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Jerry Conover
Indiana Business Research Center
conover@indiana.edu
812-855-7476

R. Jeffery Green
IU Center for Econometric Model Research
green@indiana.edu
812-855-3523

Willard E. Witte
IU Center for Econometric Model Research
witte@indiana.edu
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George Vlahakis
IU Media Relations
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Last modified: Thursday, November 4, 2004

IU's Business Outlook Panel forecasts modest growth for 2005

EDITORS: An audio recording of the panel's other presentation today (Nov. 4) in Bloomington will be available on the Web at 2:30 p.m. at http://broadcast.iu.edu. We invite you to use this resource and enhance your coverage with a link to this site. A complete schedule of the panel's other tour stops across the state can be found at http://newsinfo.iu.edu/news/page/normal/1679.html.

INDIANAPOLIS -- The year ahead should see continued expansion of the U.S. economy, but not at the strong pace experienced at the beginning of 2004, according to a forecast presented today (Nov. 4) by economists in Indiana University's Kelley School of Business.

IU economists noted several factors emerging in 2004 that limit the prospects for economic growth in the coming year. "High energy prices, rising interest rates, and ballooning government and trade deficits make it likely that 2005 won't be as good as 2004, but the recovery will continue," predicted R. Jeffery Green, co-director of the Indiana Center for Econometric Model Research and a professor of business economics and public policy.

Green expressed concerns about "imbalances in the economy" that are getting larger instead of smaller. "A federal deficit can be a useful tool to stimulate the economy during a recession, but with the economy now well into the expansion phase, the deficit should decline, and instead, it is increasing," he said.

The Business Outlook panelists agreed that the prospect of continued high deficits poses a serious threat to the long-term sustainability of the nation's economic growth.

Overall growth in the nation's output for 2005 probably will be about 3 percent, nearly a full percentage point below the 2004 average, and "disappointing for an economy that should be able to grow close to 4 percent," observed Willard E. Witte, IU associate professor of economics and CEMR co-director.

The national forecast calls for the creation of about 1.5 million new jobs in 2005, a rate Witte described as "adequate to hold unemployment at about the current rate (5.4 percent), but not sufficient to imply significant improvement for the labor market." Unemployment should hold fairly steady because productivity growth is expected to moderate somewhat.

In Indiana, employment has inched up by 14,000 jobs since this time a year ago, with lots of small gains and losses along the way. Since the state's payrolls bottomed out at 2.89 million jobs in March 2002, Indiana has gained only 28,000 jobs in total.

"We still have almost 100,000 fewer jobs than when Indiana's employment peaked four and a half years ago," noted Jerry Conover, director of the Indiana Business Research Center. "On the other hand, nearly two-thirds of all the jobs gained since 2002 have been realized this year, and we've had nine consecutive months of year-over-year gains."

Following a loss of 104,000 jobs from the industry's peak, Indiana's manufacturing sector has leveled off and actually added more than 1,000 jobs in the past several months. Manufacturing's share of Indiana employment has shrunk by 3 percentage points in the past five years, and Conover predicted that productivity improvements and outsourcing of jobs will continue to dampen growth prospects for factory jobs in the Hoosier state.

Indiana sectors that have grown substantially in the past year include education and health services, professional and business services and construction. The prospects for these sectors in the upcoming year continue to look good, Conover said.

Overall, the IU forecast calls for an increase of only about 0.5 percent -- or around 15,000 jobs -- in Indiana in the coming year. That annual rate, however, "was exceeded in only about one month out of every four during the past four years," Conover said, "so it's still a pretty ambitious target."

The state's unemployment rate is projected to end 2005 not far from its current seasonally-adjusted level of 4.8 percent.

The IU forecasters made several additional observations about the outlook for 2005:

-- International trade should continue to improve, although at a slower rate than in 2004. Total world economic output should grow this year by about 5 percent and by about 4.3 percent in 2005, according to Andreas Hauskrecht, clinical assistant professor of business economics and public policy.

This growth will be led by India and China, with growth rates projected at 6.7 and 7.5 percent respectively. The more mature economies of Europe and Japan will see growth in the low 2 percent range, while growth of the Mexican and Canadian economies should be in the low 3 percent range. Referring to the three integrated NAFTA countries, Hauskrecht said, "Their economic outlook is robust."

-- Home buying has held up well over the past year, despite upward movement in interest rates. However, as the momentum of economic expansion is trimmed back in the year ahead, housing starts -- currently at a very healthy 1.9 million per year nationwide -- will feel increased pressure from continued interest rate hikes.

-- The IU economists forecast that mortgage rates, which have remained close to record-low levels for much of this year, will rise over the coming year to about 6 percent. Nonetheless, residential construction should continue at a relatively healthy pace.

-- Short-term interest rates in 2004 finally began rising again after a long period at their lowest levels in more than 40 years. Short-term rates have fallen much more over the past three years than long-term rates, noted William Sartoris, professor of finance and director of the Kelley School's Investment Banking Academy.

"This is usually a precursor to an expansion and rising interest rates," Sartoris said. "We expect the short-term Federal Funds rate to rise to 2.75 percent. As we're predicting inflation to average 3 percent next year, short-term real rates of interest will be negative or close to zero."

-- Inflation should push long-term rates up from the current 5 percent level to the 5.5 percent range by the end of 2005, and the prime rate should be near 5 percent.

-- Corporate profits and cash flows are adversely affected by high prices for key inputs such as steel, copper and oil. The IU panel expects oil prices to remain high well into 2005 before declining, dropping to no lower than $40 per barrel. Witte said that such high prices represent "a definite drag on the economy."

Sartoris added that high costs for health care benefits and pensions will compound high commodity prices to restrict corporate profit growth to around 8 percent next year. He predicted that the stock market will offer returns 6 to 8 percent above treasury bonds, in line with long-term historical averages, but well below the returns experienced in the late 1990s.

The major risks to today's forecast come from the continued threat of terrorist actions and Middle East instability; possible overheating of the Chinese economy, leading to a hard landing that would be felt throughout Asia; and possible rapid devaluation of the U.S. dollar if foreign investors should decide to unload their substantial dollar holdings.

The same forecast also will be presented today in Bloomington. The two presentations are the first in a statewide tour that will include nine other cities through Nov. 23. The annual forecast is prepared by a group of IU economists who use specially-developed models of the U.S. and Indiana economies as their starting point. The models combine state and national statistics to develop projections for the coming year. The panel has presented an annual forecast since 1972.

Other panelists at today's Indianapolis presentation were Dan Smith, interim dean of the Kelley School; Robert Neal, associate professor of finance; and Phillip Powell, clinical associate professor of business economics and public policy.

The panel also will appear in Columbus on Friday (Nov. 5); Richmond and Anderson, Nov. 9; Kokomo and Fort Wayne, Nov. 10; Schererville, Nov. 12; Evansville, Nov. 16; New Albany, Nov. 18; and South Bend, Nov. 23. Regular panelists will be joined in most cities by an economist from that particular area who has prepared a forecast for the local economy.

A more detailed report on the Business Outlook Panel will be available in late December in the Indiana Business Review and online at http://www.ibrc.indiana.edu.