| A group of leading economists and financial experts from the kansas city region gathered at Bank Midwest’s attractive 16th floor board room in Downtown’s Town Pavilion early this January for Ingram’s eighth annual Economic Forecast. Despite an unsteady economy, most in attendance did not anticipate a recession and saw a brighter outlook toward year’s end. Overview Craig Hakkio, Advisor on Economic Policy with the Federal Reserve Bank, chaired the assembly and shared with his colleagues an outlook for the year ahead. As Hakkio sees it, the first quarter of 2008 will reflect relatively weak GDP growth, likely in the 1–1.5 percent range. This reflects the fact that productivity has been somewhat slower than in the past and that the population is aging. Housing, a key factor, is weak but continues to surprise Hakkio. He has not yet seen the deep and prolonged slump economists predicted. That said, Hakkio believes that housing is going to remain weak for the first half of the year with sluggish sales, home prices falling, and vacancy rates rising and remaining quite high. As housing starts pick up in the second half of the year, Hakkio believes this renewed activity will help prod the economy back towards trend growth. Frank Lenk, Director of Research Service for the Mid-America Regional Council (MARC), also sees the U.S. avoiding recession. He expects that GDP growth for the year will likely register between 2.2 and 2.4 percent, approaching 3 percent in the second half of the year. Michael Stellern, professor of economics at Rockhurst University, argued that much depends on the housing industry. “If the housing sector turns around in the middle of the year,” he observed, “then that’s going to give us stronger growth than if it doesn’t.” He predicted annual GDP growth in the 1 to 1.5 percent range. “I am kind of in Mike’s camp,” said Jim Moffett, lead manager of UMB Scout International Fund, “Housing takes longer to work out because it is fairly a liquid market.” He sees about a 50 percent chance of an actual recession in the first half of the year and then a fairly good comeback in the second half. Rick Smalley, CEO of Bank Midwest, was not as sanguine about the year ahead. He anticipates annual GDP growth in the 1 percent range with realistic concern about recession. He senses, however, that monetary policy may help stave off a recession. “I have a lot of confidence,” he said, “that the Fed will be pretty responsive in their concerns to keeping growth at some sort of a positive level.” Employment As Lenk observed, the unemployment rate jumped from 4.7 percent to 5.0 percent this past month. Hakkio asked the participants whether that increase was predictive of the future. Stellern thought so. He predicted that unemployment would rise very close to 6 percent before we saw a turnaround. Lenk was not as pessimistic as Stellern. In fact, he expressed surprise at the 5 percent rate. He thought it might tick up a few more tenths, but did not see the rate reaching 6 percent. Moffet noted that actual employment numbers increased in that same month that the unemployment rate went up. The economy actually added jobs. “That sounds to me,” said Moffet, “like there are a lot more people looking for jobs. “It could be,” added Lenk, “that people that were previously discouraged decided to start looking. That would be a good sign.” Hakkio observed that employment numbers have not tracked downward with the decline in housing and speculated that this might be because illegal immigrants had been doing much of the construction. Those here illegally would not be overly eager to participate in em-ployment surveys. Global Economy Hakkio observed that much of the weakness in housing has been offset by exports. The depreciation of the dollars has clearly helped exporters. As to foreign markets, Moffett sees Europe slowing down a little bit. Some of that is the drag from a more competitive dollar. Moffett described Asia as “another bubble waiting to happen.” But right now Asia continues to roll along. The Chinese, in fact, are trying to figure out how to slow their economy down. Meanwhile, according to Moffett, “Japan just limps along.” Stellern saw good news about globalization in that our exports are up significantly, close to 20 percent in the last quarter, due in no small part to a depreciating dollar. Stellern believes this is certainly helping the Midwest on the agricultural front. By contrast, imports were only up 4 percent in that same time period, which helps rebalance the trade deficit. “The question is,” said Stellern, “will the dollar continue to decline or have we bottomed out.” That, he believes, will depend on whether the Fed decides to lower interest rates or not. Lenk, however, questioned why manufacturing employment declined last month despite receptive international markets. Oil Prices One consequence of participating in a global market is our lack of control over oil pricing. Moffett sees the current high price of oil as an “ongoing drag” on the economy. “They pluck another five bucks out of your billfold every week,” he added. “That money had been spent somewhere else.” Hakkio observed that oil futures tend