March 29, 2013
An Update on 2012 GSP Growth Forecasts
Norman Wang and Scott Brave
In 2011, the Chicago Fed began providing quarterly estimates of annual GSP growth for each of the five states in the Seventh District in its Midwest Economy Index (MEI) releases. In this blog, we present what we’ve forecasted for each state in 2012 along with an explanation of the factors behind our projections.
Background on the Midwest Economy Index
The MEI is a weighted average of 129 state and regional indicators that measure growth in nonfarm business activity. Two separate index values are constructed, the MEI (absolute value), which captures both national and regional factors driving Midwest economic growth, and the relative MEI (relative value), which provides a picture of the Midwest’s economic conditions relative to the nation’s.
MEI values correspond to deviations of growth in Midwest economic activity around its historical trend. Values above zero indicate growth above its historical trend, and values below zero indicate growth below trend. For the relative MEI, a positive value indicates that regional growth is further above its trend than would typically be suggested based on the current deviation of national growth from its trend, while a negative value indicates the opposite.
Together, the MEI and relative MEI provide a picture of the Seventh District’s state economies that is closer to being in real time than does the BEA’s annual GSP data. By exploiting the historical correlation between annual GSP growth in each of the five states and the MEI, we are able to produce quarterly estimates of annual GSP growth ahead of the annual BEA release of GSP data.
Forecasting GSP Growth
The statistical model we use to explain the annual growth in GSP for each Seventh District state is as follows:
The model succinctly summarizes the historical relationships between national (real GDP growth), regional (MEI and Relative MEI), and state-specific (lagged GSP and state real Personal Income growth) factors driving each Seventh District state’s GSP growth since 1979.
The regression coefficients estimated for our model using data through 2011 are listed in the table below. Each coefficient represents the “effect” of an input on GSP growth. For example, a 1% increase in real GDP growth leads to about a 0.5% increase in GSP growth across the Seventh District states, with the effect slightly higher for Illinois and Iowa and slightly lower for Indiana and Michigan (second row of the table).
By plugging the latest data for real GDP growth, the MEI and relative MEI, state real Personal Income growth, and lagged GSP growth into the above equation, we can use the estimated regression coefficients from our model to obtain a GSP growth projection for 2012.
Projections for annual GSP growth for each of the five Seventh District states are displayed below. Coming into 2012, Iowa and Michigan stood out as having significantly higher GSP growth rates than the other three District states. In 2012, our growth projections suggest that GSP growth in Indiana outpaced the remaining District states and also exceeded the 2.2% annual growth in national GDP. GSP growth rates for Wisconsin, Illinois, Iowa, and Michigan are projected to be below the national growth rate.
Looking at the inputs into our projection, state real Personal Income growth data similarly suggest that Indiana experienced stronger growth than the other four District states in 2012, with Illinois showing the weakest growth in real personal income. In the region, growth in economic activity weakened last year with the MEI falling to an annual average of 0.14 compared to 0.41 in 2011. Growth relative to the nation also declined, decreasing to 0.21 from 0.62 in 2011; while 2012 US annual GDP growth edged up to 2.2% from 1.8% in the previous year.
Factors Behind Our Projections
As we’ve seen from the regression coefficients above, each state’s forecast is affected differently by the five inputs to our model. To further illustrate this point, we’ve broken down in the table below each state’s projected GSP growth into the expected contributions from national, regional, and state factors.
This decomposition of growth makes clear what contributed to the diversity in GSP forecasts across the District states in 2012. For instance, Michigan’s relatively weaker forecast among the five states stems primarily from its much lower expected contribution to growth from national factors. In contrast, national factors benefit Illinois and Iowa’s projections. Indiana and Wisconsin’s relatively robust forecasts, on the other hand, come primarily from state growth factors. Regional growth factors contributed about the same to each state’s 2012 projection.
Our quarterly estimates of GSP growth can be found as part of the press release for the MEI following the third release of national GDP data for each quarter. The 2013 release schedule for the MEI and the GSP growth forecasts can be found here.
March 22, 2013
Managing Economic Development in Uncertain Fiscal Times
Illinois continues to face a bleak fiscal outlook. Despite the sharp increases in Illinois’s personal and corporate income tax rates, the state still faces $10 billion in unpaid bills and an unfunded pension liability approaching $100 billion. To get back to a sustainable fiscal path, Illinois will require significant revenue increases or spending cuts or, most likely, some combination of both.
A critical point in the discussion on restoring fiscal balance is the impact that policy changes will have on Illinois’s economic development. Despite the recent tax rate increases, Illinois still ranks 27th in the nation when measuring state tax burden as a share of personal income, according to COGFA. However, given that these rate hikes were not sufficient to solve the problem, further revenue enhancements will most likely be needed—at least on a temporary basis. Accordingly, the real question is what will be the cost of future fiscal measures on economic development. In other words, can a state reach a tipping point where uncertainty over future tax rates and spending choices chills economic growth, and if so, is Illinois on the verge of tipping over?
