**CHAPTER II**

**ECONOMIC ENVIRONMENT**

This chapter discusses the economic environment and data used in
forecasting aviation demand. These data are taken from several sources.
United States economic data, derived from annual and quarterly
statistics, are taken from the Office of Management and Budget (OMB),
Congressional Budget Office (CBO), and a private forecasting
service---Global Insight, Inc. (Formerly DRI-WEFA). Quarterly data for
the three series used to develop the aviation demand forecasts\--Gross
Domestic Product (GDP), the Consumer Price Index (CPI), and the Oil and
Gas Price Index\--are presented as seasonally adjusted annualized rates.

Fiscal year (FY) estimates are calculated by averaging the 4 quarters
for the period October through September. Global Insight, Inc.
international economic estimates provide the basis for developing the
international aviation forecasts. The specified years for the economic
data discussed in this chapter are as follows: United States economic
data is on a fiscal year basis and international economic data is on a
calendar year (CY) basis, unless otherwise indicated.

**REVIEW OF 2002**

The U.S. economy experienced its 10^th ^recession since the end of World
War II during the last 3 quarters of FY 2001, which ended with the
events of September 11^th^. The U.S. economic recovery from the downturn
and terrorist attacks has proceeded in a sluggish manner. World growth
also slowed considerably during the year with all major regions of the
world showing a slowdown or only weak improvement.

UNITED STATES

The 1st quarter of 2002 marked the end the 3 quarter economic downturn
with a 2.7 percent annual growth in GDP. The recession began in the
2^nd^ quarter of 2001 and registered declines of 0.6, 1.6, and
0.3 percent over a 3 quarter period. This downturn ended the longest
economic expansion in U.S. history, which spanned the decade of the
1990s and totaled 41 quarters. The 2^nd^ quarter 2002 brought a surge in
growth of 5.0 percent due, in large part, to a build up in inventories.
Growth moderated in the 3^rd^ and 4^th^ quarters with GDP growing 1.3
and 4.0 percent, respectively. For the year, the U.S. economy expanded
by 1.7 percent, double the 0.8 percent growth in 2001, but far below
growth of 4.3 percent in 2000.

Consumer confidence as measured by the Index of Consumer Sentiment,
University of Michigan, fell off sharply at the onset of the 2001
recession. The index, which reached a high of 110 in early 2000, fell to
85 in the 4^th^ quarter of CY 2001. The index rose substantially in the
1^st^ and 2^nd^ quarters of CY 2001, a possible harbinger of a recovery.
However, this rally fizzled in the 3^rd^ and 4^th^ quarters suggesting a
weaker recovery.

![](media/image1.wmf){width="3.245138888888889in"
height="2.1215277777777777in"}

Demonstrating the depth of the downturn, the following chart shows a
substantial decline in industrial production beginning in the
1^st^ quarter CY 2001 and extending through 1^st^ quarter 2002. Like the
consumer confidence index, the recovery of industrial production also
appears weak, having fallen off in the 3^rd^ and 4^th^ quarters of
CY 2002.

Price inflation, measured by the consumer price index (CPI), slowed to
1.5 percent in 2002, less than half the 2001 rate. Volatile energy
prices, as measured by the oil and gas price deflator fell 14.1 percent
during 2002 after a rise of 5.5 percent a year earlier.

![](media/image2.wmf){width="3.2444444444444445in" height="2.20625in"}

The unemployment rate reached 6.0 percent in April 2002 and has remained
between 5.6 and 6.0 percent through November. In 2001, the rate ranged
from 4.2 to 5.8 percent, gradually rising through the year. Much of the
large increase in unemployment occurred after September 11^th^ and is
due, in part, to the major disruptions in the travel and service
industries.

In 2001, the Federal Reserve Board (FED) lowered interest rates 11 times
as the economy struggled its way out of recession. However, believing
that the U.S. economy was headed for recovery, the FED left interest
rates unchanged until November 6^th^, when it cut the overnight interest
rates (the rate banks charge one another for overnight funds) by a half
a percentage point, to 1.25 percent. Separately it lowered the rate that
banks pay when they borrow from regional Federal Reserve banks to
0.75 percent, the lowest rate in the FED's history. This rate cut
underscores the FED's changing view that the economy may not sustain the
recovery.

WORLD

Worldwide GDP expanded by 1.8 percent in 2002, slightly above the
1.2 percent growth of a year earlier but far below the 3.9 percent
expansion in 2000. The relatively weak recovery reflects the lack of an
engine to propel growth forward. Uncertainty generated by the political
tensions in the Middle East has dampened worldwide economic activity.
Furthermore, major corporate scandals in the U.S. have shaken confidence
in capital markets.

