U.S. economy should get back on track after war

ANN ARBOR, Mich.—The U.S. economy is poised for an upturn once hostilities with Iraq come to an end, according to University of Michigan economists.

"The economy is currently hobbled by a high degree of economic uncertainty and heightened geopolitical tensions, but with the assumed war ending by summer, oil prices slide, the domestic mood improves and the economy jumps out of the doldrums," said Saul H. Hymans, U-M professor of economics.

"Paced by a recovery in vehicle sales, higher defense spending to replace depleted military supplies and a bounce-up in inventory-building, the economy posts healthy growth in the second half of this year."

In their annual forecast update of the U.S. economy, Hymans and colleagues Joan P. Crary and Janet C. Wolfe predict that national economic output, as measured by real Gross Domestic Product (GDP), will grow 5.3 percent in the third quarter of this year, cool a bit to a 3.3 percent rate in the fourth quarter and then heat up again heading into 2004. Overall, the economy will expand by 2.4 percent this year and 3.7 percent in 2004.

After rising by a full percentage point to 5.8 percent last year, the unemployment rate edges upward to 5.9 percent this year, before scaling back to 5.6 percent in 2004, the forecast shows.

Low, but slowly increasing, interest rates will accompany the post-war economic recovery as the Federal Reserve continues to keep inflation in check, the economists say.

"We predict that the federal funds rate will increase over the course of next year to an average of 3 percent in the closing quarter of 2004," Hymans said. "Such a movement up in rates reflects the notion that the Fed can hardly permit rates to remain anywhere near current levels if the economy continues to expand, without risking the accrual of unacceptable inflationary pressures."

As core inflation dips to 2 percent this year before edging upward to 2.4 percent in 2004, short-term interest rates continue to rise next year while long-term rates hold fairly steady, Hymans and colleagues say.

The rate for three-month Treasury bills will increase from 1.2 percent this year to 2.3 percent in 2004, while the 10-year Treasury bond rate creeps upward from 3.6 percent in 2003 to 3.7 percent next year. The 30-year conventional mortgage rate is expected to remain stable at 5.6 percent this year and 5.7 percent in 2004.

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:

· Energy prices (both crude oil and gas fuels) will retreat in the second half of this year and then increase 4.5 percent next year.

· Real disposable income will rise 3.2 percent this year and 4 percent in 2004.

· Annual sales of light vehicles will slip from 16.7 million units last year to 16.2 million in 2003, before heading back up to 16.5 million in 2004.

· Private housing starts will decline from last year's 1.71 million units to 1.64 million this year and 1.57 million next year.

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Contact: Bernie DeGroat
Phone: (734) 936-1015 or 647-1847
E-mail: bernied@umich.edu