Boston: December 1973

Our directors fear that in the near term the energy crisis will push the economy into a recession, but they also see the energy situation as stimulating large capital outlays. They feel that both fiscal and monetary policies must be geared to encouraging investment in energy-related areas. For New England as a whole, and Massachusetts in particular, shortages of residual oil (needed to run utilities) and home heating oil will be critical, carrying real threats of rolling blackouts by the electric utilities this winter.

Looking at the supply of oil at the national level, one of our directors, who is an independent oil and gas driller in Louisiana and Texas, states that increasing prices at the wellhead will not substantially increase oil and natural gas production. It is much more important, he said, to increase acreage released by the Federal government for offshore drilling. Other productive measures, according to the director, are
stepped-up licensing of nuclear plants and building six oil refineries yearly in the U.S. Our directors pointed out that the proportion of investment in energy-related areas must be raised from the 20 percent of total business investment spending of the last decade to 30-40 percent of total capital outlays. They believe that higher energy prices have rendered obsolete much of the current capital stock, which was based on low energy costs, and that appropriate fiscal and monetary policies are needed to help finance the tremendous new investment needs.

On the demand side, one director noted that an internal company study showed it would not be difficult to cut energy use by 20 percent by simply taking energy-saving steps which they should have used all along. Another director from a large conglomerate which manufactures general aviation planes and boats said that material shortages of aluminum and fiberglass would cut his output more than the expected drop in demand. He reported that these companies are "scared to death" over the outlook.

While most New England industries are not energy-intensive, the total dependence of our electric utilities on imported residual oil makes the oil shortage very critical for the economy here. Electric power production is a necessary, if not sufficient, condition for all production. Our utilities are forecasting a 25-40 percent shortfall in needed residual oil for 1974.1. There is currently no operating allocation program at the Federal level for residual oil, and, even if there were, there are great doubts that logistically the supplies could be brought to New England. Under these conditions, the Governor of Massachusetts has asked for emergency powers to close schools, put state employees on a four-day workweek, limit retail establishment hours, etc., in order to decrease demands on the electric utilities. The electric utilities in Massachusetts have announced that without these measures, they will have to have rolling blackouts which will cut different users off about 20 percent of the time.

Professors Samuelson, Shapiro, and Wallich were contacted this month. Dr. Shapiro now sees 1974 as a year of no output growth, with the unemployment rate above 6 percent by year-end. Due to lower incomes, the budget may not show the surplus which had been hoped for. Shapiro's main concern is that the Fed doesn't loosen too much, and feels this is an opportunity to try to wipe out excessive demands and price expectations. He proposes an even keel policy for the aggregates—4 to 5 percent growth in money, 7 percent in the monetary base—even if short-term interest rates were to rise.

Noting the rise in new orders for durables, Wallich believes there is no evidence of a serious downturn. He stated that supply difficulties always lead to expansion—large cars, houses and some business equipment have become obsolescent and now need to be replaced. He doubts there will be a cutback from the 14 percent increase in business investment reported in the McGraw-Hill survey. Wallich grants there may be a downturn in the first quarter but expects the expansion to begin again, if the embargo is ended by mid-year. With prices rising faster than the money stock, he pointed out "the situation is tightening itself." He advocated a continued, moderately tight policy until the downturn is seen.

Samuelson argued that "when an exogenous microeconomic event (i.e., the energy shortage) raises the price level, that inflation is limited by the event itself and is not recurring." Accordingly, it is not the duty of the Fed to roll back those prices but instead its duty is to provide for the limited structural increase in prices. He favored a "supportive" monetary policy, focusing on interest rates, between now and next Easter. The policy target should be to bring short rates down slowly, tolerating shifts in the demand for money such as the upward shift which recently occurred.