Western Europe suffered significantly from the 4^th^ quarter 2001
contraction that developed after September 11^th^. European GDP growth
fell to 1.0 percent in 2002, down from growth of 1.4 percent in 2001 and
3.6 percent in 2000. Europe's largest economy, Germany, stagnated in
2002 with GDP growing only 0.3 percent. Both consumer and business
confidence are down substantially throughout Europe. Passive monetary
and fiscal policies under European authorities have exacerbated Europe's
economic woes.

In Eastern Europe GDP grew a modest 2.7 percent, the same as a year
earlier but more than a percentage point off the 2000 pace. The
moderation in growth for emerging Europe occurred because of a drop in
the external demand for products that they supply to the economies of
the developed world.

The Middle East and North Africa are primarily oil-based economies
highly dependent on the volatile price of this fuel. The relative
stability in oil prices over the past year has provided a reasonable
platform for economic growth in the region. The region's GDP expanded by
2.4 percent in 2002, just above the 2.2 percent increase of a year
earlier.

The combined GDP of Asia (including Australia and New Zealand) grew at a
2.2 percent rate in 2002, up from 1.8 percent last year. However, Japan,
Asia's largest economy continued a decade long pattern of sluggish
growth with a 0.2 percent decline in GDP. Asia has benefited from both
healthy consumer demand and growth in exports. In particular, the
weakness in the U.S. dollar has assisted exports in countries such as
China and Malaysia, which peg their currency the U.S. dollar.

The near‑term future for Latin America appears particularly bleak. The
combined economies of Latin America fell by 2.6 percent in 2002. The
region's second largest economy, Argentina, declined drastically in 2002
with GDP falling 12.2 percent, causing ripples throughout the region.

The G-7 nations---U.S., Canada, United Kingdom (U.K.), Germany, Italy,
France, and Japan---demonstrated moderate to negative growth in 2002.
These seven national economies make up two‑thirds of the world\'s
output. GDP growth rates ranged from a high of 3.3 percent in Canada to
a negative 0.2 percent in Japan.

Price inflation also remained quite low among the G-7 in 2002. Italy
faced the highest inflation rate among these industrial leaders with a
2.4 percent rise in the price level, while a 1.0 percent decline in
consumer prices raised deflationary concerns in Japan. The remaining
five countries experienced price increases ranging from 2.2 percent in
the U.K. to 1.3 percent in Germany.

Among the G-7 nations, short‑term interest rates ran from a high of
4.0 percent in the U.K. to a low of 0.1 percent in Japan. With the
exception of Japan, which has the same short-term rate as a year ago,
rates dropped in each of the other six industrialized nations. The
largest interest rate decline occurred in United States, down 170 basis
points.

The Japanese yen (¥) and Canadian dollar (C\$) both continued to
depreciate against the U.S. dollar during 2002. The cost of US\$1.00
increased from ¥121.5 to ¥125.3 and from C\$1.55 to C\$1.57. Both the
Euro and the British pound appreciated against dollar. The cost of a
dollar in Europe fell from 1.12 to 1.06 Euro while it took only £0.67 
in 2002 to purchase a dollar compared to £0.69 a year earlier.

# 

# 

# U.S. ECONOMIC 

**OUTLOOK**

The economic assumptions used in developing the FAA baseline aviation
forecasts are derived from estimates provided by the Executive Office of
the President, Office of Management and Budget The GDP projections are
Bureau of Economic Analysis (BEA) chain-weighted estimates with a base
year of 1996. Forecasts for the Congressional Budget Office and Global
Insight are also shown.

SHORT-TERM

ECONOMIC OUTLOOK

Graphics on the following page present an optimistic picture of economic
growth during the next 2 fiscal years. OMB projects GDP to grow 1.5 and
2.7 percent in the 1^st^ and 2^nd^ quarters of 2003, then expand at
rates ranging from 3.4 to 3.7 percent over the next 6 quarters. Global
Insight sees the recovery somewhat differently with the 1^st^ quarter
2003 growth of 0.6 percent rising to 3.2 percent in 2^nd^ quarter and
peaking at 5.6 percent in 2^nd^ quarter 2004.