to show prices stabilizing and even coming down. “But that hasn’t happened in the last five or six years,” he added wryly. Moffett argued that supply and demand in the oil business is such that “it’s hard to see oil prices coming down.” On the demand side, there are developing markets in Asia that will continue to absorb more of the world’s supply. On the supply side, the producing countries “are milking their oil. They are not investing in it.” “I don’t think that we’re going to find that much more oil,” agreed Stellern. “That is going to keep prices really high.” Lenk disagreed. He believes that the winding down of tensions in Iraq, which he thinks will happen gradually, will ameliorate the geo-political risk premium and eventually bring the price of oil down. Agriculture Smalley noted that these past few years have been a generally positive stretch for agriculture. “It should be good for a while,” he added. As in any industry, he noted, there will be pockets and there will be tradeoffs. Still, he thinks that the combination of a strong global economy driving exports and the emergence of the ethanol industry have buoyed farm income. Smalley noted, however, that the ethanol industry was not terribly stable, given its current dependence on subsidies and political will. Lenk contended that Ethanol, for all its assistance to the Midwestern economy, doesn’t represent a solution to American energy problems, at least until we get ethanol out of cellulose rather than out of corn. Brazil is already doing just that, Moffett observed. In fact, close to half of Brazil’s gasoline is ethanol-based, a figure that is impressive even in a country run largely on diesel. As Moffett also noted, ethanol creates a food versus fuel competition, which tends to push up food prices. “We conveniently leave food and fuel out of the inflation calculation,” said Moffett, “but I think that they’re real.” Inflation In defense of the Fed, Hakkio pointed out that in its effort at greater transparency, the Fed now includes overall inflation and core inflation in its statistical releases. Although “core” excludes food and oil, it “may give a better sense of the underlying trends,” said Hakkio. But with rising oil and food prices, the Fed has acknowledged the value of reporting the overall inflation rate as well. A third variable in inflation, Moffett observed, is how we measure housing. House prices in many areas are coming down. “I don’t think it’s measured well on the upside,” added Moffett, “so it probably won’t be measured well on the downside.” As to predictions, Lenk envisions the core CPI increasing at about 2.3 percent over the coming year and the overall CPI registering about 2.6 percent, which is close to trend the last year or two. Hakkio added that the blue-chip consensus is 2.2 percent for core CPI in 2008, very close to Lenk’s estimate. If oil prices level off, Hakkio continued, the inflationary impulse from flat oil prices would be to reduce the inflation rate. All of this, of course, is tied to how fast the economy is growing. If the economy does pick up to 3 percent, that will add some additional inflationary pressures. Stellern believes that more foreign residents buying more American goods will add to those pressures. Moffett questioned whether we could have both a slower economy and substantial inflation, or stagflation as it is historically known. In regards to possible stagflation, Lenk saw two possible culprits, gasoline price hikes and a decline in productivity growth. Productivity Lenk was curious as to why productivity growth has slowed down this decade. Hakkio speculated that the productivity revolution, which began in 1995, was related to advances in information tech-nology and may have represented a one- time increase. We remain more productive, he added, “but the rate of increase is not going to continue at that very fast rate.” Lenk had been expecting to see a resurgence in business investment, “but it hasn’t been like it was.” Moffett also expressed surprise that companies “don’t want to make capital expenditures, they don’t want to expand,” especially when their debt is down and their equity is up. “As economists,” Lenk summarized, “we sometimes are not quite cognizant of how much time it takes for change to penetrate all the business processes and really produce new ways of thinking and new ways of investing. It just takes some time.” Local Economy MARC expects next year to be about like this year, Lenk observed, barring a major slowdown in the national economy. This means about 19,000 new jobs—a growth rate of about 2.4 percent. Smalley has witnessed a good deal of retail being built. The question for him is how well local retail will fare if the national economy slows. Stellern agreed with Lenk that the local economy should be stronger than the national economy, especially given the contribution of the agricultural sector. “Of all the drivers in the Kansas City economy,” affirmed Jim Moffett, “agriculture is one that has to be a plus.” Hakkio agreed that energy and agriculture are both two strong sectors nationally and should help the region.
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