Indiana Model of the United States

Summary of Current Forecast: November 2009

Our August outlook correctly forecast that U.S. output would resume growth in the third quarter. Real GDP expanded in the quarter by 3.5%, which was 0.6% above our forecast.

In greater detail, however, our forecast was less accurate:

The Cash for Clunkers program caused consumption of durable goods to explode at a 22.4% rate, about four times our expectation.
Business investment in equipment was basically flat, but this was substantially better than our forecast.
Housing was up by 23.3% almost the exact opposite of its second quarter result. In August we were expecting the downturn in this sector to continue through year-end.
The collapse in international trade also reversed in dramatic fashion, with both exports and imports registering double-digit growth.

Basically, spending by both households and business was stronger than we anticipated. But much of this demand was met from inventories and imports rather than domestic production, leaving real output growth only a little above our forecast.

Clearly, the third quarter data are a definite improvement and reinforce our belief that the worst of the recession is behind us. However, we also continue to expect that the recovery will be both slow and unimpressive. Recent monthly indicators contribute to this guarded prognosis

The household survey labor market data took an unexpected turn for the worse in October, with the unemployment rate jumping to 10.2% (from 9.8% in September). In our August forecast we anticipated that unemployment would peak a little above 10% early next year. We now think the peak will be several months into 2010 and at or above 10.5%.
The establishment survey data on payroll employment were closer to, but also below, our August expectation. As a result we now put the return to job growth several months into next year, rather than at the beginning of the year. By then total job loss will be very close to 8 million.
Consumer confidence declined in both September and October. The measurement for October was done prior to the release of the unemployment data discussed above.
After the CFC surge in August, auto sales plunged in September before a modest recovery in October. We expect sales to improve during 2010, but the 17 million norm of earlier this decade is nowhere in sight.
Industrial production registered its fourth consecutive gain in October, although just barely. The IP index for manufacturing was down slightly, however.

To summarize: The economy resumed growth during the third quarter. However, by most indications households continue to be cautious in their spending and businesses very cautious in their hiring.

The new data reviewed above are generally consistent with our August expectation that the economy turned the corner during the summer, beginning what we think will be sluggish recovery that will be unimpressive by historical standards. We expect some backsliding during the current quarter, followed by a reasonably strong performance in 2010 and then a loss of momentum during the next year.

Some features of the baseline forecast:

With diminished government subsidies to demand, output growth falls off to 2.4% in the current quarter. During the first six months of 2010 growth averages 4.5%, followed by 3.7% the second half of the year. This is a little more optimistic than our August outlook. But growth stalls during 2011 with real GDP growth of only 2.9% (fourth quarter to fourth quarter). This would represent a weak recovery, especially given the depth of the downturn.
Growth is led by consumption, with business investment making a significant contribution later in 2010 and into 2011. Government spending is important over the next couple of quarters, but then less so.
Employment continues to fall through the first quarter of next year. The unemployment rate rises to 10.5%. As mentioned earlier, this is well above the level in our August outlook.
Inflation is virtually nonexistent over the next year, and of no concern out through 2011.
In the third quarter the NIPA measure of the federal budget deficit was at 9.3% of GDP. It remains close to that level through our forecast period.

The post-war cyclical pattern has been that the strength of the recovery from a recession is roughly proportional to the depth of the downturn. For example, following the deep recession of 1981-82 the economy had growth above 8% for over a year. Our baseline scenario represents a deviation from that pattern. We think the current episode will be different because this downturn was driven by a financial crisis far beyond anything since the Great Depression. Historically, recoveries from severe financial collapses have been long, slow, and difficult. The most recent example is Japan’s “lost decade” following its financial implosion in the late 1980s. Our baseline forecast is not as bad as the Japanese experience, but it is not really very optimistic either.