Moderate price inflation is expected to accompany the economic rebound
in 2003 and 2004. CPI increase is projected to increase 2.6 percent in
the 1^st^ quarter 2003 and remain between 1.9 and 2.1 percent over the
next 7 quarters. Fuel prices, as measured by the oil and gas price
index, are expected remain volatile through 2003 before leveling off in
2004. OMB expects energy prices to fall in each quarter of 2003 and the
1^st^ quarter of 2004 at annual rates of between 10 and 15 percent. Oil
prices are forecast to increase between 1.2 and 1.8 percent during the
last 3 quarters of 2004.

LONG-TERM

ECONOMIC OUTLOOK

The long-term economic outlook for the U.S. economy shows real GDP
growth averaging 3.2 percent over the 12-year forecast. Long‑term growth
in GDP is based on growth in the factors of production---labor and
capital. The relative mix these factors combined with the state of
technology determines proportional productivity of each factor. Labor
supply depends on population growth and its composition. National
savings determine capital accumulation. Technology expands the
productivity of labor and capital. In sum, changes in the factors of
production and increases in the productivity of those factors determine
economic growth.

Although still recovering from the recent recession, the U.S. economy
finds itself poised for substantial long‑term income growth. While the
labor supply will expand at only a moderate rate during the forecast
period\--elements that include low interest rates, continued capital
investment, further productivity improvements from the cyber revolution,
and growth in the internet---provide a solid base for future expansion.

The U.S. population is expected to expand at 0.8 percent annually over
the forecast period according to Global Insight. Based on the growth in
population and considering labor force participation rates, the U.S.
labor force will grow at a 0.9 percent pace over the period. Employment
is projected to increase from 134.6 to 153.0 million between 2002  and
2014 or 1.1 percent annually.

Human capital (education and skills), physical capital (machines and
computers), and technology primarily determine labor productivity.
Business investment, accumulation of capital, will remain at 12 to
13 percent of GDP during the forecast period. In real terms, capital
stock will increase at a rate of about 4.5 percent annually, slightly
above the pace seen in the past 30 years. This bodes well for increased
labor productivity. Because of insufficient savings and a Federal budget
deficit, U.S. investment will depend in part on international capital
inflows.

Productivity, as measured by output per hour, is forecast to rise
2.5 percent annually over the next 12 years. The following graph
presents historical and forecast output per hour between 1995 and 2014.

![](media/image3.wmf){width="3.2416666666666667in"
height="2.640277777777778in"}

Inflation is expected to remain moderate during the forecast period. The
consumer price index is projected to increase at an annual rate of
2.2 percent through 2014. Although expected to fall over the next
2 years (down 2.7 and 7.4 percent in 2003 and 2004), volatile oil and
gas prices are projected to settle down and increase at an average
annual rate of 1.7 percent over the last 10 years of the forecast
period. In real terms, oil prices are expected to decline at an annual
rate of 1.7 percent over the 12-year forecast period.

#### ALTERNATIVE FORECASTS

Alternative short‑term U.S. economic forecasts in Chapter X, Table 1,
were prepared by OMB, Global Insight, and CBO. Table 3 presents the
Global Insight long-term forecasts for both fiscal and calendar years.
In the long run, the differences between the fiscal and calendar year
forecasts are small.

Over the 12‑year forecast period, the Global Insight GDP forecast is
slightly higher than that of OMB\--3.3 versus 3.2 percent annually. CBO
projects growth of 3.1 percent over the same period. Global Insight
projects price increases averaging 2.3 percent annually compared to OMB
and CBO forecasts of 2.2 and 2.4 percent, respectively.

The major difference between the three forecasts relates to future fuel
prices. OMB forecasts that fuel prices will increase only 0.5 percent
(down 1.7 percent in real dollars) annually over the 12‑year period. CBO
and Global Insight project fuel prices to increase at annual rates of
3.4 and 2.3 percent, respectively, over the same time period. In real
terms, CBO forecast annual increases of 1.0, while Global Insight sees
growth as flat.

**WORLD ECONOMIC**

**OUTLOOK**

The principal economic issues related to FAA's international traffic
forecasts are discussed below. International economic data are presented
in tabular form in Chapter X, Tables 4 and 5. International GDP data are
presented on a calendar year basis and are expressed in 2000 U.S.
dollars. GDP and exchange rates for individual countries, as well as
groups of countries, are obtained from Global Insight.

WORLD GDP

The graphics on the following page depict both the historical trend and
projected GDP growth for major economic regions of the world. Worldwide
GDP is projected to increase by nearly \$908 billion to a level of
\$33.2 trillion in 2003, an annual increase of 2.8 percent. Over the
12-year forecast period, world output is projected to reach
\$47.6 trillion, an annual growth rate of 3.3 percent.

