates so high that the economy will suffer. On the other hand, he wants to increase rates to a level that will sufficiently dampen inflationary pressures. So far, the Fed seems to be reaching the comfortable balance between economic growth and inflation.
The economy is facing a series of headwinds from the storms and high energy prices. The Commerce Department reported that personal income actually declined 0.1 percent in August from the previous month. The decline included their estimated $100 billion in annualized total uninsured losses from the hurricanes.
Further, August consumer spending fell by 0.5 percent, the biggest drop since just after 9/11. While most economists feel that these declines in personal income and spending are one-time hits, some are now worried that higher energy prices will continue to drag down the economy. The Wall Street Journal (WSJ) September Survey of 56 leading economists predicts that the hurricane costs and energy prices will trim 0.6 percent off third quarter growth and 0.4 percent off the fourth. Expectations now are that GDP will expand at a seasonally adjusted annual rate of 3.6 percent in the third quarter and 3.2 percent in the fourth. On average, growth is projected at 3.3 percent in the first half of 2006, slightly higher than earlier predictions.
Inflation, as measured by the Labor Department’s Consumer Price Index (CPI), appears to be accelerating as evidenced by the 0.5 percent increase in August. Prices are up 3.6 percent from a year ago, the largest increase since May 2001. In addition, steeper increases are likely to come since 90 percent of the August data was gathered prior to the hurricanes.
The Journal forecasts for inflation were sharply increased in the past month. These economists expect inflation to be running at 3.3 percent in November and 2.8 percent in May 2006. They do expect that the Fed will be successful in taming any major inflationary pressures over the long-term, but energy costs continue to pose the biggest inflationary threat. AAA recently calculated that the average U.S. retail price of gasoline has risen 52 percent over the past year, from $1.93 a gallon to $2.94. Some analysts are now predicting that gas prices will go even higher, perhaps as high as $4 a gallon. Michigan natural gas bills are also expected to rise dramatically this winter. MichCon has filed to increase its rate nearly 100 percent since last winter. Consumers Energy has requested a 47 percent increase.
At the November 2005 Federal Reserve Board Meeting, the fed funds rate was raised 25 basis points for the 12th consecutive time, pushing the new rate to 4 percent. This is the highest level since the summer of 2001. The Fed feels that the hurricane’s economic impact, while tragic, will be short-lived in nature. The Fed thus believes it must continue raising interest rates to guard against inflation. Since the Fed has one more meeting before the end of the year — Dec. 13 — it is very likely that the rate will end 2005 at 4.25 percent.
Beyond that, the increases should begin to slow, assuming a moderation in inflation. So far, this action has proved effective as well, with inflation remaining below 4 percent. However, the energy situation will continue to pose a challenge well into 2006.
Prior to Hurricane Katrina, the national job market seemed to be back on solid ground. The nation’s unemployment rate was 4.9 percent for August, the lowest level since August 2001. Through August there have been more than 1.5 million new jobs created in 2005, which comes out to some 195,000 per month. This is on top of the 2.2 million jobs created in 2004, the best annual growth in the job market since 1999. Economists generally believe that between 120,000-150,000 new jobs are needed each month to accommodate work force expansion from population growth.
Post-Katrina, economists warn that both unemployment claims and the rate will spike upward for several months. Some estimates put hurricane-related job losses at nearly 500,000 in the short-term. The WSJ economists forecasts a drag on employment coming from a combination of factors including the hurricanes, slowing retail sales (especially automobiles), falling consumer confidence and higher energy prices. They predict that over the next year, some 173,000 new jobs will be created per month. Forecasts for the unemployment rate show a small increase to 5 percent through November and back down to 4.9 percent in May 2006.
The consensus is that the Michigan job market and economy face several major obstacles. It is clear that the sluggish auto industry is chiefly to blame for the state’s economic difficulties. Much more employment diversification is needed in the state. In addition, Michigan has structural problems such as high corporate taxes and low worker educational attainment which needs to be addressed.
The state jobless rate was somewhat improved at 6.7 percent in August. This contrasts with 7.5 percent at year end 2004, which was the worst in the nation. August unemployment rates fell in all of Michigan’s 17 major labor markets from July. Still, the Michigan rate was 49th highest among the 50 states. The loss of Michigan manufacturing jobs has been especially troublesome, with the state bleeding 32,000 manufacturing jobs over the past 12 months. Looking forward, most experts, including Governor Granholm’s own economists, agree that Michigan’s economy and job market will remain weak. Unemployment may even rise in 2006.
Auto industry analysts expect 2005 and beyond to be difficult for domestic automakers. The trouble is that GM and Ford are largely still counting on the same gas-guzzling products, namely SUVs, which have sustained sales and profits for the past decade when fuel prices were historically low. Until a large falloff in September, auto sales had remained reasonably good due to “employee pricing” incentives that may have served to pull future demand forward. However, sales fell dramatically in September as consumers shied away from trucks and SUVs. According to Autodata, overall sales were at a seasonally adjusted annual rate of 16.4 million, down sharply from 17.5 million in September 2004.
Taken together, the above factors point toward an economy that should grow at a healthy but somewhat subdued 3-3.5 percent annual pace in 2005-06. The Fed rate-tightening should be largely complete by mid-2006 with the fed funds rate stabilizing around 4.5 percent. The good news is that the most likely cause of the next recession, high and accelerating inflation met by high and restrictive interest rates, is likely not to occur anytime soon.
A more detailed economic report for fall 2005 is posted at www.mcul.org.
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