Beige Book Report: Cleveland
October 13, 1976
Economists who met to discuss the economic outlook at the Federal Reserve Bank of Cleveland on October 1 were optimistic that the expansion would continue through 1977 and the rate of unemployment would improve gradually. However, they forecast the rate of inflation to step up somewhat from 1976. Capital spending is forecast as a major source of strength in 1977, although no boom is expected. Steel operations are not expected to pick up from recent levels until next quarter. With few exceptions, there is no indication of shortages nor are any expected at least through 1977, unless the economy grows faster than the standard forecast indicates. Upward price pressures remain strong.
Twenty-eight economists who met at this Bank expect the expansion to last through 1977. Not one of the group expects real GNP to decline in any quarter next year. Forecasts of gains in real GNP for 1977 ranged from 4.5 percent to 6.5 percent, with a median of 5.1 percent. The group was not particularly concerned about relatively sluggish performance in recent economic activity, nor did they point to any excesses that might contribute to a slowdown in 1977.
The most optimistic of the group expect larger gains next year than in 1976 in both consumer spending and capital spending to support an increase in real GNP in 1977 of about 6 percent. In contrast, the less optimistic expect gains in consumer spending next year to be somewhat less than estimated for 1976. New car sales, for example, are expected to rise nearly 8 percent, following a 20 percent gain in 1976.
>The economists are counting heavily on capital spending as a major source of strength in 1977. Even the least optimistic expect gains in nonresidential fixed investment of about 13 percent from 1976, with the median at 16 percent. According to an economist associated with a large machine tool builder, the current mild recovery in capital spending reflects the fact that the drop during the latest recession was neither as severe nor as long as some other contractions in spending since World War II. His firm's orders for machine tools rose sharply in the last two months, continuing a V-shaped recovery from depressed levels in early 1975. Orders from automotive producers account for much of the recent spurt. Another economist with a major capital goods producer reported that demand for some types of capital goods, including motors and generators, has rebounded sharply in recent months, but that demand from electric utilities and for new plant construction remains weak. According to his estimates, real spending by the electric utility industry for generating capacity is unlikely to match 1970-1971 expenditures until the early 1980's, because an estimated 35 percent of the industries' capacity is idle, and because long-range projections of electric power consumption have been scaled down. Plant expansion also is being dampened by environmental regulations that lengthen lead times and by high costs that hold the return on investment on new plants lower than for existing facilities. His firm has no plans for new plant construction but will accelerate spending for modernization and replacement in 1977. A bank economist estimates there should be ample funds to finance capital spending, reflecting further improvement in corporate cash flow and new sources of lending by life insurance companies and foreign banks.
Steel economists have scaled down their estimates of steel shipments and production for this quarter but expect production next year will be about 10 percent higher than in 1976. They are depending on acceleration in capital spending and some inventory building to boost production. Industry plans to add upward of 20 million tons of capacity over the next few years are apparently being held in abeyance because of environmental regulations, high costs of new plants, lower return of new investment, and inadequate prices to finance new plants. One economist expressed the view that the spot shortages that might surface in 1977 can apparently be accommodated with foreign steel.
Various industry sources indicate they do not expect shortages to reappear in 1977. One economist reported that projected gains in real GNP of 4 to 5 percent for 1977 do not imply bottlenecks in supplies, although some spot problems may surface, especially for some chemicals. Utilization of capacity in materials-producing industries is projected to increase to about 86 percent by year-end 1977, compared with 80 percent last quarter and a high of 93 percent in 1973. If the economy were to expand at a 6 percent or higher rate in 1977, bottlenecks might appear in some other industries, including steel, aluminum, and paper. A financial officer with a petrochemical firm confirmed tightening in demand for some chemicals. Demand for flat-rolled steel products, which were informally allocated by some steel producers last spring, fell sharply during summer months, and these products are no longer considered in tight supply. Production in the steel industry, which fell to about 80 percent of capacity last month, continued to ease in early October.
There is little evidence of relaxation in upward price pressures. Preliminary results from a limited sample of this Bank' s monthly survey of manufacturers show nearly 70 percent of respondents expect price increases in October, as was the case during the summer months. Need for higher prices to finance high costs of new plants, a continued rise in energy costs, and management worry over some type of wage-price guidelines seem to be the most frequently cited reasons. An executive with a fastener producer noted weak demand and heavy imports have prevented a price increase since August 1974, but his company hopes to raise prices for some lines late this year or early next year. One steel source expects that the industry will again seek to raise prices for sheet steel in December or January as consumer inventories are brought down to desired levels. He noted that although scrap prices have declined substantially in recent months, prices of iron-ore, transportation, natural gas, and oil continue upward.