Canada

In the near term, Canadian economic growth will continue to outpace that
of the U.S. The Canadian economy grew by 3.3 percent in 2002, double the
U.S. and world rates. Canada's GDP growth is projected to increase its
that pace in 2003 and 2004 to 3.4 and 3.7 percent. Although the Canadian
economy remains heavily dependent on the health of the U.S. economy, it
is well positioned to sustain long‑term growth at a 3.0 percent annual
rate.

Canada's major strengths at this time are its trading position as a
member of the North American Free Trade Area (NAFTA) and an exchange
rate that makes its exports attractive. World exports are projected to
grow at 9 percent next year, while Canadian exports are forecast to grow
at a 12 percent pace. With the recovery of the U.S. economy, Canada
remains well poised to take full advantage of its close economic and
political ties with its neighbors to the south.

A government and central bank both aiming towards stable long-term
economic growth have carefully crafted Canadian fiscal and monetary
policy. Since 1992, the Bank of Canada has focused it monetary policy on
maintaining inflation in the 1 to 3 percent range. Global Insight
projects Canada's price inflation at 2 percent over the forecast period.
Fiscal policy in Canada has centered on a \$100 billion tax reduction
program. This program will lower all aspects of taxation. Although
Canadian taxes remain higher than those in the U.S., tax reductions have
assisted economic growth.

The primary risk to the Canadian economy remains the strength of the
economic recovery in the U.S. If the U.S. economy recovers more slowly
than anticipated, Canadian near‑term growth will not reach levels now
expected. Another risk affecting both the U.S. and Canada is the
increased time required to process border crossings. Although delays
have lessened since the initial impact of added security, the tighter
security arrangements at the Canada/U.S. border have hindered the
efficient flow of truck traffic for both imports and exports. The affect
of these delays is significant given that exports to the U.S. contribute
substantially to Canada's GDP.

### 

### 

### Pacific/Far East

The combined economies of Asia and the Pacific\--including Japan, the
developing Asia Pacific, China, India, and Pakistan, along with
Australia and New Zealand\--produced a 2.2 percent growth rate in 2002,
the 2^nd^ consecutive year of sluggish growth in this vibrant economic
region. Global Insight projects Asian GDP to increase 3.6 and
3.7 percent in 2003 and 2004.

Consumer demand within Asia has bolstered inter-Asia trade. This
internal Asian trade has increased the export sector that was already
experiencing increased trade with the U.S. Business investment is also
projected to increase.

Japan's GDP, which makes up 55 percent of Asia's output, shrank
0.2 percent in 2002 after rising only 0.3 percent a year earlier. The
world's second largest economy is projected to

grow slowly over the next 2 years as the country attempts to climb out
of its decade long slump. GDP is projected to grow by 2.0 and
1.8 percent in 2003 and 2004. Over the 12‑year forecast period, Japan's
economy is projected to expand by 1.8 percent annually.

Japan's lingering economic slump continues to show few signs of
immediate near‑term relief. Although the rest of Asia is projected to
grow substantially, Japan continues to wrestle with the same economic
problems it has dealt with for the past decade. The Japanese economy
continues to suffer from two primary weaknesses: a financial system in
need of substantial reform and price deflation.

Japanese banks are undercapitalized and saddled with bad loans. With so
much bad debt, banks continue to resist making loans. With the exception
of export firms, corporations are not borrowing based on the bleak near
term expectation for growth.

Deflation continues to plague the Japanese economy. Falling prices have
lowered domestic demand because both consumers and business have
postponed purchases as they wait for lower prices. Deflation also raises
the real cost of debt. Both corporations, who are saddled with large
outstanding loans, and the government, who borrowed heavily to fund
deficit spending over the past several years, find repayment of this
debt burdensome. Deflating prices also prevent the real interest rate
from dropping, as the nominal interest rate is essentially zero. Hence,
the Bank of Japan cannot stimulate the economy with lower interest
rates.

Japan's structural inefficiencies continue because creditors allow
bankrupt firms to continue operating thus maintaining excess capacity
and adding to deflationary pressures. Japan also suffers from excess
labor in the construction and manufacturing sectors. Unemployment
reached 5.3 percent in 2002 and is expected to continue to rise. Japan's
system of "lifetime" employment appears to be a notion of the past.

