March 15, 1978
First District respondents remain encouraged about the performance of the New England economy. There is, however, significant concern about the national situation. Retail sales have weakened, but this is attributed to poor weather. Inventories are well under control. Manufacturers appear to be doing well. Loan demand is moderately good and expected to improve.
Retail sales in New England have weakened but bad weather was undoubtedly a contributing factor; so it is difficult to determine the underlying trend in consumer spending. A representative of a large department store chain believes he sees the beginning of more long lived slowing in retail sales. However, in northern New England the tourist industry and all the retail outlets associated with it are faring very well. Also, New England telephone companies report a very active installation business, a phenomenon which they feel is indicative of general economic health. Retail inventories are low and no problems are expected in this area.
In the manufacturing sector, most reports are favorable. In northern New England the electronics and plastics industries are enjoying healthy demand; backlogs for machine tools continue to grow. Large employers in the high technology fields in Massachusetts are also reported to be doing well. One large producer of instruments has a nine month order backlog. Another reports that they are still below capacity but that order backlogs are significantly above this time a year ago. The region continues to benefit from large defense purchases. The one negative note, a mild one, came from a supplier to the tire industry; sales of a key ingredient in tires are down 10 percent from a year ago. Other chemicals made by the same company are also off slightly. As yet, New England has not seen any effects of the coal strike, although there is some concern about what will happen next month.
Loan demand at commercial banks is fairly good and is expected to get better. According to one of the region's largest banks, domestic loan demand is not as strong as desired, but there is substantial optimism about 1978. A medium-size bank in northern New England reports that commercial loan demand is very strong, although there has been some seasonal weakening in construction loans. Installment loan business after a brief slump has picked up.
Conversations with consultants following national industries indicate that, aside from the coal strike, shortages are not going to be an issue in 1978. There are some shortages of fine coated papers but these can easily be dealt with by turning to imports or heavier grades. One manufacturer reports difficulties getting electronics components, particularly those from California. In the steel industry, cutbacks in capacity combined with continued recovery could produce shortages of certain products after 1980; however, at present only oil and gas drilling equipment is in short supply. In addition, despite its dependence on coal, the steel industry is not any more likely to be affected by the coal strike than are other industries in the mid-west. Coke stockpiles are substantial and electric power cutbacks will limit production before coke availability becomes a constraint. In petrochemicals and most of the paper industry the problem is overcapacity. Among these consultants there is considerable concern about the impact of higher interest rates on the housing industry. One lumber specialist claims that when rates on Treasury bills reach 6 percent, there is a marked effect on housing and consequently on the lumber industry. In the energy sector, the natural gas situation has improved. Production last year was better than expected and this experience combined with price increases has led at least one energy expert to increase his production forecasts for 1978.
Professors Houthakker, Eckstein and Solow were available for comment this month. All respondents agree that the dollar cannot be successfully "defended" on foreign exchange markets unless the imbalance in our trade and capital accounts is corrected. Moreover, the recent decline in the dollar's exchange rate represent a normal market response to our foreign deficit. In time, the declining dollar will encourage foreign demand for our exports and discourage our demand for imported goods; in this manner the recent depreciation of the dollar will bring our accounts back into balance. According to Eckstein, many businessmen fear that the defense of unrealistic dollar exchange rates will ultimately lead to exchange controls and further import restrictions. Although Houthakker recognizes the need to temporarily settle disorderly conditions which may arise occasionally on exchange markets, he recommends selling gold rather than accumulating large debts in foreign currencies.
Due to the coal strike and the winter weather, Eckstein expects 2.4 percent real growth during the first quarter of this year. Much of the lost activity will then be regained in the second quarter when growth will exceed 6 percent. Despite this acceleration, Eckstein expects that real GNP will average only 4 percent growth during 1978, and there is a 45 percent chance that weak demands or a credit crunch in the second half of the year could push the year's expansion close to 3.5 percent. He believes it is important for the Fed not to be misled by the "snap-back" in activity during the coming months, the problem for 1978 is to avoid losing too much momentum.
Solow is surprised by the sharp decline in the reported unemployment rate since the end of 1977. The slow economic growth suggests that policy should not become tighter; with low rates of capacity utilization and the modest growth forecasts for 1978, the Fed should still be concerned about maintaining the recovery and regaining full production.
Neither Houthakker or Solow believe that the recent behavior of the wholesale price index and the consumer price index warrant reaction from the Fed. It is inappropriate to address problems of food shortages with aggregate monetary policy. Recognizing that food prices are highly volatile, especially during periods of adverse weather, Houthakker has not changed his forecast of inflation, 6 to 7 percent for 1978.