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Last modified: Monday, August 23, 2004

Concerns over oil prices add uncertainty to IU economic forecast

Indiana employment picture muted

BLOOMINGTON, Ind. -- With another record near $48 per barrel of crude oil being set Thursday (Aug. 19), it's becoming more difficult for economists to look forward confidently.

In the new forecast released today (Aug. 23) by the Center for Econometric Model Research at Indiana University Bloomington, the control forecast is relatively sanguine -- about 3.5 percent growth nationally and 2.6 percent growth in Indiana during the second half of this year.

But if oil prices continue to rise, the IU economists could become more concerned that it will lead to higher inflation and negative impacts on consumer confidence and the stock market.

"The longer that oil prices stay up over $40 a barrel, the more apprehensive I get," admitted Willard E. Witte, IU associate professor of economics and a director of the center, which is based in the Kelley School of Business. "For a lot of people, that's a significant drain on their budget. The longer these prices stay up where they are now, the more difficulty it raises," Witte said in an interview. "In a lot of ways it's like a tax increase, and right now it's a big tax increase.

"I've seen people talking about $60-a-barrel oil and higher. It don't think that's likely, but I don't think you can rule that out," he said. "If something like that happens, then the whole foundation of the economic recovery gets really shaky."

The price of crude oil has risen by 55 percent in the past year. Like many economists and analysts, Witte is hopeful that oil prices will drop to below $35 by the end of the year and that the employment picture also will improve.

Economic events in the last three months have led to concerns for many. Real output grew by only 3 percent, far below the May forecast. "The weakness came from consumer expenditures, which rose overall at only a 1 percent rate," the forecasters wrote. Household spending on goods fell by $7 billion.

Business investment was a bright spot nationally as investment in equipment grew by 10 percent and in structures by 5.1 percent. Residential investment grew by 15.4 percent and exports rose by 13.5 percent.

In Indiana, two other factors have led to a more pessimistic view for the second half of the year. The Bureau of Labor Statistics revised downward the state employment data for the first quarter. The estimate of total payroll employment was reduced by 12,900 or more than 0.4 percent. Secondly, the second quarter's job growth of 5,800 fell far short of the 15,000 previously forecast.

The center's new forecast now projects that total establishment employment in Indiana will grow by 0.7 percent in 2004, equal to only 20,900 jobs. This is down from the 1.5 percent it forecast in May. In the current forecast, employment is expected to rise by more than 1 percent during 2005.

An increase in non-manufacturing employment will offset decreases in manufacturing employment for 2004, according to the forecast.

"Looking out over the long term," Witte said, "Indiana is going to be an economy in which manufacturing employment will be a smaller and smaller fraction of the total. That simply is a reflection of the fact that manufacturing productivity grows more rapidly than productivity in non-manufacturing, particularly in the service industries.

"In summary, our control forecast represents an economy that comes through the temporary 'soft patch' and resumes a healthy expansion," concluded the forecast. But the economists assigned a significant probability to the possibility that higher oil prices could lead to a less positive outcome.