The economies of the Pacific and developing Asia\--the Pacific Basin,
China, India, and Pakistan\--show surprising strength. This region which
experienced an average growth rate of 6.7 percent during the 1990's,
slumped to a 4.0 percent pace in 2001, but increased to 5.6 percent in
2002. The combined GDP of these countries is projected to grow by 6.0
and 6.3 percent annually over the next 2 years. Over forecast period,
these Asian economies will increase its GDP by \$3.2 trillion
(5.8 percent annually), nearly double the current level.

Pacific Basin countries appear to have recovered from their slump of
2000, growing by 4.1 percent in 2002. These countries GDP is expected to
increase by 4.7 and 5.3 percent in 2003 and 2004, then average 4.9
percent a year over the 12‑year forecast. China continues to drive this
area's economic growth, expanding at a 7.9 percent pace rate in 2002.
Over the forecast period, China is projected to grow 6.9 percent
annually.

Although Asia appears to have a prosperous future, the region holds
numerous risks. Terrorism threatens many Asia nations with the emergence
of radical Islamic groups. The recent terrorist attacks in Bali have
created uncertainty over Indonesia's economic future. Another risk is
the needed institutional reform that constrains many Asian countries.
Although China and South Korea have moved toward reform of their
financial institutions, several Asian nations, most notably Japan, have
dragged their feet on reform.

Latin America

Mexico and Latin America are struggling through tough economic times.
The GDP of Mexico rose a mere 0.9 percent in 2002 after falling
0.3 percent a year earlier. In Latin America, GDP fell 2.6 percent in
2002 but is projected to grow by only 1.8 percent in 2003. Over the
forecast period, this region is expected to grow at a 3.9 percent annual
pace. The combined economies of Mexico and Latin America are projected
to increase at an annual rate of 4.0 percent over the next 12 years.

Argentina remains immersed in the worst political, social, and economic
crisis in its history without a solution in view. Its economy is in
shambles with half of its population below the poverty line and an
unemployment rate of 23 percent. Argentina is experiencing a depression
of the magnitude not experienced in the U.S. since the 1930's.

As Latin America's second largest economy, Argentina, will undergo a
12.2 percent loss in GDP during 2002 but is forecast to increase by
0.5 percent in 2003. The export sector provides the one bright spot in
the Argentine economy. Although merchandise exports fell by 2.6 percent
in 2002, this sector is expected to grow by 3.4 percent in 2003. The
spur to this sector came from a drastic devaluation of the peso that
decreased its value relative to the U.S. dollar by two-thirds. The peso
is expected to continue to devalue over the next few years.

With its economy in ruins and a recent default on a World Bank loan,
Argentina faces substantial problems with the International Monetary
Fund over another loan agreement. To stabilize the country and its
economy, Argentina has undergone market and political reforms with only
partial success. In the past decade, Argentina privatized inefficient,
corrupt state-owned enterprises and opened up its economy to domestic
and international competition. However, political and fiscal reform
remains elusive.

Brazil, Latin America's largest economy, grew by a 1.0 percent in 2002
and is forecast to grow by 1.5 percent in 2003. The slump is expected to
end in 2004 with projected GDP growth of 3.2 percent. The long‑term
growth target for Brazil is 4.2 percent.

Although Brazil has an optimistic long‑term economic outlook, its
economy has several short and mid‑term risks. Most immediately the
change in the Brazilian political landscape may threaten its ability to
finance and roll over its debt. Uncertainty regarding the likely
policies of the newly elected populist government presents significant
risks for financial markets.

Mexico, a country heavily dependent on its northern neighbors, grew by
1.5 percent in 2002 after suffering a yearlong downturn in 2001. Growth
is projected to expand by 3.1 and 4.0 percent in 2003 and 2004. Mexico
is expected to average 4.2 percent annual growth over the forecast
period.

The Mexican central bank will continue to pursue a tight monetary policy
as it remains focused on a target inflation rate of 3.0 percent. Mexican
fiscal policy emphasizes fiscal responsibility that calls for increased
taxes. The government is expected to continue to lower the budget
deficit as targeted.

As usual, Mexico's largest risk comes from its heavy dependency on the
U.S. economy and the economic malaise affecting the rest of its southern
neighbors. If the U.S. economy slows or if the downturn in Latin America
worsens, the Mexican economy may dip into recession again.

Europe/Middle East/Africa

The combined economies of Europe (Eastern and Western), the Middle East,
and Africa are projected to grow by 2.0 and 2.9 percent in 2003 and
2004, after rising a meager 1.2 percent in 2002. Over the 12‑year
forecast period, this European dominated region is expected to grow by
2.7 percent a year. Western Europe, responsible for 85 percent of the
region\'s output, grew by 1.0 percent in 2002. This region is dominated
by the European Union (EU) countries\--Austria, Belgium, Denmark,
Finland, France, Germany, Greece, Ireland, Italy, Luxembourg,
Netherlands, Portugal, Spain, Sweden, and the United Kingdom\--and is
forecast to increase by 1.8 and 2.7 percent over the next 2 years. Over
the forecast period, Western Europe is projected to grow 2.4 percent
annually.

