joel prakken april 14,2004

April 2004 © Macroeconomic Advisers, LLC 1

Macroeconomic Advisers, LLCMacroeconomic Advisers, LLC

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Challenging Transitions:The US Economic OutlookDr. Joel L. Prakken, ChairmanMacroeconomic Advisers, LLC

Presentation forThe Global Interdependence Center:

Global Issues and the US Outlook

April 14, 2004


Themes in the Outlook

• Above-trend (> 3.5%) GDP growth in ’04 and ’05 – Healthy (monthly) profile heading into ’04– Still positive (but waning) fiscal/financial stimulus– Synchronized global recovery, weakened dollar– Capital excesses of the 1990s turned to shortfalls– Lean inventories (outside of vehicle sector)

• Still, only gradual improvement in labor markets• Further, but temporary, disinflation thru mid-’04• First monetary tightening in early ’05• Key transitions: withdrawal of policy stimulus; rotation

to cap ex, net exports; inventory rebound• Biggest imponderables: productivity, terrorism


Monthly Real GDP through January 2004

9600

9800

10000

10200

10400

10600

10800

2000 2001 2002 2003 2004

Bill

ions

of C

hain

ed (2

000)

Dol

lars

Q4

JanJan/Q4 = 3.0% a.r.Did you know that MA’s monthlyGDP is now used by the NBERto date business cycles?!


First-Half Growth: MA vs. Our Own Consensus Panel

10 Nov 8 Dec 5 Jan 2 Feb 1 Mar 29 Mar0

1

2

3

4

5

6First Quarter

Shaded region represents +/- 1 standard deviation

9 Feb 8 Mar 5 Apr0

1

2

3

4

5

6Second Quarter

Survey results reported regularly inMA’s Weekly Economic Commentary.


The Forecast in Summary

-2

-1

0

1

2

3

4

5

6

7

8

9

2000 2001 2002 2003 2004 2005

Ann

ual P

erce

nt /

Per

cent

Cha

nge

GDP GDP Price Unem Rate Fed Funds Rate T-Note Yield

Growth of: '04:H1 '04:H2 '04 '05Real GDP 4.4 4.2 4.3 4.0 GDP Price 1.4 1.1 1.2 1.2

H F


Growth of Real GDP in 2004: MA vs Blue Chip

3.0

3.5

4.0

4.5

5.0

Aug 03 Sep 03 Oct 03 Nov 03 Dec 03 Jan 04 Feb 04 Mar 04 Apr 04

Per

cent

Cha

nge,

Yea

r / Y

ear

MA

Blue Chip


The Forecast in Summary

2003Q4 Q1 Q2 Q3 Q4 03 04 05

Real GDP, PCAR 4.1 4.4 4.3 4.2 4.1 4.3 4.3 4.0CIPI (Contribution) 0.9 1.1 0.5 0.0 0.1 -0.1 0.5 0.0Final Sales, PCAR 3.4 3.3 3.8 4.2 4.0 4.4 3.8 4.0 Consumption 3.2 3.6 4.0 3.6 3.3 4.0 3.6 3.7 Nonres Fixed Inv 10.9 7.4 11.9 13.4 13.1 7.4 11.4 9.2 Residential Inv 7.9 -0.6 -4.2 -4.8 -9.5 9.5 -4.8 -8.9 Exports 20.5 0.7 11.8 12.0 12.1 6.4 9.0 11.8 Imports ( - ) 16.4 3.2 12.3 6.4 4.9 4.5 6.6 4.0 Govt C&GI -0.1 2.2 3.5 1.9 1.8 2.1 2.3 1.1Dom Demand, PCAR 3.6 3.5 4.2 3.8 3.3 4.2 3.7 3.2

Unem Rate (%) 5.9 5.6 5.6 5.5 5.4 6.0 5.5 5.2Core CPI, PCAR 1.0 1.4 1.3 1.3 1.4 1.1 1.3 1.7Fed Funds Rate (%) 1.0 1.0 1.0 1.0 1.0 1.0 1.1 2.010-Yr T-Note Yld (%) 4.3 4.0 4.0 4.3 4.5 4.0 4.2 5.3

Foreign GDP, PCAR 4.9 3.0 3.3 3.4 3.1 2.6 3.2 3.3Exchange Rate 115.6 113.3 113.8 113.7 113.5 119.3 113.6 112.3

Equity Wealth, % Chg 12.2 0.4 2.4 1.7 2.0 30.1 6.7 10.3Corp Profits, PCAR 32.3 10.2 10.2 9.5 8.2 29.1 9.5 6.0

