5 posts from February 2012

Minneapolis Fed regional forecasts: Not a bull’s-eye, but on target

Every December the Minneapolis Fed releases a Ninth District economic forecast for the upcoming year. This past December the forecast predicted moderate economic growth for 2012.

But as with any regular projection, it’s useful to know how accurate past forecasts have been. A review of Minneapolis Fed forecasts going back to 1998 shows that they’ve been pretty good, but have some soft spots that are inherent in current forecast models. That is, economic forecasting is not an exact science.

The Minneapolis Fed’s regional models forecast nonfarm employment growth, unemployment rate, personal income growth and housing units authorized growth for states in the Ninth District. Research department staff use a technique called Bayesian vector autoregression (BVAR). The forecasting models base projections on historical trends and recent movements in each of the data series combined with a BVAR forecast for the national economy.

This forecasting technique shares an unfortunate feature common to all forecasting models—they don’t predict turning points (i.e., recessions) very well. For example, in Chart 1 the forecast error, or difference between the forecast and actual data, in nonfarm employment for Minnesota was much larger during the recession periods when economic growth dipped. The forecasting model either didn’t anticipate the drop, as during the 2001 recession, or didn’t anticipate the size of the decrease, as during the 2007-09 recession.

Forecast -- Chart 1 2-27-12

A similar picture is found in Chart 2 for the unemployment rate. Here the forecasts for Minnesota also didn’t anticipate increases during recessions; forecast errors grew.

Forecast -- Chart 2  2-27-12

Table 1 shows that the 12-month unemployment rate forecast is within 0.7 percentage points on average from the actual unemployment rate. Meanwhile, the 12-month nonfarm employment growth forecast is within 1.3 percentage points of actual employment figures. As the time period between the forecast and the actual data narrows, forecast errors decrease since the models have more contemporary data on which to base the forecast; the exception is housing forecasts (see Table 1). (For those interested in technical details, the BVAR models calculate a confidence interval to estimate a range in which 70 percent of the expected outcomes would fall. You can see these ranges in the most recent forecast table.)

Forecast -- Table 1  2-27-12

Forecasts for personal income growth and especially housing units authorized have larger errors. (Housing units authorized is the total number of units authorized in permits for single- and multi-unit housing projects.) The vigorous climb in housing units authorized prior to the recent recession and subsequent steep drop were difficult for forecasting models to account for as authorizations in Minnesota and Wisconsin dropped below levels observed over 30 years ago. Meanwhile, personal income growth is often affected by volatile levels of farm income, particularly in North Dakota. In Table 1, North Dakota is removed due to volatile changes in farm income; average errors would be about 1 percentage point higher with North Dakota in the mix.

Given the uncertainty, the Minneapolis Fed doesn’t rely only on forecasting models, but also conducts surveys of business and community leaders throughout the year to hear what they expect at their own companies and communities going forward. To learn more about surveys and other data collected by the Minneapolis Fed, go to our district data web page.

Banking conditions improve, but still spotty

Banking conditions continued to improve with the overall economy in the final quarter of 2011, as they did through much of the entire year. But like the economy, improvements were modest, and some weakness remains in the industry, according to a quarterly update of banking conditions just released by the Federal Reserve Bank of Minneapolis. The survey looks at 367 commercial banks headquartered in the Ninth District.

Overall asset quality showed strong improvement in 2011, fueled by continued improvement in commercial and other real estate loans. Profitability improved, but not to the same extent. Liquidity and capital both improved over the year, though neither has been a particular challenge for most banks, even in the depths of the recent crisis. Overall loan growth in 2011 was negative, but even here there are some positive signs; the decline was not as steep as the previous year-over-year results, and this metric improved throughout the course of 2011.

Also for the first time, the Minneapolis Fed released a banking forecast for 2012 for three basic metrics: profits, loan growth and asset quality. The forecast projects the coming year to be much like last year—continued improvement, but with geographic differences. For example, conditions are expected to strengthen in the Dakotas, where banks are already on very solid footing. The forecast for these measures at Minnesota and Montana banks is also positive, but less so, and levels are expected to remain below precrisis levels.

For a recap of 2011 banking conditions in the Minneapolis Fed's Ninth District, see the video below. Those also interested in a recap of the 2012 forecast can download a summary video here.

 

State unemployment insurance programs appear to be on financial mend

With unemployment rates slowly improving, the safety net that supports jobless workers seems to be stabilizing in district states.

Last year, the fedgazette reported that state unemployment insurance (UI) programs were spending significantly more in benefits than they were receiving from contributions (a.k.a. taxes) from employers, which fund the UI program. Typically, states keep a fairly healthy cushion in their UI trust funds to handle shifts in the economy. But heavy job losses meant that trust funds were doling out more money than they were taking in, particularly given the extension of jobless benefits in most states well beyond the typical 26 weeks.

Trust fund balances plummeted as a result; those in Minnesota and Wisconsin have yet to recover (see chart). Technically speaking, Minnesota’s trust fund currently is no worse off than last year, but has just $9 million (for the last three years, in fact), according to figures from the federal Bureau of the Public Debt. Wisconsin’s dwindling trust fund fell another $25 million since early last year, to $14 million.