Europe's already declining production received a shock in the wake of
September 11^th^ terrorist attacks that sank business and consumer
confidence to long‑term lows. Domestic demand continues to be weak and
the export sector that had led the recovery has come under pressure from
weaker world output.

Prices in Western Europe rose 3.6 in 2002 and are forecast to rise 3.2
and 2.7 percent in the next 2 years. Interest rates among the six
largest economies of Europe---Germany, France, U.K., Italy, Spain, and
the Netherlands\-- ranged from 4.0 in the U.K. to 3.3 in each of the
other five countries. In 2003, rates are projected to rise to 4.6 in the
U.K. and drop to 2.8 percent in the remainder or these countries with
the exception of France whose rate is expected to rise to 3.4 percent.

The European outlook has significant risks. Fiscal policy among European
Union members could become excessively restrictive as governments move
towards targets committed to under the Stability and Growth Pact. The
European Central Bank may over tighten monetary policy in an attempt to
stem inflationary concerns. A rise in the value of the Euro relative to
the dollar would weaken the EU export competitiveness.

Eastern Europe's GDP expanded 2.7 percent in 2002. Each of the regions
largest economies---Poland, the Czech Republic and Hungary---continued
to show growth, although Poland GDP grew by only 1.3 percent. This
emerging economic region is projected to grow 3.6 and 4.3 percent in
2003 and 2004. For the forecast period, Eastern Europe is projected to
grow 4.1 percent a year.

The former Soviet Union's economy grew (GDP up 4.8 percent) at nearly
twice the pace of Eastern Europe and more than four times the rate of
Western Europe during 2002. These countries are projected to expand 4.4
and 3.8 percent over the next 2 years. Over the forecast period, the
region is projected to expand 4.3 percent a year.

The oil-producing region of the Middle East grew by 1.8 percent in 2002
and is forecast to rise 3.2 and 4.0 percent in 2003 and 2004. For the
next 12 years, the region is expected to grow at a 4.0 percent annual
rate. This region's dependence on the production, sale, and export of
oil places its fate in the hands of the volatile oil market. An
increased supply of oil from Russia and possibly Iraq could send the
price of oil down rapidly, creating a substantial risk for this region.

The most significant risk in this part of the world remains the manifold
political and war related concerns. One concern is related to the
on‑going conflict between Israel and Palestine and the increased
terrorist activity that has accompanied that conflict. A second major
area of concern is a potential war in Iraq. This conflict could have
broad implications for the stability of governments in the region.

African economies grew by 2.9 percent in 2002. This commodity rich
continent is forecast to grow by 3.4 and 4.4 percent in 2003 and 2004.
Over the forecast period, African GDP is forecast to expand by
4.2 percent annually. Political stability and commodity prices remain
the primary concern in most of the countries of this very large
continent. If the political instability of the Middle East spreads to
North Africa or if commodities prices continue to fall substantially,
the positive growth scenario for African nations could diminish.

### DOLLAR EXCHANGE RATE

The graphics on the following page show historical and forecast values
for the U.S. trade-weighted nominal exchange rate index with selected
other developed countries.[^1] The trade-weighted exchange rate measures
the relative purchasing power of the U.S. dollar against economically
developed countries accounting for trade differences. The graph also
displays the historical and projected dollar exchange rates against the
Japanese yen and the Euro. Table V in Chapter X displays the historical
and forecast exchange rates from 1997 to 2014 for the Canadian dollar,
the British pound, the Japanese yen, and the Euro.

In trade-weighted terms, the dollar fell marginally against its major
trading partners in 2002. The U.S. dollar is projected to continue to
fall throughout the 12-year forecast period, declining at an average
annual rate of 1.5 percent. The U.S. dollar rose against the Canadian
dollar in 2002\--one Canadian dollar cost \$0.666 in 2002 compared with
\$0.646 a year earlier. The downward trend in the Canadian dollar is
expected to reverse in 2003, rising to \$0.656 in that year and
continuing to rise throughout the forecast period, reaching \$0.775 by
2014.

