All posts by Thomas Walstrum

First half review—A good year so far for the Seventh District

Summary: We now have data through the first half of 2018, and they indicate that the Seventh Federal Reserve District’s economy did quite well. The manufacturing sector is the primary source of the good performance—growth has been strong enough that there are now signs of some manufacturers running into capacity constraints. While the nonmanufacturing sectors are not running as hot as the manufacturing sector, they still have had a fine year so far. Positive outlooks for both U.S. growth and global growth suggest that the District’s economy will continue to do quite well in the near term. That said, respondents to the Chicago Fed Survey of Business Conditions (CFSBC) are getting more and more worried about the potential negative impacts of an escalating trade war. Continue reading

First quarter review—A good start to the year for the Seventh District

Summary: Growth in the Seventh Federal Reserve District picked up from an already healthy pace during the first quarter of 2018, with almost all indicators pointing to above-trend growth. The manufacturing sector was doing especially well, with good results spread across manufacturing subsectors. Outside manufacturing, most sectors returned to about trend growth, up from a lull that bottomed out in the summer of 2017. Overall positive outlooks for both the U.S. and global economies suggest that the Seventh District economy will continue to do well in the near term.

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How do the Chicago Fed’s business contacts expect the steel and aluminum tariffs to affect their businesses?

On March 1 of this year, the Trump administration announced its intention to implement import tariffs of 25% on steel and 10% on aluminum. The tariffs went into effect on March 23. At the moment, a number of our major trading partners are excluded from the tariffs: For the time being, Canada, Mexico, the European Union (EU), South Korea, Argentina, Australia, and Brazil are among those that do not face the tariffs. And while a number of factors affect commodity prices, prices in the Midwest are about 11% higher for steel and 7% higher for aluminum since President Trump’s March 1 announcement.

How might the steel and aluminum tariffs affect businesses in the Midwest? We asked our business contacts about that in the most recent Chicago Fed Survey of Business Conditions (CFSBC).

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How Should the State of Illinois Pay for its Unfunded Pension Liability? The Case for a Statewide Residential Property Tax

The views expressed in this post are our own and do not reflect those of the Federal Reserve Bank of Chicago or the Federal Reserve System.

Note: This post is based on previous work presented by the same authors at the forum “Navigating Pension Reform in Illinois: What Lies Ahead”, held on April 17, 2018 at the Chicago Fed. The original presentation is available here.

The State of Illinois has a very large unfunded pension liability and will likely have to pay much of it off by raising taxes. The Illinois Commission on Government Forecasting and Accountability estimated the state’s unfunded liability at $129.1 billion in mid-2017,[1] which was about 19% of state personal income.[2] Benefits to public employees are protected under the Illinois Constitution, and a recent attempt to reduce the unfunded liability by reducing retirees’ benefits was struck down by the Illinois Supreme Court.[3] So, assuming that the state can’t reduce its current pension obligations and that it wants to maintain its current level of services, Illinois residents are going to have to pay higher taxes. What’s the best way to do it?

Because the debt is so large, it’s unrealistic to think that new taxes (such as a tax on legalized marijuana or financial transactions) or increases that affect only a narrow segment of the population will be enough.

Illinois will have to find additional revenues from already existing tax bases, either by increasing rates, expanding the definition of what is taxable, or a combination of the two.[4] Illinois state and local governments have three primary tax revenue sources—income, sales, and property—and each presents a unique set of tradeoffs in terms of how it affects the economy and who pays it.

In our view, Illinois’s best option is to impose a statewide residential property tax that expires when its unfunded pension liability is paid off. In our baseline scenario, we estimate that the tax rate required to pay off the pension debt over 30 years would be about 1%. This means that homeowners with homes worth $250,000 would pay an additional $2,500 per year in property taxes, those with homes worth $500,000 would pay an additional $5,000, and those with homes worth $1 million would pay an additional $10,000.