2004 4/4 or Yr Avg


Qualitative Features of the Forecast

• Steady growth in final sales (~ 4% ) punctuated by a sharp increase ($49 bil) in inventory inv during ’04

• Gradual deceleration of domestic final demand offset by robust recovery of net exports, especially in ’05

• Household expenditures, government C&GI under-mined by the withdrawal of policy stimulus– PCE, govt C&GI grow slower than GDP– Residential construction declines in ’04 and ’05

• Partial offset from a sharp acceleration of capital expenditures, especially E&S

• Trade benefits from recovery of global growth, deceleration of domestic demand, weaker dollar


Qualitative Features of the Forecast

• Gradual improvement in labor markets– Trailing edge of recent productivity surge– Modest cyclical rebound in labor force participation

rate, average workweek– Lethargic employment not a threat to recovery…– …or even very mysterious!

• Despite high oil prices, lower dollar, little inflation risk– Labor market slack: modest growth in wages– Productivity surge: falling unit labor costs

• Fed is patient, but long rates eventually edge up in anticipation of first tightening.


Fiscal Policy Assumptions

• Provisions assumed to expire on schedule– Emergency unem benefits (“soft” expiration Dec 03)– 50% expensing “bonus” (Dec 04): impact on BFI?

• JGTRRA provisions assumed not to expire in Dec 04– Expanded 10% bracket (JCT: $4.3 bil in FY05)– Child credit at $1000 ($2.6 bil)– Relief from “marriage penalty” ($5.4 bil)– Increased AMT exemption amount ($6.9 bil)

• $48 bil decline in net nonwithheld taxes in 2004– $30 bil as refunds (BEA: $26 bil; OTA: $36 bil)– $18 bil as reduced final settlements (OTA)

• Late-year Iraq supplemental, smaller than last two


Other Key Forecast Assumptions

• Monetary policy (more from Larry, next)– First tightening in Jan ’05– Fed funds rate hits 3% by Dec ’05

• Oil prices remain high in ’04, decline modestly in ’05 • Uncertainty that has restrained both businesses and

investors gradually lifts – Further rise in stock prices– Businesses willing to rebuild inventories, re-hire labor– And resume accumulating fixed capital

• Recent, rapid productivity growth is unsustainable• US leads, but global recovery in phase• No significant terrorist acts in the US


Notes on the Implementation of Fiscal Stimulus

• There is a lot a tax money hitting the economy in the first half of 2004, but overall stimulus is modest

• Refunds of over-withholdings from first half of 2003 are a one-time event with a “temporary” MPC

• The decline in final settlements is mostly against estimated taxes on dividends and capital gains– We do assume this is permanent (not sunset in ’08)– But expectation of tax cut already working via wealth effect– With little extra kick when lower settlements realized

• Tax stimulus partly offset by impact of the expiration of emergency unemployment benefits in Dec

• Discretionary outlays will slow (relative to trend)


MA's Fiscal Conditions Index

-3

-2

-1

0

1

2

3

4

1999 2000 2001 2002 2003 2004 2005

Per

cent

age

Poi

nts

of G

DP

Gro

wth

H F

Transition from fiscalstimulus to restraint


MA's Monetary & Financial Conditions Index

-3

-2

-1

0

1

2

3

4

1999 2000 2001 2002 2003 2004 2005

Per

cent

age

Poi

nts

of G

DP

Gro

wth

From Rates/Yields

TotalH F

Transition from monetary / financialacceleration to deceleration


MA's Combined Fiscal/Financial Conditions Index

-3

-2

-1

0

1

2

3

4

1999 2000 2001 2002 2003 2004 2005

Per

cent

age

Poi

nts

of G

DP

Gro

wth

H F

The gradual withdrawalof combined stimulus.

For more see “A Combined Monetary, Financial, andFiscal Conditions Index”, Economic Outlook (Sept 2003)


Surprise! Refiners' Cost of Oil Imports

0

5

10

15

20

25

30

35

1989 1991 1993 1995 1997 1999 2001 2003 2005

Dol

lars

per

Bar

rel

H F

July 2003Forecast

2003 2004 2005 $28 $31 $27

For more, see “Are High Oil Prices a Threat”,US Economic Outlook (March 20, 2004)


Growth of Labor Productivity

-1

0

1

2

3

4

5

6

1989 1991 1993 1995 1997 1999 2001 2003 2005

4-Q

uarte

r Per

cent

Cha

nge

H F

Actual

Potential


Phased Global Slowdown…& Recovery

-2

-1

0

1

2

3

4

5

6

1989 1991 1993 1995 1997 1999 2001 2003 2005

4-Q

uarte

r Per

cent

Cha

nge

H F

U.S. Real GDP

36-country GDPexcl US (OEF)

