The 2007 economic
forecast
Mostly sunny, with chance of cooler weather
By John W. Mitchell
Oregon’s economy continued to prosper in 2006, with
growth in employment, income and population greater than the
national average. The New Year promises to usher in more
expansion but at a slower pace that mirrors the outlook of a
national cooling.
Along with neighbors Idaho and Washington, Oregon was a top-10
state for employment growth through most of 2006. After
bottoming in mid-2003, employment has trended up since. It made
up the 3.3% recession decline by the fall of 2004 and has
continued to set new highs. Job growth has been fueled by the
rebound in business investment and trade, robust travel and
tourism and the housing boom, and has touched many regions,
including Bend, Medford, Grants Pass, Hood River, Eugene and
Springfield, as well as the Portland metro area.
At the end of the third quarter this year, Oregon employment
was 3.1% ahead of 2005 levels — a growth rate more than
twice the national figure. The weakness in housing seen at the
national level was evident in Oregon, with residential permits
down 12.8% up to September. House-price appreciation was
greater than the national average, but rising inventories and
falling closed sales suggest that prices will weaken.
Bend had the most rapid home-price appreciation in the nation
in the first six months of 2006, but even there, prices were
moderating, according to the Office of Housing Enterprise
Oversight. Weakening residential construction has affected
forest products industry with scattered cutbacks and layoffs.
The recent interruption of the long decline of forest products
employment was just that — an interruption. Rising
productivity will keep employment on a declining path.
The construction surge that accounted for about 30,000 jobs,
or one-fifth of employment growth, in the
2003-to-September-2006 period has run its course. The
supporting sectors, including finance and real estate, also
will weaken in the coming year. Nonresidential construction,
trade activity, equipment and software investment and continued
gains in travel and tourism will keep Oregon growing.
Population growth will remain above the national figure, but
softening California residential markets will make it more
difficult for some to move here. Oregon’s employment
growth will subside, moving down to about 1.8%, or 31,000 net
new jobs. Personal income will increase about 5.8%. In 2007,
Oregon’s relative concentration in durable goods, other
than forest products, will be an advantage with business
capital formation and exports.
Oregon is in the sweet spot of its fiscal cycle with its
unique income tax kicker system. Rapid employment and earnings
growth, capital gains and corporate profits mean both the
personal and the corporate income-tax components of the kicker
apparently will be triggered. Anticipated revenues for both are
predicted to come in more than 2% above the forecast for the
2005-07 biennium. The personal income tax rebate, expected to
be $1.04 billion, will be paid out before Christmas 2007.
Oregon’s overwhelming reliance on volatile income
taxation without a general reserve fund, other than one funded
by gambling losses, makes a replay of the 2001-2003 episode a
strong possibility when the next downturn causes revenues to
come in below forecast. Newly re-elected Gov. Ted Kulongoski
will have another four years to deal with this system
unconstrained by the spending limit that was rejected in the
November election but ever closer to the next revenue
disappointment.
NATIONALLY, THE UPTURN THAT BEGAN in November 2001 has
entered its sixth year, but there are signs of a slowdown. The
cycle has been marked by vigor in consumer spending and a
long-lasting housing boom that is now in its death throes. The
third-quarter preliminary real GDP growth rate was 1.6%, held
down by a housing drag of 1.12 percentage points. Employment
growth was late to the party, but now the unemployment rate has
plunged into the mid four’s, and the Bureau of Labor
Statistics has announced that there will be large upward
revisions to the employment data on the order of 810,000
additional jobs in early 2007.
The employment strength combined with a slowly growing
labor force is already making hiring more difficult and putting
upward pressure on wages. The industrial sector is operating at
rates above the long-term average. Recurrent energy shocks
buffeted the system, reflecting supply disruptions, strong
demand and international tensions in 2005 and 2006, but failed
to derail it. The Federal Reserve slowed its monetary stimulus
in mid-2004, when it commenced 17 consecutive increases in the
federal funds rate before pausing in mid-2006. In 2007, the
national economy is expected to slow to a more modest 2.5% to
3% growth rate with a different mix of output.
The slower growth will be driven by capacity constraints, the
lagged effects of the monetary policy and the unwinding of the
housing boom. The decline in housing and slower growth in
consumer spending will be partially cushioned by continued
strength in business investment including non-residential
construction and trade in an expanding world economy which bode
well for this region. Business investment will be supported by
high operating rates, strong balance sheets and buoyant export
demand.
How the housing boom ends is the most critical issue in 2007
for Oregon and the nation. Residential construction has been
declining since late 2005. Price weakness, adjusting adjustable
mortgages and tighter lending will dampen people’s
willingness to borrow against their homes and diminish the real
estate’s contribution to rising net worth. The wealth and
equity withdrawal have been elements in the strength of
consumer spending.
The fortuitously timed decline in energy prices in fall 2006
will help support consumer spending. For the world’s
largest oil consumer, oil-price declines boost the standard of
living as we give up fewer exports or debt to get a barrel of
oil. The tightening labor markets offer additional support for
spending.
September’s headline inflation number fell .5%
driven by a drop in energy prices, but the core, which excludes
volatile food and energy prices, remains above the Fed’s
desired range. Moderation in growth, productivity, previous Fed
policy and room for profit margins to decline should keep
inflation near 2.5% in 2007. The Fed continues to emphasize its
worry about inflationary pressures; its hard-won credibility is
something Chairman Ben Bernanke doesn’t want to lose. The
Fed’s next move will be to lower the federal funds rate,
but it will be a slow process given the inflation concern and
the upward surprises on employment.
Contemplating the coming year, one can worry about housing
weakness, another energy shock and the inverted yield curve
(short rates above long rates) that often have been a harbinger
of recession. But the angst is diminished by the decline in
energy prices, the apparent strength in labor markets,
prospects for faster wage growth and rising stock and bond
markets that help support household balance sheets. In
addition, business balance sheets are strong and funds are
available to finance investment.
In 2007, the U.S. and regional economies will face increased
risks in this aging upturn. Housing is searching for a bottom,
the risk of another energy shock has diminished but not
disappeared, and inflation is still a Fed concern. The
Northwest, with is large capital goods sector, its trade
exposure, and its population growth will continue to outperform
the nation.
John W. Mitchell is the
western region economist for U.S. Bank and the principal of
M&H Economic Consultants.
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