Perhaps the best counterargument to adding a statewide property tax is that Illinois homeowners already pay higher local property taxes compared to the national average.[5] But remember that Illinois residents will be paying higher taxes one way or another. Would you rather pay your higher taxes through a higher sales, income, or property tax? At the very least, higher property taxes should be part of the solution, perhaps in addition to the solutions proposed by the Civic Federation.

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Mid-Winter Review—Economic Activity in the Seventh District Picked Up After a Bit of a Lull

Summary: The Seventh District economy maintained a healthy pace of growth through the end of 2017 and into January, with most signs pointing toward above-trend growth. The manufacturing sector finished 2017 well, with good news spread across its subsectors. And it’s worth noting that while the auto industry struggled in the middle of the year, it ended the year in decent shape. Outside of manufacturing, most sectors continued to experience slow but steady growth. Positive outlooks for global growth and the energy sector suggest the Midwest economy is well positioned for a good start to 2018. In addition, as noted in an earlier post, our Chicago Fed Survey of Business Conditions (CFSBC) contacts expect a boost from the federal tax reform (though it is not clear how strong the boost will be).

Now let’s look at the economic indicators that support this analysis.

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How Do the Chicago Fed’s Business Contacts Expect to Spend Their Federal Tax Windfall?

On December 22nd of last year, President Trump signed the Tax Cuts and Jobs Act, a law that makes substantial changes to the federal tax code for individuals and businesses. An important provision of the act is tax cuts for both groups worth an estimated $1.46 trillion over the next ten years. Congress’s Joint Committee on Taxation estimates that businesses will pay $330.4 billion less in taxes over that period, with more than two-thirds of the reduction coming in the first three years.

In the run-up to the tax bill’s passage, there was a substantial debate about what businesses would do with the extra money from the tax cuts. Commentators in favor of the bill generally argued that strong competition would force businesses to invest their tax savings in capital, which would result in higher worker productivity, output, and wages. Commentators opposing the bill generally argued that weak competition would allow businesses to forgo spending on capital and labor and instead allow them to pay out increased profits to shareholders.

While it is still too soon to know what business leaders will actually do, it is possible ask them what they expect to happen. We did just that: We asked the respondents to our Chicago Fed Survey of Business Conditions (CFSBC) how they expect the new tax act to affect their businesses and how they expect to spend their tax windfalls (if they get one). While the sample size is fairly small and not representative of the universe of Seventh Federal Reserve District firms, the results do offer some perspective on these very interesting questions.

Figure 1 shows the results from our first question. It reports that 63 percent of respondents expect the tax act to have a positive impact on their firms. Most respondents who expect a positive impact anticipate a direct effect on their firms’ net incomes, though some said that while they do not anticipate a direct effect on their firms, they do expect the act to stimulate the economy, which would result in greater demand for their firms’ products. The few respondents (17%) who said they expect the tax act to have a negative impact were from multiple sectors. However, one sector that we survey—nonprofits—was particularly negative about the tax act because they believe that the large increase in the standard deduction will encourage more households to not itemize, thereby reducing the incentive to make charitable donations.

We next asked our contacts how they expect to spend their tax windfalls, if any. Sixty percent of the respondents answered this question. Businesses have options in addition to capital spending, labor expenditures, and profit payouts, such as mergers and acquisitions, price decreases, and balance-sheet repair (i.e., holding more cash, paying down debt, or buying other financial assets). Figure 2 shows the average share our contacts expect to put toward each major spending category. The largest was capital spending (27%), followed by balance-sheet repair (25%), profit payouts (18%), and labor spending (14%). Our manufacturing contacts expect to spend a greater share of their savings on capital and balance-sheet repair than our nonmanufacturing contacts.

The results shown in figure 2 suggest that there is some truth to the arguments made in favor of the act and those made in opposition to it. Our contacts expect to spend about 40% of their tax savings on capital and labor and just under 20% on profit payouts. They also expect to spend a large share on balance-sheet repair, which could be interpreted as a wait-and-see approach: Rather than spend the money now, they plan to put their firms in a better financial position for the future.

