ECON 5003 Module 4 Macroeconomic Impact Analysis Example

When Mortgage Rates Reach Seven Percent: Tracing Interest Rates and Inflation Through to a Concrete Producer's Volume, Costs and Plans

Student Name

American College of Education

ECON5003: Economics Analysis

Module 4 Assignment

Instructor Name

July 24, 2028

The Macro Setting in This Case

In the setting of this case, the central bank has raised its policy rate over eighteen months to bring down inflation that had reached about 6 percent, and 30-year mortgage rates have risen from about 4 percent to about 7 percent. General inflation has slowed to about 4 percent but remains above target. Bellwether Ready-Mix, the composite producer followed through this course, must decide within weeks whether to buy six new mixer trucks, how to price for the coming season and how much to borrow on its floating-rate credit line. Each decision depends on what the macro environment will do to demand for concrete. A concrete producer does not sell to the economy; it sells to builders, and interest rates reach builders at different speeds.

How Rates Reach Construction

Construction is among the parts of the economy most sensitive to interest rates. Bernanke and Gertler (1995), examining how monetary policy affects the economy, found that residential investment responds strongly and quickly to tighter policy, and they argued that the effect works partly through a credit channel, as higher rates weaken borrowers' balance sheets and reduce the availability of credit, beyond the direct increase in the cost of borrowing. Leamer (2015) went further, arguing that housing is central to the business cycle in the United States, with residential investment typically weakening well before recessions and serving as an early signal of them.

For Bellwether, the mechanism has three paths. Higher mortgage rates reduce what buyers can afford, lowering demand for new homes and, with a short lag, housing starts and foundation pours. Higher construction loan rates squeeze builders' margins and slow speculative building. Commercial projects respond more slowly, because they are planned and financed further in advance, so rate increases show up in commercial concrete demand a year or more later. Public works respond least, since they depend on government budgets rather than borrowing costs.

A Segment-by-Segment Forecast

Bellwether's volume is about 45 percent residential, 35 percent commercial and industrial and 20 percent public works. The forecast for next year applies a separate assumption to each. Residential: metropolitan housing permits are already down about 18 percent from a year ago, and because foundation pours follow permits within a few months, residential concrete volume is forecast to fall by about 18 percent. Commercial: the pipeline of projects financed before rates rose will keep pours going for much of the year, but new starts have slowed, so commercial volume is forecast to fall about 8 percent. Public works: federal and state infrastructure funds are supporting road and bridge projects, and public volume is forecast to rise about 5 percent.

Weighted by each segment's share, total volume is forecast to fall by about 9.9 percent. The forecast carries real uncertainty, especially in commercial construction, where a sharp fall in office and retail building could deepen the decline. A pessimistic case, with commercial down 15 percent and residential down 22 percent, would reduce total volume by about 14.2 percent. In either case, the mix shifts toward public works, where Bellwether competes on large bids at thinner margins.

Inflation on the Cost Side

Inflation affects Bellwether's costs unevenly. Driver and plant wages are rising about 5 percent, faster than general inflation, because the market for commercial drivers is tight. Diesel prices have fallen from their peak but remain volatile. Cement, which the integrated rival supplies, is scheduled to rise about $10 a ton, roughly 6 percent. Aggregates are rising with general inflation. Taken together, variable cost per yard is expected to rise about 4.5 percent. If Bellwether's prices rise only with the leader's, which Module 3 suggests is its best strategy, and the leader raises by about 3 percent in a weakening market, Bellwether's real contribution per yard will shrink.

Falling volume and a squeezed margin together make next year materially harder than this one. The company's own experience of the last housing downturn, when volume fell 22 percent and took four years to recover, is a reminder that demand in this industry can fall further and recover more slowly than a one-year forecast suggests. Collard-Wexler (2013) found that demand fluctuations in ready-mix markets lead producers to exit during downturns, which means the market may emerge with fewer competitors, and a well-capitalized survivor may gain share.

Signals to Watch

A forecast made now will be wrong in some direction, so the company needs signals that tell it which way, early enough to act. Four indicators, each available monthly, will be reviewed by the owners and the sales director. Metropolitan housing permits lead residential pours by two to four months; a further 10 percent fall would move the company toward the pessimistic case, while stabilization would suggest the residential decline is ending. Commercial construction contract awards, reported by a regional data service, lead commercial pours by about a year, and they are the best early warning of whether the commercial decline will deepen. Mortgage rates and the central bank's statements indicate whether rate pressure is still building or beginning to ease. And Bellwether's own backlog of scheduled pours, measured in yards booked for the next sixty days, is the most direct signal of all.

Each indicator has a trigger. If permits fall another 10 percent or the backlog drops below 30 days of normal volume, the company will move to its pessimistic plan: idling one plant on Saturdays, freezing hiring and delaying refurbishment of the fourth truck. If mortgage rates fall by a percentage point and permits turn upward for two consecutive months, the company will revisit the deferred truck purchase, since a recovery can outrun a fleet that has been allowed to shrink. Setting triggers in advance keeps the owners from reacting to each month's headlines while ensuring they react to the ones that matter.

Four Decisions

The analysis points to four decisions. First, defer the purchase of six new mixer trucks, about $1.2 million, and instead refurbish four older trucks at about a quarter of the cost; with volume falling about 10 percent, the current fleet has enough capacity. Second, follow the leader's price increases but do not lead, and raise prices on residential delivery windows and small loads, where customers value service more than price. Third, tighten credit on contractors, because higher rates strain builders' cash flow and slow their payments; Bellwether's days sales outstanding should be reviewed monthly, and new accounts should require personal guarantees. Fourth, reduce the balance on the floating-rate credit line, since each percentage point of rate increase on the current $3 million balance costs about $30,000 a year, and consider fixing part of the rate if the lender offers a reasonable swap.

None of these decisions is a prediction that a recession will occur. Each is a way of making the company resilient to the most likely forecast while keeping its options open if the downturn is milder, which is the most a macroeconomic analysis can do for a firm of Bellwether's size.

References

Bernanke, B. S., & Gertler, M. (1995). Inside the black box: The credit channel of monetary policy transmission. Journal of Economic Perspectives, 9(4), 27-48. https://doi.org/10.1257/jep.9.4.27

Collard-Wexler, A. (2013). Demand fluctuations in the ready-mix concrete industry. Econometrica, 81(3), 1003-1037. https://doi.org/10.3982/ECTA6877

Leamer, E. E. (2015). Housing really is the business cycle: What survives the lessons of 2008-09? Journal of Money, Credit and Banking, 47(S1), 43-50. https://doi.org/10.1111/jmcb.12189