October 21, 1975
The directors of the First District are more unsettled this month. They are aware that the economy may not trace out a classic recovery; ''to look around and see the wreckage, it is hard to feel cheerful." Many more problems, many more hazards seem to be plaguing business. There are suspicions that "our system doesn't work right." New England unemployment in August increased to 12 percent from 11.1 percent for July. Rhode Island's figure improved substantially, dropping to 13 percent, but significant deterioration in Massachusetts (13 percent) and Connecticut (11.4 percent) more than compensated.
Banking directors report sluggish or declining asset portfolios. All components of loan demand continue weak, and consumer credit has shown only feeble activity. Inventory liquidation seems to be reaching a nadir, but firms which are in positions to restock are proceeding extremely cautiously. Consequently, banks are improving their money market positions, unwinding liabilities and buying Treasuries. The lack of profits continues to restrict municipals investments to local issues, at best. New York City evokes divided attitudes, but none of the directors is intimately involved.
The banking directors expect short-term interest rates to remain flat for a few months. There is hope that recent money stock data may occasion a fall in the federal funds rate. "It would be regrettable if short-term rates rose."
Retail sales in the district have yet to recover convincingly. Most markets have seen only feeble increases in volume since April. One more successful retailing director reports a softening in activity for the last three weeks. He is stocking cautiously for Christmas, and business uncertainties are moderating his optimism for spring. In general, retail outlets have not begun restocking inventories. There seem to be few reported ripples from Grant. Although suppliers may have been caught, it was no surprise to our retail director. The firm had lost identity in a highly competitive market.
A director from Connecticut has become more optimistic about his state's prospects for 1977-78. Foreign companies anxious to locate in the U.S. have been impressed with Connecticut. Also, corporate headquarters of U.S. firms have been moving to the state. Defense contracting is continuing strong as well. Other New England states cannot look forward to these sources of growth at this time, and concern about long-term development is becoming substantial.
Capital goods producers and manufacturers of intermediate goods are still working off backlogs. So far there has been little stimulus for the First District in these industries. One director has identified a "key factor syndrome." Business is paying close attention to interest rates: rising rates are depressing, a fall is encouraging. There are reports that the war against inflation is misplaced if it requires high interest rates. With sluggish business and sales uncertainty, current rates are very high in both nominal and real terms. Lower rates would be necessary to bring out investment, expand capacity, and nourish the recovery, according to this view. Financial markets are much more than a veil over the real economy, and business is not poised to spring or encouraged to do so by high interest rates, a director reports.
Professors Houthakker, Solow, and Tobin were available for comment this month. Houthakker is still comfortable with general developments, while Solow and Tobin are very concerned about the propriety of policy.
Houthakker feels that the economy and policy are on the right track. He feels that a very vigorous rate of growth will prevail for a few months driven by exports, consumers, and an end to inventory liquidation; he then looks forward to growth of about 7 percent by the end of 1976 as business investment assumes a positive role. Inflation will slow to 4 percent at that time. He cautions against rapid money growth, and hopes that policy will favor the low end of the 5 to 7-1/2 percent range. He fears that the considerable money expansion in Europe should be discouraged, perhaps through official discussions: such European policy will present some danger that the dollar will become unduly strong, or that domestic monetary policy may be unfavorably undermined.
Solow is not impressed with Ford's proposed fiscal program, but he also believes the Fed need not be too concerned since there is little chance of enactment. He expects rates of growth of 8 to 10 percent for the near future which is not out of line with a natural rebound—especially given the foregoing collapse. Such rates of growth need not imply that a sustaining drive for recovery has surfaced, so he remarks that the Fed need not feel tempted to lean against the wind. He notes that most optimistic forecasters have assumed money growth in excess of 7-1/2 percent. Policy is not doing its part: "I have seen no calculation of cyclical increases in velocity that would make 7 to 7-1/2 percent money growth appropriate in this economic situation. It is an empty belief that this time will be different."
Tobin emphasizes that velocity increase is related to money growth. Low money growth and high interest rates tend to cause a more sluggish expansion of GNP (or even a stalling of growth) which yields slow velocity expansion, at best. Tobin also stresses that high long-term interest rates reflect market expectations of rising future rates of interest, coupled with risk. There is a positive relationship between inflation and interest rates because the market has learned that price increases entail tight policy. The Fed should permit money growth to exceed 8-1/2 percent and explain that such a policy does not include a compensating stringency in the future. A temporary increase in money growth is appropriate for recovery; in fact, a recovery without big U.S. budget deficits requires this policy.