**KEEYA McMANUS and KELLEY BARNWELL**
**College of Business**
**Western Carolina University**

**Abstract**

*North Carolina real gross state product (GSP) is forecast to grow
approximately 2% per year throughout 1999 and 2000. The GSP data only continued
up to 1996; therefore, forecasts for 1997 and 1998 were performed. The
forecast is based on a Keynesian aggregate expenditures model which assumed
consumption spending would gradually increase over time. The marginal propensity
to consume (MPC) and marginal propensity to save (MPS) are 54% and 46%
estimated from 1977 - 1996 yearly data. GSP will continue to rise slowly
over the next two years in the future, alleviating the current labor shortage
without creating significant new unemployment. The Federal Reserve should
try to keep interest rates as stable as possible, allowing consumption
spending to rise; thus allowing the unemployment rate to stay low. (JEL:
E21, E66)*

**Part 1. Introduction**

This paper forecasts N.C. gross state product (GSP) for the years 1997, 1998, 1999, and 2000. The explanatory variable is real consumption. The approach is based on the Keynesian aggregate expenditures model using the U.S. consumption expenditures as a proxy for N.C. consumption expenditures. The Keynesian approach benefits from simplicity of implementation, and exploits the fact that if consumption increases, then GSP will also increase.

Continued growth of real GSP is necessary to sustain low unemployment and a rising standard of living. A downturn in GSP would constitute a recession. The forecast horizon of two years into the future was chosen to minimize the possibility of external factors impacting the economy in an unknown way. The forecast horizon is brief enough to avoid potentially serious overstating or understating future GSP.

The rest of this paper is organized as follows: Part 2. presents the data used to forecast GSP and the consumption function; Part 3. presents the theoretical basis of the approach adopted in forecasting GSP; Part 4. presents forecasts of GSP for 1997, 1998, 1999, and 2000; Part 5. evaluates the importance of the forecast for the economy; and Part 6. discusses conclusions for economic policy.

**Part 2. Data**

The variables were taken from the Federal Reserve Bank of St. Louis Federal Reserve Economic Data (FRED) and the U. S. Department of Commerce, Bureau of Economic Analysis. Real personal consumption expenditures are FRED variable PCEC92, which are measured in billions of chained 1992 dollars at seasonally adjusted annual rates (SAAR). The U.S. gross domestic product implicit price deflator is FRED variable GDPDEF, which is a seasonally adjusted percentage, where 1992 = 100.

The measures of GSP are from the U.S. Department of Commerce, Bureau of Economic Analysis, that are given in millions of current dollars yearly. For the sample period of our consumption function, the consumption and price deflator data are averaged monthly data to provide yearly data from 1977 to 1998. The GSP data is given yearly for 1977 through 1996. This means that 1997 and 1998 had to be forecast before the horizon of two years into the future (lagging the data two years). Real GSP is needed for this forecast. It was calculated from the nominal GSP multiplied by the GDP implicit price deflator. These estimates reflect the uniqueness of each State's industry mix.

Federal Consumption Expenditures and Gross Investment were used because the Keynesian model depends strongly on the consumption behavior of households and the investment behavior of private firms. Although government spending also plays a major role in the Keynesian model, it is determined by the government independently of GDP.

**Part 3. Economic Theory: The Consumption Function as a Forecasting
Instrument**

This forecast assumes the interest rate will remain constant for the next two years and will have no impact on consumption spending or GSP. The Keynesian consumption function is written as:

*C _{t} = C_{0} + MPC x Y_{t},(1.*

Where C_{o} is autonomous consumption , MPCxY_{t} is
induced consumption and Y_{t} is real GSP. Since real GSP equals
real aggregate expenditures (AE) in equilibrium, the AE function can be
written as:

*Y _{t} = AE_{t} = C_{t} + I_{t}
+ G_{t} + X_{t}*

Thus, consumption plays a major role in GSP. This is the reason why we used this variable to find future GSP for North Carolina.

