U.S. economy: Slower growth, but more jobs and lower oil prices

August 15, 2005
Contact:
  • umichnews@umich.edu

ANN ARBOR—Although oil prices continue to set record highs this year, America’s economy will remain solid through the middle of next year, say University of Michigan economists.

After that, it will slow down a bit, even as oil prices fall back to less than $50 a barrel in the next two years, they say.

“The economy has managed to run on all cylinders, despite having to absorb rapidly increasing oil prices,” said Saul Hymans, U-M professor emeritus of economics. “The robust pace of economic growth that has characterized the past two-and-a-half years is expected to continue through mid-2006, but the pace of expansion then moderates to a rate at or slightly below trend.”

In their annual mid-year forecast update of the U.S. economy, Hymans and colleagues Joan Crary and Janet Wolfe predict growth in national economic output (as measured by real Gross Domestic Product) at a 4 percent rate during the second half of this year, then scaling back to growth rates of 3.1 percent in 2006 and 2.8 percent in 2007.

Despite slower economic expansion in the next two years, job growth will remain healthy as the unemployment rate continues to edge down, the forecast shows. Non-farm payroll employment increases by 2.2 million jobs in 2006 (the same as this year) and 1.8 million jobs in 2007. The unemployment rate improves from this year’s 5.5 percent to 4.8 percent next year and 4.7 percent the year after.

Solid job growth over the next two years will be accompanied by a drop in inflation in 2006 as oil prices retreat, Hymans and colleagues say. The all-items Consumer Price Index (CPI) moves down from this year’s 3 percent to 2.5 percent next year, before edging up to 2.7 percent in 2007.

With inflation expected to be contained, the U-M economists say that the Federal Reserve Board, which raised the federal funds rate by 25 basis points last week, will make two more moves to push the rate to 4 percent by year’s end, followed by a rate-hike hiatus. Eventually, they say, the funds rate will reach 5 percent during 2007.

“The Fed clearly regards itself as backing pressure off the accelerator, not as applying the brakes to the welcome economic expansion,” Hymans said. “In our view, the Fed has not yet gotten to a resting point as it sets monetary policy on a less expansionary, but still supportive, path.”

As a result, the 30-year conventional mortgage rate will increase from an average of 6 percent this year to 6.9 percent next year and to 7.6 percent in 2007. The rate for three-month Treasury bills will jump from 3.2 percent in 2005 to 4 percent in 2006 and to 4.6 percent the year after, while the 10-year Treasury bond rate climbs from 4.5 percent this year to 5.5 percent next year and to 6.1 percent in 2007.

“Our characterization of the monetary environment is ‘tightening but not enough to be contractionary,'” Hymans said. “It’s exactly as one might expect in the absence of upside inflationary shocks and a forecast economic growth rate that we think of as firm but moderating.”

The U-M forecast, which is based on the Michigan Quarterly Econometric Model of the U.S. Economy and compiled by the U-M Research Seminar in Quantitative Economics, also predicts that:

Private housing starts will slip from 2 million units this year to 1.84 million in 2006 and to 1.76 million in 2007, as mortgage rates rise.

Sales of light vehicles will total 17 million units this year and then edge upward to 17.1 million in both 2006 and 2007.

For more information on the U.S. economic forecast and RSQE, visit www.umich.edu/~rsqe.

 

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