UI update -- 2-15-12

In contrast, last year saw the Dakotas and Montana strengthen their UI trust funds. South Dakota was in a dire predicament, with just $1 million in its trust fund in 2010. But a temporary surtax on business UI contributions, along with a comparatively strong economy and low unemployment, has put that state’s trust fund above prerecession levels. The state also tends to keep a lower fund balance than either Montana or North Dakota because program benefits to the unemployed are lower.

Minnesota and Wisconsin were also among a gaggle of states whose UI programs bled so much cash they had to lean on emergency loans from the federal government to continue paying unemployment benefits. But this federal IOU shows that Minnesota’s unemployment insurance program is also on the mend. Over the past year, the state has managed to winnow a $770 million federal debt down to $180 million.

Wisconsin is mostly still treading water. Its federal loan debt dropped from $1.4 billion last year to $1.3 billion as of mid-February—a small improvement (even given the drop in its trust fund) that suggests the state is at least taking in more UI contributions than it is spending in benefits. However, the state’s federal loan debt is still the 10th highest in the country.

Welders have struck gold in the oil patch

In North Dakota and Montana, wages and employment for welders have grown very quickly near the Bakken shale-oil formation in recent years.

The Bureau of Labor Statistics gathers employment data in urban and rural areas of every state and further delineates rural (or nonmetropolitan) areas from each other so that regional patterns can be investigated. Both North Dakota and Montana have four nonmetropolitan areas (in brown in Figure 1) and three metropolitan areas (in white). While the Bakken shale-oil formation covers a significant portion of western North Dakota and eastern Montana, the heart of the Bakken is in red.

 Bakken map -- 2-6-12

Much has been written about the economic activity occurring in the district’s oil patch (including in the fedgazette). That growth has led to strong demand for workers in occupations directly tied to oil extraction. That’s particularly the case for welders, which include cutters, solderers and brazers, who are vital in maintaining drilling rigs, pipelines and other oil-related infrastructure.

Not surprisingly, wages and employment for welders in the oil patch are rising, and BLS data offer a snapshot of how they compare to other regions. Chart 1 below plots average annualized employment and wage growth from 2006 to 2010 among nonmetropolitan regions of North Dakota and Montana. Welders generally had much plumper checks and were on more payrolls in the nonmetropolitan regions in or near the Bakken than their coworkers in other nonmetropolitan areas.

 Welders in Bakken -- 2-6-12

The growth of employment and wages near the Bakken is impressive, but it’s also a function of how few welders there are in these nonmetropolitan areas. For example, welders’ employment in eastern Montana almost tripled, from 60 to 170. In fact, in 2010 none of North Dakota’s nonmetropolitan areas had more than 400 welders, and none of Montana’s rural regions had more than 200.

The Minneapolis Fed is currently investigating the employment effects of the oil boom in the Bakken formation. Watch for a cover article on this topic in the April fedgazette.

A brave new ethanol world?

The past decade or so has been manic-depressive for ethanol producers. The fuel went from a niche market to being praised as the savior of rural America and a key to breaking the U.S. addiction to foreign oil. Then, seemingly overnight, it became reviled for its inefficiency and was blamed for higher prices at the grocery store and food riots in the developing world.

Popular or not, ethanol has become big business in the Ninth District. In addition to the many corn producers growing the primary feedstock for ethanol, the district is home to some 43 ethanol plants, mostly in Minnesota and South Dakota (see map). Together they produce almost 2.5 billion gallons a year, according to the Renewable Fuels Association.

Critics of ethanol have charged that the industry is dependent on subsidies. Meanwhile, producers and advocates have shot back that improvements in technology and increasing oil prices mean that ethanol is now competitive without subsidies. This theory is now being subjected to a real-world test.

That’s because the primary ethanol subsidy, the federal Volumetric Ethanol Excise Tax Credit, ended on Jan. 1. The credit (45 cents per gallon, most recently) went to blenders who mixed ethanol with gasoline. In addition, a 54-cent per gallon tariff on imported ethanol also expired at the end of 2011. Even though the tax credit, which had been in effect for more than 30 years, went to blenders, it had always been an indirect subsidy to ethanol distillers and feedstock farmers.

All of this has some district corn growers and distillers worried about the impact of removing subsidies. They can take heart from a pair of studies that estimate the impact will be minor. An analysis by the Center for Agricultural and Rural Development at Iowa State University focused on how much blame ethanol deserved for the surge in corn prices from 2006 to 2009. They did this by creating a model of the corn market and then running simulations in which various economic factors and policies were removed. It turned out that while ethanol was responsible for a large share of the rise in corn prices, most of that increase was due to demand-driven factors; only 8 percent of the price increase was due to direct ethanol subsidies.

A June forecast by the Food and Agricultural Policy Research Institute at the University of Missouri suggested that the effects of removing the blender’s credit and the tariff will be modest—a reduction of average corn prices over the next 10 years by 18 cents per bushel, less than 4 percent. An earlier analysis found that removing the tariff had a more substantial impact than removing the subsidy.

One reason the impact of removing subsidies and tariffs is less dramatic than might be expected is because there are still federal and state mandates for ethanol use. In addition, last January the Environmental Protection Agency approved a 15 percent ethanol blend (up from 10 percent) for cars made in 2001 and later. So there are other demand-drive government policies to support the ethanol market.

Ethanol plant map -- 1-31-12