July 5, 1979
Directors and businessmen in the First District report increasing signs of economic weakness; however, activity in several sectors remains vigorous. During the past two weeks there has been a significant slowing in retail sales. Retailers attribute much of this to the gasoline shortage. The trucking strike has not yet created significant disruptions but this may change in the next few days. Reports from manufacturers are mixed. Capital goods producers are doing well; however, some manufacturers of consumer durables are seeing a falloff in demand. Loan demand in the First District remains high; deposit growth is minimal.
Retail sales have fallen off significantly in the past couple of weeks. The head of a major department store chain reports that June sales are below last year's in nominal terms. Another large retailer finds that sales are just barely keeping pace with inflation. The gasoline shortage is believed to be an important source of this weakness; downtown stores are faring better than ones further from the population centers. Tourism in northern New England is also suffering from the gasoline situation. Thus far the strike by the independent truckers has not caused substantial disruptions at the retail level. Produce prices, which normally decline at this time of year, remain high; however, there have not been widespread shortages. The next week is considered critical. A large meat wholesaler has begun laying off employees because of reduced supplies.
In the manufacturing sector producers of capital goods are experiencing strong demand. One major manufacturer of nonelectrical machinery says that backlogs are well above last year in three of four areas; the greatest strength is in heavy equipment, particularly for the chemical industry. Automotive product orders, on the other hand, have fallen off. Consumer durables are faring less well; while one major producer of appliances has had sales above expectation, another reports that white goods are moving very slowly. The jewelry industry in the region is experiencing weak demand, although this may reflect style considerations rather than economic factors. One rather discouraging note in view of the current gasoline situation is that an important supplier of engineering services for the construction of refineries and power plants reports very little activity. Several firms contacted believe that their inventories are now too high. For the most part, shortages of materials are confined to specialized components with lead times for electronic components particularly long.
Loan demand in New England remains high. One large bank in southern New England reports that it reached an historic peak in mid-June. All lines are doing well, although one respondent notes that much of his commercial demand is from small-and medium-sized organizations. The one dissenting report is from a bank in northern New England, which has seen a softening in the past two weeks. The only deposit growth is in money market certificates. To supplement deposits, one small bank reports that it is actively borrowing in the secondary market, while a very large bank is bringing back funds which had been lent abroad.
Professors Eckstein, Samuelson, Solow, and Tobin were available for comment this month. All agreed that the economy has probably entered a recession, so that an easier monetary policy is appropriate at the present time. Since they also agreed that the current inflation is primarily the result of supply shocks, all believe that at least partial monetary policy accommodation is warranted despite the high probability that rapid price increases will continue for a few more months.
Professor Eckstein describes the downturn as a "supply recession" attributable to oil price increases, gas rationing, and such attendant supply-side phenomena as the truckers' strike. In his view the demand element is slight—mainly the depressing effect of high consumer debt loads—so that it would be an error to act as if the economy is experiencing a demand recession. Eckstein believes that the Fed would be wise to let the funds rate drift down, but not according to the historical pattern. In particular, he thinks a rate no lower than 8.5 percent is appropriate if a damaging reflation is to be avoided. He warns that should rates move sharply lower, forcing the system back up against the supply ceiling from which it has recently fallen, the next business cycle will be accompanied by much worse price behavior than was experienced in the current one.
Professor Samuelson believes that it is time to let the market know that interest rates have peaked. Some easing in interest rates is necessary in order to prevent a "hard landing," an outcome he sees as excessively costly given the modest inflation gains that would likely result. Since the current inflation is not the kind that can be easily reversed by Fed policy, Samuelson warns that we must be prepared to accept slow economic growth for an extended period of time if a more acceptable inflation rate is to be achieved.
Professor Solow notes that the arrival of the recession somewhat earlier than many forecasters had previously expected can in a certain sense be regarded as fortunate, since it provides less opportunity for unwanted inventories to accumulate. Without an inventory overhang, he expects the downturn to be relatively mild and short-lived, the recovery well underway by early 1980. Solow believes that the challenge for monetary policy is to avoid a repetition of the 1974 experience, which in his view would do little to moderate the supply-induced inflation. Arguing that easier monetary and tighter fiscal policy would be preferable to the current policy mix, Solow advises the Fed to ease now in order to head off a possible tax cut.
Professor Tobin observes that the recession is "just what the doctor ordered" last November. Unless a severe downturn is deemed politically desirable, he thinks that the Fed should now begin to ease its policy stance. Although Tobin is concerned that recent price increases may be built into future wage demands, he sees no evidence that this is occurring yet nor does he think that a gradual decline in short-term interest rates is likely to alter labor's behavior.