May 10, 1978
First District respondents are fairly optimistic about the economy and believe that underlying economic conditions are stronger than most published indicators suggest. In the manufacturing sector, production has picked up although some of the increase reflects the effects of severe weather in earlier months. Retailers look to somewhat slower growth this year than last but do not see any major fall-off in sales. Commercial loan demand is improving but the New England region still seems to be lagging the rest of the Nation.
Manufacturing production is recovering from the earlier effects of severe weather. New orders are rising and there has been an increase in the number of firms reporting higher backlogs. The improvement is quite general with machine tools and electronics doing particularly well. Capacity utilization has improved and order backlogs are also good for a large manufacturer of heavy capital equipment. Manufacturing inventories have increased but, while in some cases they are now higher than desired, this is not seen to be a serious problem.
Retailers expect sales to grow more slowly this year than last but they do not foresee any major slowdown. A large department store in southern New England reports that a brand new discount store is enjoying the most successful opening within its knowledge of the industry. In northern New England spring sales have stimulated activity, but consumers are showing some resistance to higher prices.
Commercial loan demand in New England is improving. Those areas which had been doing well in the past continue to report heavy demand while other parts of the region are experiencing substantial increases. Despite this, the growth in commercial and industrial loan demand in New England seems to be significantly below that in the country as a whole. The head of one of the region's largest banks, commenting on the national banking situation, expects there to be upward pressure on interest rates throughout the year. He believes that increases in prime rates have been delayed by competition from foreign banks in the United States. This competition is felt disproportionately by the major banks in New York, so that their loan figures give a distorted picture of national loan demand. A number of large banks are reentering the real estate area. On the supply side, a large Boston bank reports that savings and NOW deposits are flat, while a representative of the region's thrift institutions observes that their deposits flows, on a seasonally adjusted basis, have been negative for several months.
Professors Houthakker, Solow, Samuelson, and Tobin were available for comment this month. They all agree that the economy has not yet attained full capacity production. Tobin and Houthakker, in particular, find no indication of imminent production bottlenecks in capacity utilization data, and the comparatively low rate of investment spending predicted for 1978 only reinforces their conviction that businessmen do not expect current and prospective levels of output to strain capital resources.
No respondent believes that labor shortages are imminent. Tobin, noting the relatively high unemployment rate of prime workers which still prevails, sees no evidence of a sustained acceleration in wage inflation. Both Tobin and Solow feel that the recent growth of Public Service Employment may be "distorting" reported unemployment rates; accordingly, the Fed may have to interpret unemployment rates cautiously. Solow is puzzled by the recent increase in employment which accompanied the first quarter's fall in real GNP. However, because employment responds mainly to confirmed trends in real growth, last quarter's slump in GNP followed by this quarter's compensating rebound may leave the unemployment rate essentially unchanged during the first half of 1978. Solow's forecast of 3 to 4 percent growth for the remainder of 1978 and the first half of 1979
Houthakker and Samuelson insist that the "natural" rate of unemployment should be defined according to objective, technical criteria, and they agree with Tobin and Solow that the natural rate is not as high as 6 percent. Houthakker claims that the natural rate of unemployment is between 4.5 and 5 percent: "The economy is not now at full employment unless it is defined in an unnatural way." He believes that the economy is still recovering and that there is danger in prematurely arresting the process before full capacity is attained. According to Samuelson, there has been no change in the technical evidence in the past year or two to warrant believing that the natural rate of unemployment has been increasing. Samuelson suggests that monetary policy can do little to reduce significantly the current rate of inflation short of causing a recession. Furthermore, he is concerned that "restrictive monetary policy encourages more aggressive fiscal policy which is a recipe for a low rate of capital formation."