April 11, 1979
Directors and other respondents in the First District report that the level of economic activity remains very high. The only sign of weakness is a slight softening in retail sales. Manufacturers continue to experience strong orders and capacity utilization is high. Delivery lead times are growing and price increases are becoming larger. In the banking sector, loan demand is strong, but regular time and savings deposits are not growing at all. This situation is causing the smaller banks considerable concern. No one reports any serious problems in the first week of the Teamsters strike; however, several respondents expect to be adversely affected around the middle of the second week.
Retail sales in the First District may be weakening slightly. The head of a department store chain in the region believes that the momentum has gone out of consumer purchases; it has become harder to sell. A director associated with a large food chain reports that, after several very dynamic months, there has been a marked softening in the past three weeks. On the other hand, directors from northern New England say that sales in their states remain strong. Automobile dealers are doing particularly well.
Manufacturers in New England enjoyed a very strong March. Orders and production were up; capacity utilization is high. The prosperity is widespread: among the areas said to be doing well are automotive products, both commercial and military aircraft engines and parts, machine tools, instruments, graphics and apparel fasteners. Housing products (windows, cabinets and various built in products) are selling very well; however the demand for small appliances is slightly off. All the manufacturers contacted felt that their inventories are at appropriate levels; they are much more concerned about continued increases in delivery lead times and higher prices. Increases in lead times have been particularly marked for electronic components and castings and forgings. Prices have risen especially sharply for brass, plastics, and repairs and services. One large manufacturer expressed the view that price increases by uncontrolled vendors will destroy the voluntary wage-price controls.
In the banking sector loan demand is stronger than expected, while regular time and savings deposits are not growing at all. In northern New England this situation is forcing banks to become restrictive in their lending. Smaller banks are worried about the possibility that the denomination of the six-months certificates will be lowered. In contrast to the country banks, a number of the money center banks are reported to be marketing loans very aggressively. This is said to be holding down interest rates; however, the quality of the loans is also somewhat lower than it would otherwise be. These banks are not concerned about the availability of funds; they are willing to buy whatever they need to make loans.
Professors Eckstein and Houthakker were available for comment this month. Eckstein believes that the level of economic activity is very near full capacity. His clients and his reading of current business conditions also suggest that production and sales are still "moving along smartly." The married male unemployment rate has struck "rock bottom," help wanted ads abound, and the DRI indices show that labor market conditions are "tight." The current low first quarter growth estimates reflect the vagaries of quarterly GNP estimates, not a sharp deceleration in business activity.
Despite high demand, the economy does not appear to be running out of cash. At present, credit needs are modest compared to the banking system's ability to supply funds. The slow growth of the standard monetary aggregates is misleading in this regard. The public is acting as though it has adequate money resources because it is accumulating liquidity in the form of "near money" assets excluded from the standard aggregates. For example, high interest rates have caused a rapid expansion of money market mutual funds. To the extent these intermediaries purchase large CDs from commercial banks, M4 would provide a better gauge of recent "money" growth than M1, M1+, or M2. Eckstein believes that it would be a mistake to reduce the Federal Funds rate at this time. In fact, the Fed should take steps to tighten policy further, raising the funds rate only as a last resort, however.
Houthakker is less optimistic than Eckstein. He believes there is a 60 percent chance of a "pause" and 40 percent chance of a recession by year end. Like Eckstein, Houthakker believes that the standard monetary aggregates are misleading. Considering the growth of money market mutual funds and other money substitutes, monetary policy has been neither too tight nor too loose. As long as the public's liquid assets continue to grow at current rates, there is no need to change the Federal Funds rate. Furthermore, the Fed should not change the Funds rate to "defend the dollar." The dollar has been doing well recently. It is more important to "defend the economy." "A prosperous economy is the best support we can give the dollar."
Houthakker is pleased with the President's energy program. In time, decontrol of energy prices should tend to reduce domestic prices as our supply of oil increases and our dependence on foreign oil is reduced. Initially, however, decontrol will increase prices. The Fed should not repeat the mistake it made in 1974 of tightening monetary policy too severely in response to these higher energy prices. Houthakker suggests a "middle course:" The Fed should not adamantly hold the line on price increases, nor should it passively permit higher energy prices to set off ensuing rounds of inflation.