The Japanese yen also depreciated against the dollar, falling
3.0 percent to \$7.98 per ¥1,000. Over the forecast period the yen is
forecast to rise against the dollar by an average 1.8 percent per year,
reaching \$9.94 per ¥1,000 in 2014. The Euro rose 5.0 percent against
the dollar in 2002. Over the next 12 years, the Euro is projected to
rise by 1.7 percent a year\--from 0.94 to 1.15 to the dollar in 2014.

**U.S. REGIONAL ECONOMIC GROWTH**

The 2001 recession and its manifold difficulties, including the
terrorism of September 11^th^, the fall of the stock market, and the
bursting of the high tech bubble, brought with it considerable hardship
in the U.S. Although all regions suffered, those more reliant upon
tourism and air travel, high tech firms, finance and manufacturing felt
the impact of the slump somewhat more.

While a downturn in manufacturing led the slump, other factors combined
to produce a broad-based recession affecting most states and all
regions. Though the pop of the dot-com bubble had its largest impact in
2001, it continues to affect those regions that had prospered with the
high-tech boom. The region most notably harmed by the bust in high tech
are the West Coast, the Mountain states, and particularly Colorado, New
England, and especially Boston, and Southern metros such as
Raleigh-Durham, Atlanta, Dallas, and Austin. The impacts of the general
stock market slide, while felt everywhere, most severely impacted
financial centers such as New York and Charlotte. The terrorist events
affected tourism dependent destinations such as Orlando, Las

Vegas, and Hawaii. The accumulation of these factors resulted in a slump
that left no region untouched. In 2002, employment declined in all nine
census regions for the 2^nd^ year in a row. In absolute and relative
terms, the East North Central region---Illinois, Indiana, Michigan,
Ohio, and Wisconsin\--the industrial Midwest, lost the most jobs with
employment dropping by nearly 200,000 or 0.9 percent; The Middle
Atlantic states consisting of New Jersey, New York, and Pennsylvania
lost 154,000 jobs or 0.8 percent. The East South Central---Alabama,
Kentucky, Mississippi, and Tennessee---lost the least number of jobs
(3,000), less than 0.1 percent.

The following chart shows the employment growth forecast by region for
two time periods, 2002 to 2007 and 2007 to 2012. For the entire period,
the South Atlantic (Delaware, the Virginias, the Carolinas, Maryland,
Georgia, and Florida) and Mountain (Arizona, Colorado, Idaho, Montana,
Nevada, New Mexico, Utah, and Wyoming) regions show the largest
employment gains.

The South Atlantic region has benefited from automotive manufacturing
that has migrated steadily south and southeast in recent years. For
instance, Georgia officials recently announced that it had been chosen
as the site for DaimlerChrysler\'s new \$754-million van plant. In the
Mountain region aerospace and computer industry jobs will maintain
employment growth.

![](media/image4.wmf){width="3.2416666666666667in"
height="2.3743055555555554in"}

Slowest growth will be experienced in the East North Central region
(Illinois, Indiana, Michigan, Ohio, and Wisconsin). These rust belt
states will continue to lose jobs to southern and western states.

The following table shows the 10  fastest growing metropolitan areas
ranked by annual employment growth from 2002 to 2004. Las Vegas
continues to lead the list, having become both a leading tourist
destination and retirement community. All the cities on this list are in
four states in the Sunbelt region: Florida (6), North Carolina (2),
California (1), and Nevada (1).

+-------------------------------+---------------------+----------------+
| **TOP 10 METROPOLITAN AREAS   |                     |                |
| IN EMPLOYMENT GROWTH 2002 -   |                     |                |
| 04**                          |                     |                |
+-------------------------------+---------------------+----------------+
| ##### Metropolitan Area       | **2002 Employment   | **2002-04      |
|                               | (000s)**            | Growth (%)**   |
+-------------------------------+---------------------+----------------+
| **Las Vegas, NV**             | 798.0               | 3.6            |
+-------------------------------+---------------------+----------------+
| **West Palm Beach, FL**       | 521.8               | 3.0            |
+-------------------------------+---------------------+----------------+
| **Sarasota, FL**              | 284.6               | 2.8            |
+-------------------------------+---------------------+----------------+
| **Orlando, FL**               | 910.5               | 2.8            |
+-------------------------------+---------------------+----------------+
| **Jacksonville, FL**          | 577.5               | 2.7            |
+-------------------------------+---------------------+----------------+
| **Tampa, FL**                 | 1238.3              | 2.4            |
+-------------------------------+---------------------+----------------+
| **Charlotte, NC**             | 839.4               | 2.4            |
+-------------------------------+---------------------+----------------+
| **Raleigh, NC**               | 694.9               | 2.4            |
+-------------------------------+---------------------+----------------+
| **Riverside, CA**             | 1063.2              | 2.3            |
+-------------------------------+---------------------+----------------+
| **Ft. Lauderdale, FL**        | 702.7               | 2.2            |
+-------------------------------+---------------------+----------------+

