EconSouth (Fourth Quarter 2005)
EconSouth (Fourth Quarter 2005)
Ill Winds Cant Blow U.S. Economy Off Course
In 2005 Mother Nature buffeted the South with a series of violent hurricanes, causing widespread damage and loss of life. Despite the resulting temporary disruption to the nations fuel supply, the economy showed remarkable resilience and is poised for continued growth.
Three destructive fall hurricanes severely disrupted regional economic activity, yet the nations economy appears to have preserved its momentum going into 2006. Consumer inflation, outside of direct energy costs, has remained remarkably low (see chart 1). Unusually high energy costs during the winter should not significantly slow the pace of overall consumer spending or business investment, and the economy should continue to grow in the 34 percent range in 2006.
Before the storms
Economic activity in the months leading up to the storms was robust. For the 12 months ending in August 2005, the economy added more than 2.2 million jobs, or an average of 188,000 additional jobs per month. This solid rate of job growth was better than many expected and was enough to bring the unemployment rate in August to its lowest level since 2001. Growth in real gross domestic product (GDP) was a solid 3.3 percent (3.6 percent year-over-year) for the second quarter of 2005, continuing a string of strong gains since 2003 (see chart 2).
A look at inflation activity brings the picture of the economy leading up to the hurricanes into focus. Since 2003, oil prices have been on an upward trend. Worldwide petroleum demand is growing, as is industrial production and overall economic activity, but additional supply is limited. Domestically, the most apparent problem is the lack of additional refinery capacity. The pressure on energy prices intensified during the summer, especially for natural gas, yet there was little evidence of higher energy prices causing higher consumer prices for nonenergy goods and services. Measures of consumer inflation that exclude energy costs increased only moderately from an already very low base.
After the storms
The U.S. economy was humming along fairly well in late August: Real economic output was growing solidly, employment was expanding, and core inflation remained low. Then Hurricane Katrina roared through the Gulf of Mexico and wrecked a large part of the nations oil and gas production and distribution network. A few weeks later, Hurricane Rita brought more damage to the same area, and a few weeks after that Hurricane Wilma barreled across south Florida. In addition to the significant human suffering, these hurricanes caused a large loss of capital, jobs, income, and spending in the affected areas.
Despite these events, the national economy has remained relatively strong during the latter part of 2005. Employment outside of the storm-damaged regions continued to expand in the months after the storms, and estimates show 4.1 percent (3.6 percent year-over-year) GDP growth for the third quarter ending in September, with similar gains forecast for the fourth quarter.
Because the New Orleans area and the Mississippi Gulf Coast combined represent only approximately 0.5 percent of U.S. economic activity (based on income and employment), the immediate impact of the hurricanes disruptions to production, income, and consumer and business spending on GDP and employment was relatively small. Experience from previous large storms, such as Hurricane Andrew in 1992, suggest that rebuilding efforts will offset the loss in economic activity and boost overall GDP growth for the nation in the near term.
Hurricanes put energy on center stage
While the storm-damaged area of Louisiana represents only a small part of the national economic landscape, it casts an outsized shadow because of its very large role in oil and gas production and processing. Katrina and Ritas disruptions of this production and processing spilled over into the national economy, generating uncertainty about the availability and price of energy products.
Before Katrina, U.S. oil refineries were already operating near capacity, placing upward pressure on the prices of refined products. When the storms temporarily knocked out approximately 20 percent of U.S. refinery capacity as well as related distribution channels, prices immediately jumped. However, prices quickly retreated to prehurricane levels as oil was made available from the Strategic Petroleum Reserve, imports of refined products increased, and repairs to damaged refineries and distribution pipelines improved availability.
The near-term outlook for natural gas is of greater concern because several of the natural gas production facilities in the Gulf of Mexico and the associated pipeline system remain off-line. Also, the United States does not import significant quantities of natural gas. As a result, natural gas prices rose dramatically after the hurricanes and have remained quite high going into the winter months of heavy demand.
Consumers, businesses respond to higher energy costs
Higher energy costs can have a direct effect on economic activity. Past experience has shown that a sharp run-up in energy prices tends to lower consumption of energy-intensive goods and services, but spending on some other goods and services may decline as well because the lower energy consumption does not fully offset the higher prices. Thus, consumers may delay some types of expenditures because more of their financial resources are going to energy costs. However, because energy expenditures represent a relatively small share of most consumers income, the direct negative impact of higher energy costs on consumer spending should not be very large.
Manufacturers are also facing increased production and distribution costs as a result of higher energy costs, which may cause some firms to alter their production and investment plans. For chemical and other companies that use natural gas as a primary input, this situation could be a serious concern.
Price pressures and inflation risks
Part of the reason why consumer spending has been so resilient in the face of higher energy costs is that the average price for most consumer goods and services has been relatively unaffected. The steep rise in energy prices during 2005 caused most measures of inflation, such as the overall consumer price index (CPI), to increase. In October 2005, the overall CPI was 4.3 percent higher than a year earlier. On the other hand, core CPI, which excludes food and energy costs, increased only 2 percent over the same period.
Producers inability to pass higher energy costs on to consumers reflects the relentless competitive pressures at work in the U.S. economy to constrain price increases. Manufacturers continue to develop new ways to control costs through technology, and in many cases domestic producers simply cannot fully recover higher energy costs because of the ever-present threat of foreign competition. Retailers also play an important role in the price equation by aggressively seeking out low-cost suppliers. All these factors help to ease inflationary pressures.
|Photo courtesy of the Federal Emergency Management Agency|
|Hurricane Katrina wreaked havoc on these shipping containers at the Port of New Orleans, one of the nation’s busiest ports.|
In a few exceptional instances, though, some energy-related price increases have passed through to consumers. For instance, demand for trucking services was strong in 2005, but excess trucking capacity was scarce. This situation made it easy for most trucking firms to impose and maintain fuel surcharges.
Determining how much increases in energy costs will affect core inflation is difficult. Data in the coming months will provide more reliable indicators of inflation risks. But the most likely outcome is that current inflation pressures caused by elevated energy prices will turn out to be temporary and will not significantly change the nations favorable longer-term inflation outlook. Despite Mother Natures assault on the U.S. energy infrastructure in 2005, the national economy appears to be on firm footing heading into 2006.
This article was written by Melinda Pitts, John Robertson, and Ellis Tallman of the Atlanta Feds research department. Unless otherwise specified, annual employment growth is for November 2004November 2005.