November 10, 1981
The First District economy appears to have softened in the last month. The downturn is most pronounced in the retail sector with sales falling sharply from the relatively healthy volumes of September. There has not been a comparable deterioration in manufacturing; rather the weakness that has characterized this sector since the summer has continued and become more pervasive. In banking, smaller banks serving smaller businesses are encountering increasing numbers of problem loans. The all-savers certificates have been somewhat less popular than most respondents expected; several banks have estimated that between two-thirds and three- quarters of their all-savers funds are transfers from accounts in the same banks.
The retail sector has weakened. Several "soft goods" retailers reported October sales well below the reasonably strong September, and only slightly ahead of last year in nominal terms, thus not matching inflation. The weak sales and resulting rise in inventories are visible across the board, but two department store representatives mentioned that the downturn is particularly noticeable in women's, misses, and junior sportswear. Because these lines usually contribute more than proportionally to gross margin, slack here has a greater impact on profits.
Merchants are "wary" about the next six months. They intend to control inventory investment carefully, stimulate sales with discounts and other promotional activities, and watch expenses. Because some stores began placing orders for next spring's products in August, inventory adjustments can be made only with a substantial lag and have consequences for later next year. One retailer said little change in employment is planned because the workforce is as "lean" as is consistent with customer service and store security.
In manufacturing, signs of weakness are less pronounced than in the retail sector but longer term and more pervasive. After a vigorous recovery in the early part of the year, manufacturing activity leveled off early in the summer and has remained fairly constant— well below capacity. For many products this continues to be the situation; a local survey of purchasing managers has shown little change in the past several months. However, signs of further weakness are beginning to appear. The most dramatic deterioration has been in the already weak home furnishings business. A representative of this industry reports that at a recent home furnishings show, attendance was down 50 percent from attendance in 1980 which was down, in turn, 30 percent from attendance in 1979. He characterized this industry as a "disaster area" and predicted numerous bankruptcies in the carpet, yarn, and furniture industries. The wire and cable industry, which like home furnishings, is affected by the level of new housing construction has also begun to experience difficulties. Other products which were identified as problem areas included original equipment tires, jewelry, lumber, and belting for farm machinery. New orders for packaging have also begun to fall, indicating a more general slowdown. A manufacturer of packaging for products ranging from cookies to chemicals to medical supplies reports that sales were good through September and October, but in the last couple of weeks there has been a slowing in orders for packaging for consumer products and a marked downturn in the demand for industrial packaging.
Despite the weakness in manufacturing, all respondents reported success in keeping inventories down. Several firms have seen an increase in accounts receivable, but most respondents have been watching receivables closely and have been able to prevent increases.
Financial respondents report large inflows to the "all-savers certificates" in the first ten days of October. Interest has tapered off since then although there was some pickup in early November. Overall, the response to the all-savers has been somewhat less than expected. Most of the funds for the all-savers are transfers from other deposits within the same institution. According to three bank spokesmen, only a quarter to one-third of the all-savers at their institutions represent new money. Loan difficulties appear to be more pronounced among smaller banks serving smaller businesses. Two small-to-medium-sized banks in northern New England report that bad loans are appearing with increasing frequency. On the other hand, representatives of two of the region's larger institutions claim that, despite some problems, loan losses compare relatively favorably with last year.
Professors Eckstein, Houthakker, Samuelson and Solow were available for comment this month. Eckstein summarized his remarks at the academic consultants' meeting as follows: (1) the Fed should allow interest rates to fall with the recession but maintain a positive real rate of interest (2) the FOMC should make sure to hit at least the mid-point of the 1982 growth targets for the monetary aggregates (3) the Fed should plan seriously for use of its lender of last resort function.
Although Houthakker remains an "unreconstructed hard money man," he anticipates a considerable downturn in the economy, with the unemployment rate rising to 10 percent. In contrast to most previous recessions, the foreign sector will hinder rather than help real growth this time. He believes this will help reduce wage inflation and he expects a 5 to 8 percent increase in the CPI next year. He does not favor a formal incomes policy but recommends establishing a dialogue with labor unions to stress the implications of inflation when monetary policy limits the increase of nominal GNP.
Samuelson noted that the signs of a recession are fairly clear. The Federal Reserve has no mandate from the Congress, the Administration, or the American public to initiate or countenance another recession in the name of fighting inflation. In the interest of preserving long-run credibility—and bound by a previous commitment, however misguided—the Fed should encourage lower interest rates and allow M1B to return to within its target range. M2 growth should not deter these efforts. Notwithstanding the historical association between "old" M2 and GNP, there is no reason to expect the velocity of the part of M2 that provides market yields would be the same as its low-yield components.
Solow felt there is a good chance of five consecutive quarterly declines in real GNP. His major concern is that the Fed has been so sensitized by attacks by Secretary Regan and so intent on avoiding being perceived as "caving in" that it will be too rigid to allow the short-term easing that it normally would have done. An objective of achieving a prolonged period of minor slack in the economy does not preclude short-term variations to lean against the cyclical winds. Solow urged the Fed to use the opportunity of "the stupid M1B being below the stupid target" to support the economy. The time has come for the Fed to abandon monetarism on the grounds that in the modern financial world "as soon as you impose a rigid target on any particular aggregate, the financial system will find its way around that aggregate." The Fed's goal should be to try to influence the economy not any particular monetary aggregate.