GulfWar

AsianCrisis


FRB Broad, Real, Trade-Weighted Dollar

80

85

90

95

100

105

110

115

120

125

130

1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

Inde

x (M

arch

197

3 =

100)

H F

Dollar reversal tohelp spur trade


Equity Wealth & S.E. Band Around "Fair" Value

0

2

4

6

8

10

12

14

16

18

20

1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

Trill

ions

of D

olla

rs (E

nd o

f Qua

rter)

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

0.50

1987 Correction

Gulf War

Irrational Exuberance

Ruble Collapse

Tech Bubble

Ratio of NASDAQto Wilshire (Right)

H F

Geopolitical Uncertainties


Contribution of Equity Wealth to GDP Growth

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

Ann

ualiz

ed P

erce

ntag

e P

oint

s

H F


Consumer Durables & Residential Investment:Contr to 4-Qtr % Chg in Real GDP

-3

-2

-1

0

1

2

3

4

1979 1982 1985 1988 1991 1994 1997 2000 2003

Per

cent

age

Poi

nts

of A

nnua

lized

Gro

wth

H F

Usually negativein recessions

This time itwas positive


Nonfarm, Nonvehicle Inventories

15

16

17

18

19

20

21

1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

Per

cent

-120

-80

-40

0

40

80

120

Bill

ions

of C

hain

ed (2

000)

Dol

lars

I / S Ratio (Left)

Inventory Investment (Right)

Record LowI /S Ratio

H F


Investment in Equipment & Software

-20

-10

0

10

20

30

40

50

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

4-Q

uarte

r Per

cent

Cha

nge

Other Equipment

Computers & Software

H FFor more, see “What Happens when the Expensing BonusExpires”, Economic Outlook (February 19, 2004)


Capital Excess/Shortfall: Computers & Software

0

100

200

300

400

500

600

700

800

900

1000

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003

Bill

ions

of C

hain

ed (2

000)

Dol

lars

-20

-16

-12

-8

-4

0

4

8

12

16

20

Per

cent

of C

apita

l Sto

ck

Co-integrating Equation:log(K) = 2.95 + 1.00*log(Q) – 1.36*log(R)

Error (right)

Predicted (left)

Actual (left)


Capital Excess/Shortfall: Other Equipment

2000

2200

2400

2600

2800

3000

3200

3400

3600

3800

4000

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003

Bill

ions

of C

hain

ed (2

000)

Dol

lars

-5

-4

-3

-2

-1

0

1

2

3

4

5

Per

cent

of C

apita

l Sto

ck

Error (right)

Predicted

Actual

Co-integrating Equation:log(K) = 4.60 + .80*log(Q) – 1.17*log(R)


Contributions to PNF Price Inflation

-2

-1

0

1

2

3

4

5

1991 1993 1995 1997 1999 2001 2003 2005

4-Q

uarte

r Per

cent

Cha

nge

H FFrom "Unit Labor Costs"

Actual Inflation

From unemploymentand exchange rates


Interest Rates & the Term Spread

-2

-1

0

1

2

3

4

5

6

7

8

9

10

1989 1991 1993 1995 1997 1999 2001 2003 2005

Per

cent

per

Ann

um

H F

Fed Funds Rate

10-Yr Note Yield

Term Spread


Unemployment Rate & the NAIRU

0

2

4

6

8

10

12

1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

Per

cent

H F

Initial conditions matter! Historically small unemploy-ment gap is consistent with slow employment growth.

Unemployment Rate

NAIRU

90% Confidence Interval:Full Employment


Elasticity of Pvt Nonfarm Estab Employment with Respect to MA's Index of Monthly GDP

0.00

0.20

0.40

0.60

0.80

1.00

1.20

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

Months

0.00

0.01

0.02

0.03

0.04

0.05

0.06

0.07

0.08

0.09

0.10

Cumulative (Left)

Incremental (Right)


Private Nonfarm Establishment Employment

-0.4

-0.3

-0.2

-0.1

0.0

0.1

0.2

0.3

2001 2002 2003 2004

Mon

thly

Per

cent

Cha

nge

H F+/- 1 Std. Err

For more see “Can Sluggish Employment Growth Scuttlethe Expansion?”, Economic Outlook (March 10, 2004)

joel prakken april 14,2004

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