November 9, 1977
Most respondents in the First District observed little change in the level of economic activity in the past month. There were, however, scattered reports of reduced capacity utilization. Consumer spending was strong but has tapered off slightly during recent weeks. Industrial production is generally unchanged although several firms report that capital goods orders and foreign sales are disappointing. Inventories are being watched closely.
Retail sales in New England are up, but there seems to have been some slowing in the rate of growth during recent weeks. One major retailer reports that manufacturers are promoting their merchandise more aggressively. This is seen as a sign of a weakening sales position. There is some concern that inventories are too high. The tourist industry in northern New England did very well in the foliage season; there were more tourists and they were bigger spenders.
Most manufacturers report no significant changes in their operating levels. A few have experienced reductions. Production for all aspects of the automotive market is high. Machine tools, automotive plastics and tires are all selling briskly. Among consumer products, appliances, which are tied to housing, are doing well. One firm reports a drastic decline in shoe production; this is attributed in part to foreign competition. Sales of capital goods, especially heavy machinery, have been disappointing. This is thought to be due to slow capital spending and the weakness of foreign economies. However, one large machinery manufacturer reports that capital goods sales, including exports, are very strong. Manufacturing inventories are being watched closely; no problems are expected.
Professors Eckstein, Houthakker, Samuelson, Solow, and Tobin were available for comment this month. Houthakker remains very concerned about recent above-target money growth. He believes that the existing targets are appropriate, but if the Fed cannot attain them, he advises the FOMC to raise the targets so that "the economy will know, at least, what game they are playing." Houthakker is reassured by recent economic developments: he expects real growth to average 4.5 to 5.0 percent next year, he sees some hints that inflation is ebbing, and he believes the peak in Treasury bill rates is near.
All other respondents believe that a return to target rates of money growth is unwarranted at this time. Samuelson noted the consensus forecast of the 1978 year-over-year growth rate has been reduced by .1 percent each month. Given the wane in confidence, the Fed should compromise between increasing interest rates and returning to its money growth targets. With due regard to the long-run, overshoots in the money stock should be tolerated for the time being to avoid repetition of the experience of 1974 of jeopardizing fixed investment by sharp increases in interest rates.
Tobin believes that the days of puzzling, rapid velocity growth are over. Since early 1976, M2 velocity has generally fallen, and Ml velocity has increased only at a 3 percent annual rate. Given a realistic outlook for price inflation, the Fed can no longer rely on velocity to make the stated money targets consistent with output goals. Because the recent acceleration of money growth has occurred when output growth has slowed, it would be a mistake for policy to adhere to its money stock targets—the changing link between money and GNP mandates closer attention to interest rates as a policy guide at this time. Any further increases in short-term interest rates can be expected to spill over more strongly into mortgage and bond yields now that the prime rate is a notch below 8 percent and bills are reaching yields of 7 percent. The continuing decline in stock prices reflects this concern. Eckstein claims that "pure monetarism now will lead to disaster." Policy must consider the state of the economy and credit markets as well as money growth. Real growth may average 4 to 4.5 percent in 1978 if nothing upsets the economy, and at this stage of the recovery credit markets are very sensitive to monetary restraint. Not only is disintermediation a real threat, but the increasing reliance of business on bank financing means that significant increases in interest rates or reduced money growth can have a pronounced, adverse effect on real growth.
Although Solow foresees no downturn in 1978, real growth will average 4 or 4.5 percent, at best. This performance is "utterly inadequate." The economy needs and could stand 5 or 6 percent growth without rekindling inflation. Since the proper role of policy is to support a healthy recovery, the announced money growth targets are "utterly destructive and inadequate." Focusing on M2 and generously presuming a 5.5 percent rate of inflation, a minimal money growth target for 1978 is at least 10.5 percent. Solow is "uncomfortable with the Fed's forcing the Administration to undertake more fiscal expansion and then complaining about the size of Federal budget deficits."