Look for a follow-up blog post about a year from now, when we will be able to learn how things went for our business contacts after a year under the new federal tax regime.

Appendix: Below is the full distribution of responses for how our contacts expect to allocate their tax savings across each of the five spending categories.

Early Fall Review—Economic Conditions Continued to Be Good in the Seventh District

Summary: We now have data for the Seventh District economy for the early fall, and they largely indicate that the nice run of good growth in the District continued. As has been the case throughout the year, the manufacturing sector was the driving force behind the good conditions—solid global growth and a revival in the U.S. energy sector continued to support important industries, such as steel, fabricated metals, and heavy machinery. In addition, national auto sales were quite good in September and October after a difficult summer. Outside of manufacturing, most sectors continued to experience slow but steady growth.

Now let’s look at the economic indicators that support this analysis.

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Late Summer Review—Seventh District Economy Still in Decent Shape

Summary: Growth in the Seventh District was pretty good to start the second half of the year, even though the pace was clearly slower than that of the first half. As is usual for the District, the manufacturing sector was the driving force behind this development. As I noted in the mid-year review, the boost in manufacturing activity appears to have been driven by growth in the global economy and the energy sector. Outside of manufacturing, most sectors continued to experience slow but steady growth. While the outlook for global growth and the energy sector generally looks good, concerns continue to mount for the auto industry.

Now let’s look at the economic indicators that support this analysis.

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2017 Mid-Year Review—A Solid First Half for the Seventh District, Thanks to Revivals in Global Growth and U.S. Oil Production

With the recent release of the Chicago Fed’s June Midwest Economy Index (MEI), we now have a good picture of how the Seventh District’s economy has done in the first half of this year. Overall, things went pretty well, and it appears that revivals in global growth and U.S. oil production are behind the good results. These revivals have lifted some long-struggling manufacturing industries in the District, including steel and heavy machinery. One cautionary note, though, is that the first half of the year has been disappointing for the auto industry, with signs that sales are slowing down to their long-run pace sooner than expected. Continue reading

Seventh District Update, July 2017


A summary of economic conditions in the Seventh District from the latest release of the Beige Book and other indicators of regional business activity:

  • Overall conditions: Growth in economic activity in the Seventh District picked up to a moderate pace in late May and June and respondents’ outlooks for growth over the next 6 to 12 months also improved some.
  • Employment and Wages: Employment growth continued at a moderate rate. While contacts indicated that the labor market was tight, wage growth was only modest.
  • Prices: Prices again rose modestly. Retail and freight prices increased slightly and materials prices were little changed.
  • Consumer spending: Consumer spending increased modestly. Non-auto retail sales were up modestly, but auto sales changed little on net.
  • Business Spending: Growth in capital spending continued at a moderate pace and inventories were generally at comfortable levels.
  • Construction and Real Estate: Residential construction, home sales, and commercial real estate activity increased slightly, while nonresidential construction was little changed.
  • Manufacturing: Manufacturing production continued to grow at a moderate rate. Growth was widespread across industries, though auto production declined some.
  • Banking and finance: Financial participants noted that volatility continues to be low. Business loan demand ticked up and consumer loan demand was little changed.
  • Agriculture: The sector continued to operate under financial stress. The crop harvest is expected to be about average. Hog prices moved up, but cattle and milk prices were lower.

The Chicago Fed Survey of Business Conditions (CFSBC) Activity Index increased to +1 from –8, suggesting that growth in economic activity picked up to a moderate pace in late May and June. The CFSBC Manufacturing Activity Index declined to +3 from +20, while the CFSBC Nonmanufacturing Activity Index rose to a neutral value from –24.

The Midwest Economy Index (MEI) decreased to +0.51 in May from +0.72 in April. Three of the four broad sectors of nonfarm business activity and four of the five Seventh Federal Reserve District states made positive contributions to the MEI in May. The relative MEI moved down to +0.09 in May from +0.65 in April. Three of the four sectors and three of the five states made positive contributions to the relative MEI in May.