Copyright© 2004 by School Services of California, Inc.

Volume 17                   For Publication Date: December 17, 2004             No. 24

UCLA Forecasts Moderate Growth in 2005, But Risks in 2006  

On Wednesday, December 8, 2004, forecasters at UCLA predicted that the state and national economies would grow at a reasonable pace through 2005. They warned, however, that rising interest rates and excessive home prices could threaten the expansion.  

Economists with the UCLA Anderson Forecast anticipate a general slowing of the national economy from an increase in the gross domestic product of 4.4% in 2004 to 2.8% in 2005 as interest rates rise. They project an increase in the federal funds rate, a key short-term rate controlled by the Fed, from 2% currently to 3% in 2005 and 3.5% in 2006. This rise in the short-term rate has been ongoing since earlier this year when the Fed began a program to gradually increase the rate from historically low levels.  

For California , UCLA projects a similar slowing of the growth rate in 2005, with personal income growth easing slightly from 5.6% in the current calendar year to 5.2% in 2005. Payroll employment, a lagging economic indicator, will show greater strength in 2005, increasing 1.6% from an anemic pace of .8% in 2004. We would note, however, that UCLA's state employment forecast is slightly less optimistic than the one they issued last quarter in which they projected 2.0% employment growth for 2005.  

Edward Leamer, the director of the forecast project, warned in this and the prior quarterly report that home prices were rising too rapidly to be sustained and that a price adjustment is likely. He specifically commented on the underlying demographic makeup of the state in making the case that home prices are too high. Leamer acknowledged that in California there is strong demand for housing; however, this demand is not aligned with those whose incomes are sufficient to afford the average home. Specifically, there is a great need for housing among recent immigrants to the state, with this group having on average larger families and younger children than longtime state residents. The average income of these new Californians, however, is less than the statewide average, making it difficult for them to afford a home at current prices. The UCLA forecasters anticipate a gradual adjustment in the relationship between personal income and home prices, with price increases stalling as incomes rise to levels at which more residents will qualify for mortgage loans.  

In comparison to the recently released forecast of the Legislative Analyst's Office (LAO), the UCLA forecast is slightly more conservative. UCLA’s outlook for personal income growth is about two-tenths of a percent weaker than LAO's for 2005 and about three-tenths of a percent weaker in 2006. These differences, however, are not material and both forecasts identify similar risks. The key forecast for state budget purposes will be the one that accompanies the Governor's Budget, which will be released on January 10, 2005. We will provide a comparison of all of the major forecasts at that time.

—Robert Miyashiro