May 16, 1979
Business activity in the First District continues to be very strong although there are scattered signs of the beginning of a slowdown. Many manufacturers report that they are operating at close to capacity; loan demand is very high across the district with some northern New England banks rationing credit. Although some retailers report a softening, sales continue to be healthy overall. In general, there is no problem with shortages although lead times for electronic components continue to stretch out.
A Vermont director reports that the machine tool industry in that state has the highest backlogs ever. The chairman of the board of an optical goods manufacturer indicates that sales of safety eyeglasses, which he considers a leading indicator, are very strong. The region's electronics and mini-computer industries are operating at high levels of capacity and many have substantial backlogs. A large tire manufacturer indicates that sales have snapped back sharply in May after a very slow April. Production at this company is at very high levels in order to produce inventory in anticipation of the rubber workers strike.
The chairman of a large commercial bank reports that commercial loan demand is exceptionally strong across all segments of the economy; deposit inflows are only moderate with little growth in time and savings deposits. While large banks seem to have no liquidity problems, smaller northern New England banks indicate shortages of funds and the necessity to ration credit. The chief executive officer of a large Connecticut insurance company expects poorer cash flow in the property and casualty insurance industry later this year, associated with a deteriorating underwriting experience, this will result in diminished availability of funds for lending.
The Boston outlet of a large national department store chain reports that, although sales are still relatively healthy, they have not increased as much as expected thus far this year. However, soft goods sales have been very strong in the last few weeks, with the slowdown occurring in durables. A New England chain of discount stores reports some softness across all lines; similarly, food store sales have been somewhat less than expected. In general inventories are not considered a problem.
While there is no general problem with the availability of materials or labor there are some spot shortages. A survey of New England purchasing managers indicates that lead times on electronic components in particular continue to stretch out. In order to protect themselves from unintended inventory buildups, some purchasing agents are negotiating more long-term contracts with provisions for rescheduling deliveries in case of a recession. In general, materials prices are increasing at a 10 to 11 percent rate.
Professors Houthakker, Eckstein, Solow, and Tobin were available for comment this month. Houthakker believes that real growth will decline by summer and that there is a 40 or 50 percent chance of a recession this year. He also believes that the inflation rate will decline modestly during the remainder of 1979. A recession would do little to depress the inflation rate more rapidly, because more investment and a more rapid growth of potential output is needed. Recessions alone are not "cost effective." The Fed should "aim for a modest, positive growth rate of Ml at this time," and the funds rate should move freely to attain this goal.
Even though Eckstein expects a "slow-down/recession" to commence in the second half of 1979, he welcomes the recent increase in the Federal Funds rate. Unless "continuing and convincing signs of a slow-down emerge," the funds rate may have to rise still higher. Because Eckstein expects only a mild "slow-down/recession" the Fed should "avoid following the historical pattern of dramatically increasing or reducing interest rates" in the coming year, however.
Solow believes that the odds still favor a slow-down or mild recession commencing this year. He would be surprised if real GNP increased more than 1 or 2 percent from 1978:IV to 1979:IV. Because interpretations of recent money growth rates are speculative at best, monetary policy must rely on the funds rate for the time being. Solow is content with a Federal Funds rate near 10 percent, but he believes the Fed has prudently exercised its independent judgment in resisting apparent pressures to raise the rate much faster or much higher.
Tobin also thinks it was a good idea to increase the funds rate. He believes the economy is stronger than most forecasts suggest. The high unemployment rate is a cause for concern, but the Fed has done a commendable job, not attempting to attain unrealistically low unemployment or inflation rates. While future increases in the funds may be required, Tobin feels the Fed has done well to avoid overreacting as it did in the summer of 1974.