January 31, 1979
Business conditions in New England remain at a high level. Most directors and businessmen see no signs of a slowdown. Manufacturers continue to have large backlogs. Retail sales are fairly strong—autos are doing particularly well. Loan demand is generally vigorous for this time of year. Lead times for some materials and components are lengthening and skilled and semi-skilled labor is in increasingly short supply.
New England's manufacturing sector has just completed a very successful year and most respondents see no signs of a slowdown. Defense has been an important factor; one large defense contractor and the government division of another large, high technology company report that 1978 was their best year ever. Order backlogs for these companies are very high. Machine tool companies also continue to have large backlogs. Several firms in the instruments category are planning major capital expansion programs. New capacity is needed because of the high level of demand and because investment projects were postponed in the past. Directors believe this is a fairly common situation. On the negative side one large machinery company reports that consumer appliances have been moving slowly. Lead times for materials and components are lengthening. Electronic components, sheet metal, and machine parts are the greatest source of concern. Skilled and semi-skilled labor continues to be in short supply. Electronics engineers, computer personnel, and machinists seem to be in particular demand.
Reports from the retail sector throughout the region are favorable. Auto dealers in particular, are doing well and in parts of the region are selling cars faster than they can be delivered. Sporting goods stores are also experiencing very brisk sales although this is partly a seasonal phenomenon. The head of a large department store chain in southern New England thought that Christmas sales were a little less than some had expected, but they still compare well with a very strong 1977 Christmas season. It is somewhat difficult to assess the retail sector's performance in January as the weather has been much better this year than last; however, most retailers are pleased with sales thus far. There is some concern about the effects of high interest rates and the increase in the minimum wage.
Banking directors report that loan demand is good. There is usually some falling off in demand at this time of year; however, the head of one large southern New England bank reports that this seasonal decline did not occur at his institution. All categories of loan demand held up well. The director thought that other banks in his area were having similar experiences. Two northern New England bankers report that they have had a seasonal decline, particularly for mortgages, but one of the two thinks that the fall-off in the areas other than mortgages has been less than normal. Commercial demand has been strong.
Professors Houthakker, Samuelson, Solow, and Tobin were available for comment this month. All agreed that the economy showed surprising strength in last year's fourth quarter, especially in view of the relatively low rate of money growth that has occurred in the past few months. On the other hand, no clear consensus emerged on the implications of these facts for the near-term course of monetary policy, nor were the respondents unanimous in their view of the outlook for the real economy in 1979.
Professor Houthakker feels that the Fed may be "overdoing" its tight money policy and is concerned about the consequences for the real economy of two or three more months with low rates of money growth. He believes that growth within the target ranges is compatible with further increases in real GNP, albeit at a slower rate than currently, but that the present restrictive policy probably makes a recession inevitable. More optimistically, Houthakker expects the current account to show a surplus by the end of the year whether or not there is a recession; thus, he believes that tight monetary policy can no longer be justified on balance of payments grounds.
According to Professor Samuelson, the combination of strong real growth with weak money growth merely reflects the effect of high interest rates on velocity. For this reason, he sees no cause to worry if the aggregates remain below their target growth ranges for a prolonged period. Although he is not happy to make the recommendation, Samuelson argues that since the real economy is stronger than expected, another round of credit tightening is probably necessary to fulfill the promise of a policy-induced recession made implicitly last November 1.
In the opinion of Professor Solow, the recent data provide no reason to change one's "expected value" for the size, length, and timing of the 1979 recession. He thinks that the outlook for the year depends crucially on the economy s performance in the first quarter: if it's too strong, then the ensuing downturn will be sharp; if the fourth quarter represented only a "last gasp," then a mild "consensus-shaped" slowdown will occur, probably beginning late in the third quarter. Solow cautions, however, that the economy cannot be fine-tuned—that there is always a non-negligible probability that a mild downturn will cumulate into a severe one—so he advises the Fed to follow Brainard's dictum: "If you don't know what you are doing, then do it gently."
Professor Tobin reluctantly agrees with Samuelson that if the actions of November 1 are to retain credibility, that is, if the "irrevocably decided" policy is to produce a recession, then further credit restraint would be called for. Tobin is not particularly pleased with this policy, though, because he would expect inflation to decelerate this year as long as real growth is below the pace in 1978. Noting that what used to be considered a normal cyclical increase in the price level is now being interpreted as a permanent increase in the inflation rate, Tobin argues that 3 percent real growth would probably produce about the same inflation outcome in 1979 as a full fledged recession.