###### RISKS TO THE FORECAST

A substantial threat to the U.S. and world economies comes from the
potential outbreak of war in Iraq and the possible spread of that
conflict throughout the Middle East. With weapons inspectors on the
ground in Baghdad and the U.S. denouncing the Iraqi regime for its
duplicity in hiding weapons of mass destruction, the likelihood that
rhetoric will turn into a military conflict appears more and more
likely. A breakout of war in Iraq may paralyze travel between North
America and Europe and send both economic regions into recession with a
potential for a worldwide downturn. Such a war may also raise the price
of oil at least in the short-term.

Additional global uncertainty comes from the U.S.-led war against
terrorism. Potential hostilities with Iraq has strained relations among
the countries of the North Atlantic Treaty Organization (NATO) and
exacerbated tensions between the Western and Muslim states. Further, the
Arab-Israeli conflict plays into the hands of extremists and al-Qaeda
terrorists who exploit such tension by going after "soft" targets
worldwide.

Deflation provides another significant risk to the world economy. The
fragile global recovery is increasingly vulnerable because of the lack
of pricing power in the goods sectors. Deflationary pressures have
intensified in manufacturing and the traded goods sectors and have
increased the risk of a double-dip recession.

Falling prices or deflation has severe economic costs. First, it affects
consumption by reducing demand as buyers put off potential purchases.
Deflation also makes debt more onerous for debtors. Hence, individuals
and corporations will tend to borrow less (reduced spending and
investment) or are more likely to default. In either case, economic
growth declines.

Another recent risk to the forecast is a possible reduction in import
demand across the industrialized world. Global Insight reports that
recent data from Japan, Europe, and the United States show a slowdown in
imports.

Global Insight projects economic growth are more pessimistic that those
of the International Monetary Fund (IMF) both in total for the world and
for Mexico and Brazil. All in all, significant risks accompany the
near-term forecast.

![](media/image5.wmf)

**SUMMARY AND**

**IMPACT ON AVIATION**

The travel industry underwent considerable hardship following the events
of September 11^th^ and the 2001 recession. Expenditures on intercity
travel declined 14 percent from their peak (4^th^ quarter 2000) to its
trough (4^th^ quarter 2001). The following chart shows expenditures on
intercity travel in the U.S. from the 1^st^ quarter 1998 to the
projected 4^th^ quarter 2004. Although the industry recovered somewhat
in early in 2002 it has remained flat for most of the year. Global
Insight has forecast a full recovery of this sector with peak levels in
4^th^ quarter 2000 exceeded in 4^th^ quarter 2003.

![](media/image6.wmf){width="3.2444444444444445in"
height="2.216666666666667in"}

Although projected to expand by 2.7 percent in 2003, the U.S. economy
faces significant risks of further deterioration. Three
factors---insufficient fiscal stimulus, a reduction in consumer
expenditures, and a weakening of the housing market might produce a
second dip to this slowdown. Global Insight puts the risk of a double
dip recession at 30 percent.

The aviation industry has several risk factors beyond the possibility of
a second downturn in the economy. Another act of terrorism would upend
airlines attempt to regain profitability. The outbreak of war in Iraq or
the Middle East would significantly reduce trans‑Atlantic traffic.
Airline's inability to attract higher fares from their business
passengers will seriously limit their profitability. So far six U.S.
airlines have gone into bankruptcy in the wake of the terrorist attacks
of September 11, 2001. Further bankruptcy and restructuring may leave
the U.S. aviation industry substantially weakened.

Worldwide economic growth continued on a path of recovery in 2002 from
the slump experienced in 2000 and 2001. Global GDP is slated to grow
2.6 percent next year and to expand at an annual rate of 3.8 percent in
2004. Over the 12‑year forecast period, GDP is forecast to increase
3.3 percent annually.

Despite the rosy picture of the world economy faces several risks. The
risk of war in the Middle East threatens the worldwide recovery.
Deflationary pressures persist creating a threat to GDP growth. The
economic woes of Japan and Argentina present added risk to the world
forecast.

[^1]: Note: A fall in the index implies a depreciation of the dollar
    against other currencies; a rise in the Euro and yen also implies a
    depreciation of the dollar against these currencies.