May 13, 1981
The First District economy is in a holding pattern. Retail sales are flat. Loan demand is flat. Manufacturing activity is generally flat, except for exports sales which have softened. No one seems to be hiring now. While there has not been a noticeable increase in layoffs, neither are there any vacancies.
Manufacturing
Manufacturers report that overall activity remains unchanged at
levels generally described as depressed. There is, however, considerable
variation from division to division and product to product. Thus, one
large manufacturer of industrial machinery reports that backlogs for heavy
capital equipment for the process industries are at their lowest levels in
four years while special purpose machinery which increases productivity is
selling very well. Manufacturers of aircraft and parts are enjoying a
strong defense demand but are laying off in the commercial jet divisions.
One important new development is a weakening in export sales; several firms
reported that sales abroad, particularly in Europe, are now one of their
greatest sources of concern. This weakness is attributed by some to the
strong dollar and by others to the poor economic performance of the United
Kingdom and West Germany.
Inflation
Perceptions of the rate of inflation are highly varied. Some
respondents claim to see signs that inflation is abating: prices are not
actually falling but increases seem to be less frequent and/or more
moderate. Others, however, see no evidence of a change. In an April
survey of New England purchasing agents, the number of firms reporting
higher prices for materials and supplies increased from the previous month
but was below the number reporting increases a year ago. Approximately
two-thirds of those responding to the survey expect higher prices over the
next three to six months; this is the lowest proportion reporting such
expectations in more than a year of surveys.
The City of Boston faces a fiscal crisis. The problem is political rather than economic. The City has been enjoying a period of unpxecedented economic development. However, Boston is now caught between (1) the need to raise substantial additional revenues to fund schools and court-ordered property tax refunds and (2) a major reduction in its revenue raising capacity. This reduction in revenue capacity is due to a state referendum limiting property taxes to 2-1/2 percent of the full value of a municipality's property. Boston and other communities above the limit must reduce their levies 15 percent each year until the limit is reached; overrides are very difficult. Various solutions have been proposed but a consensus has proved elusive.
Professors Eckstein, Houthakker, Samuelson, and Tobin were available for comment this month. Professor Eckstein feels the Fed has no choice—it must stick with its stated policy—because the Fed has a mandate from society to meet its long-run targets. He believes this policy will defer a housing recovery until 1982 and reduce this year's real growth to just over 2 percent and next year's to under 3 percent but that it will reduce next year's inflation .2 percentage points. He urges the Fed to get on with reforms such as contemporaneous reserve accounting and improvements in the discount window. He notes that fiscal policy is likely to be more restrictive than the President's proposals because tax cuts will be scaled back.
Professor Houthakker urges the Fed to hold firm in its pursuit of lower monetary growth and not to worry about the foreign reaction or the market's "overreaction" to high interest rates. He acknowledges that interest rates will remain high for some time but sees some progress in reducing inflation and no collapse in the real economy and no extraordinary difficulties in the financial sector. He does feel that the current level of the dollar is sufficient to expect a deterioration in the trade balance after 1981.
Professor Samuelson doubts that a supply-side miracle could resolve the overly optimisitic assumption about money demand implicit in the Administration's forecast. Given the Fed's desire to continue to make progress in reducing inflation, the Fed must act on the basis of the strength in the economy rather than what a priori reasoning suggests high interest rates will do. The Fed's task is to convince the markets that its tolerance for high rates is not simply the politically opportune thing to do now but a willingness to move in the Thatcher direction. However, he cites the recent French elections as evidence of the need to consider carefully how weak the economy can be expected to be.
Professor Tobin feels the important issues are larger than the decisions at this meeting. The Federal Reserve has locked itself into a broader, inconsistent economic program. It is being "set up as the scapegoat for the evenual failure of that program." Even though the immediate situation seems to require no hard choices, the difficult decisions will arise when either strong loan demand forces interest rates to 30 percent or a "crunch" is avoided only at the cost of unemployment rising to 9 percent. Tobin believes missing the long-run money growth targets for two consecutive months is not an important issue.