On April 4, 2013, the Civic Federation and the Federal Reserve Bank of Chicago will hold a program examining these issues. Bill Testa, of the Chicago Fed, and Therese McGuire, of Northwestern University’s Kellogg School of Management, will discuss what economists have to say about the relationship between fiscal policy and economic growth. Testa will provide insights on Illinois’s tax structure and the gap between revenues and projected expenditures; and he will also assess the economic competition occurring among Midwestern states, putting it into context of tax rates and incentives . McGuire will summarize the literature on the effect of state tax rates on economic growth and describe what economic development strategies might best serve states. McGuire will also discuss what the cost of fiscal uncertainty is on economic growth. With regard to the tax structure, most academic literature on state tax rates suggests that rates tend to matter only when the other costs of doing business are equal at a competing location (e.g., a neighboring state). However, it is not clear yet if this will hold true for Illinois. On the spending side, much of the literature suggests that it is the composition of state spending that most matters for growth. States that spend more on infrastructure and education tend to do better in terms of economic development. In the case of Illinois, a potential solution might have taxpayers paying more taxes and receiving fewer state services. Accordingly, in regions where economic competition is fierce, such as the Midwest, tax rate imbalances may be reaching that tipping point where future tax increases in certain states can make development in adjacent states more attractive to businesses.
Of course, such fiscal problems are not unique to Illinois. Other states and localities have also had fiscal shocks, and much can be learned from how they have restored fiscal balance and tried to promote economic growth. The recent fiscal problems of California have been particularly challenging, forcing the state to make significant budget cuts and income tax increases. Several prominent California municipalities have been forced into bankruptcy; and only recently has the state been able to report a balanced budget. However, evidence suggests that the California economy is beginning to pick up steam. Recent job gains have been running above the national average, with unemployment in the state falling by 1.24 percentage points in 2012 while key housing markets in the state are showing strength. How has California managed its fiscal situation and what has been the impact of its fiscal measures on its economic development strategy? To discuss this, Tom Tait, the mayor of Anaheim, will describe fiscal changes and economic developments at the state and local levels in California.
At the state level, Michigan is another interesting example. Arguably the state has not yet recovered from the 2001 recession and has faced more than a decade of fiscal stress. Throughout this period, Michigan has made many tax and spending adjustments, such as changing the structure of its primary business tax three times. Recently the state has started to show growth again. Mitch Bean, who is with Great Lakes Economic Consulting (and who previously served as director of the Michigan House Fiscal Agency), will discuss Michigan’s roadmap for reaching fiscal balance while encouraging economic growth.
Fiscal measures at the level of localities can have an immense impact on economic growth. What are the terms and conditions that are being attached to current deals to draw business investment, according to local developers and researchers? Are unresolved fiscal issues becoming an obstacle? A panel—comprising Ivan Baker, director of economic development for the Village of Tinley Park in Illinois; Jon DeVries, director of the Marshall Bennett Institute of Real Estate at Roosevelt University; and Stephen Friedman, president of SB Friedman Development Advisors—will provide perspectives on the local development landscape and how fiscal issues affect business location and expansion decisions.
The program concludes with a keynote address by Steve Koch, the deputy mayor of Chicago. Koch has been in this position since September 2012, and his portfolio of responsibilities includes economic development strategy. Prior to his current position, he spent most of his career in investment banking. Koch will discuss how Chicago is stabilizing its fiscal position while pursuing a new economic development strategy. He also will discuss how state fiscal problems affect local governments.
To register for this April 4 program, please visit the Civic Federation’s website.
March 6, 2013
Seventh District Update
by Norman Wang and Scott Brave
A summary of economic conditions in the Seventh District from the latest release of the Beige Book and from other indicators of regional business activity:
• Overall conditions: Economic activity in the Seventh District continued to expand at a slow pace in January and February.
• Consumer spending: Consumer spending increased at a slower rate. Retailers pointed to the negative impacts on household budgets from rising gas prices and the end of the payroll tax holiday as explanations for the slower pace of retail sales. Auto sales were steady for much of the reporting period before increasing slightly over the last few weeks.
• Business Spending: Growth in business spending slowed. Inventory investment declined, and spending on equipment and structures was again limited. Labor market conditions were little changed.
• Construction and Real Estate: Construction and real estate activity was mixed. Demand for residential construction continued to increase slowly, buoyed by ongoing strength in multifamily construction. Although there was some modest growth in nonresidential construction, the level of activity remains weak.
• Manufacturing: Growth in manufacturing production picked up over the reporting period. The auto industry remained a source of strength, with light vehicle sales expected to increase throughout the year. Demand for heavy equipment weakened, with lower coal prices contributing to less mining activity.
• Banking and finance: Credit conditions continued to ease. Credit spreads and financial market volatility remained low and asset quality continued to improve. Banking contacts reported moderate growth in business and consumer loan demand, with pricing relatively unchanged but some loosening of loan standards.
• Prices and Costs: Cost pressures were moderately higher. Contacts noted some upward pressure on raw materials prices, particularly for lumber, drywall, steel, aluminum, and copper. Wage pressures remained moderate.
• Agriculture: Snow and rain continued to boost topsoil moisture levels, although depleted subsurface moisture remained a concern for farmers. Corn, wheat, milk, hog, and cattle prices dipped during the reporting period, while soybean prices moved a little higher.
The Midwest Economy Index (MEI) increased to –0.18 in December from –0.30 in November, but remained negative for the sixth consecutive month. The relative MEI decreased to –0.01 in December from +0.55 in November, primarily because of significantly lower contributions from the Midwest’s manufacturing and service sectors.
The Chicago Fed Midwest Manufacturing Index (CFMMI) increased 0.7% in December, to a seasonally adjusted level of 94.7 (2007 = 100). Revised data show the index was up 2.0% in November. The Federal Reserve Board’s industrial production index for manufacturing (IPMFG) moved up 0.8% in December. Regional output rose 6.2% in December from a year earlier, and national output increased 2.7%.