February 11, 1976
The directors of the First District report a continuation of recent favorable economic trends. Retailing has retained the momentum of the Christmas period, and vacation areas are recording one of the best seasons ever. However, business loan demand, capital goods orders, and manufacturing employment have yet to improve. In general, the directors are convinced that the recovery has really commenced in New England, but it is neither widespread nor very vigorous.
The real estate and residential housing markets remain depressed. One director reported that virtually all residential development in the Boston area had depended to some degree on Massachusetts Finance Agency funds. The distressed condition of the municipal bond market, especially for this state's securities, has brought a halt to development activity.
Directors also report evidence that various thrift institutions in the region have begun to sharply reduce mortgage interest rates. In the month of January, some mutual savings banks lowered quoted mortgage rates by 25 basis points; for a 30 percent down payment, the interest rate has been cited as low as 8.5 percent at banks which had offered 9.5 or 9.25 percent loans to identical customers four months earlier. One banking director expresses concern that mortgage interest rates cannot decline much further. He feels Regulation Q establishes a "base point price" for bank certificate rates which, in turn, props the mortgage rate. Only illegal collusion could initiate and maintain a general reduction of interest rates on these instruments.
Banking directors report continued weakness in loan demand. However, they continue "enforcing the standards we always thought we were." Some competition for loan customers by New York City banks is noted, but there is no aggressive seeking of borrowers as yet. Bankers are considering service charges on checking accounts, especially those that bear interest, and they are content to let certificates of deposit run off.
Capital goods orders are feeble and directors expect them to remain so in 1976. Although a recovery in orders of smaller machine tools is expected this year, there is no evidence of it as yet.
Retailing has shown no pause from the vigorous pace of the Christmas season. January was well above plan for stores throughout the District, and sales show every evidence of continued strength. People are beginning to purchase hard goods in quantity. Directors definitely hesitate to label this experience as a boom, and they stress that retailers remain conservative about stocking inventory; buyers are maintaining flexibility on a weekly basis.
Professors Houthakker, Tobin, Eckstein, and Samuelson were available for comment this month. All are concerned about the weaknesses in current economic data as well as the sluggish outlook.
Houthakker is not convinced that a 1976 forecast of 6 percent real growth and 6 percent inflation is possible in view of recent money expansion. Previously, he forecasted the inflation rate to be substantially below 6 percent, but noting recent spot price behavior and productivity reports, he has altered his personal inflation forecast to 5 percent. Even so, 6 percent real growth seems unattainable, since he suspects that recent velocity increases are not sustainable. He counsels a cut in the Federal funds rate to 4 percent to stimulate money growth and investment by reducing market interest rates.
Tobin shares Houthakker's view that the funds rate should be reduced to 4 percent. He is most interested in improving securities prices to hasten the investment revival. Although the recent rally has been encouraging, it has fallen short of the mark: stock prices would have to increase 10 percent faster than capital goods prices just to raise real business fixed investment by 7 percent in two years' time. The lower funds rate is necessary to bring pressure on interest rates which influence borrowing and spending decisions. The current setting of 4.75 percent can only be judged high or low by considering the attendant path of recovery. Tobin's view is that the weakness of commercial and industrial loan volume is at once responsible for the large velocity increases and an omen of sluggish investment as other sources of funding carry relatively more of the burden. The spread between long and short interest rates is a symptom of the economy's portfolio strains. He noted that market rates firmed with the announcement of the new targets; interest rates are responsive to Fed policy and a positive signal is required.
Eckstein believes there has been a structural shift in money demand. So he advises that there be no change in the Federal funds rate at this time. However, due to the "obvious and demonstrated weakness in business investment demands," he has lowered his forecast of 1976 real growth to less than 6 percent. Believing that both interest rates and money growth should be consulted in framing policy, Eckstein feels that a reduction of the funds rate is not in order yet. In spite of modest money growth, the economy has begun a convincing recovery; should the recovery begin to falter, then the funds rate must be reduced. In any case, the rate of money expansion should not be erratic.
Samuelson feels that the goal of policy should be to secure 7 percent real growth from 1975:IV, once all risks are taken into account. He believes the Federal Reserve and the Administration should actively pursue this target and attempt to achieve it. Noting that lower interest rates could assist plant and equipment spending, which is now "a gleam in the eye," he feels there is no initiative to raise interest rates. If faster money growth is necessary in coming quarters to attain policy goals, then there should be no hesitation to stimulate M1.