This paper's approach has a shortcoming in that investment spending is known to respond to changes in interest rates and other factors, which are unpredictable. Also, the U. S. consumption is used as a proxy for state consumption. The GSP forecasts here are best interpreted as long-term trend real GSP, that is, what GSP should be in the absence of a recession. Actual GSP may deviate from its long-term trend. Since, consumption does not necessarily grow at a constant rate and the MPS and MPC may not be constant over long periods of time, a short forecast horizon, and here two years, is the most appropriate use of this model.

**Part 4. Estimates of Consumption and Forecast GSP**

Solving the consumption function, equation 1, for Y yields the inverse consumption function used to forecast GSP. The right-hand-side was lagged by two years and the regression equation was estimated with 1977-1996 yearly data. The regression estimate is (t-statistics in parentheses):

*Y _{t} = -497.91(-5.80) + 0.521598(22.19)(C_{t--2})*

The estimated MPC is the coefficient on Y, indicating a value of 48%= 0.48 for the MPS. The adjusted R-square of the estimate is 0.9665, indicating approximately 97% of the variation of C is explained by variation in Y. High R-squares are not unusual for time series regressions. The t-statistic of the inverse MPC is greater than three, indicating strong rejection of the null hypothesis that the MPC = 0. The t-statistic of the intercept is greater than one, indicating failure to reject the null hypothesis that the intercept equals zero.

Forecasts of GSP are presented in table 1:

Table 1
Forecast Real North Carolina GSP, 1995-2000
in billions of 1992 dollars |
|||

Data |
Year |
Projected % Change in Real GSP (Y) |
Projected Real GSP |

Actual |
1995 |
0.03 |
178.8 |

Actual |
1996 |
0.04 |
186.5 |

Projected |
1997 |
(0.09) |
190.4 |

Projected |
1998 |
0.02 |
198.1 |

Projected |
1999 |
0.02 |
206.5 |

Projected |
2000 |
0.01 |
218.8 |

This forecast projects real GSP to increase 2% in 1999 and 1% in 2000. Although a mild slowdown is predicted these growth rates are not unfavorable and are consistent with the consensus value of 3% for long-term U.S. real GDP growth. This forecast suggest the North Carolina economy will continue to expand at a moderate rate, assuming no change in interest rates.

**Part 5. Forecast Implications**

GSP is the most comprehensive measure of economic activity for each state. The forecast presented here could be compared to N.C. projected GSP data to provide early warning of problems in the N.C. economy. The forecast predicts a mild downward decline in the growth of GSP, but nothing too drastic or overwhelming.

The forecast suggests little chance that unemployment will remain so low that output prices will be driven upward. Since unemployment will begin to rise slightly (in the next two years), employers will be able to find vacant jobs easier, thus causing low involuntary unemployment.

**Part 6. Policy Conclusions**

Real GSP is forecast to rise approximately 2%, with real consumption rising approximately 1%, for the next two years.

Assuming the forecast is correct, companies can expect hiring employees to get much easier in the next couple of years. Since there has been a shortage of workers actively seeking employment, many companies have given up trying to fill vacant positions. The present shortage of workers, however, may be a long-term problem, but should not be a major factor to be concerned with during the next two years.

In the future, workers will be unable to command such high wages and bonuses because companies will be able to hire workers at lower rates. Unemployment should not increase above the natural rate of about 6%.

The forecast assumes no significant change in North Carolina consumption spending over the next two years. The forecast assumes no change in the interest rates over the next two years. The Federal Reserve should take great caution in not changing the interest rate unless they feel it is clearly justified, and any change should be gradual. Since the interest rate is currently low, consumption spending will continue to rise, keeping unemployment low.

**References**

- Federal Reserve Bank of St. Louis, Federal Reserve Economic Data (FRED),
http://www.stls.frb.org/fred/

Gross State Product by Industry 1977-1996, U.S. Department of Commerce,
Bureau of Economic Analysis, http://www.ospl.state.nc.us/sdn/gsp/percent.htm/