Beige Book Report: Boston
November 14, 1979
More and more First District respondents are reporting signs of a recession. Retail sales are soft. Manufacturers generally report that business is fairly good but "good" seems to have been redefined over the past few months. Previously it meant that unit sales were growing, now it seems to mean that sales are holding even with last year. In the financial sector, loan demand seems to have slowed slightly although it still remains quite strong. Mortgage money continues to be available although at high rates--lenders are rationing by price.
Retail sales in New England are quite weak. There have been occasional weeks in which sales have been vigorous but these have been followed by periods in which sales have been very depressed. The erratic nature of demand is making inventory management very difficult. The head of a large department store chain with national ties believes that sales in New England are considerably weaker than those elsewhere. This same firm is reassessing its expansion plans.
Reports from the manufacturing sector are significantly less gloomy but respondents no longer question whether we are really in a recession. Thus, the head of a firm making graphics reports that business has been quite strong but that he is reevaluating capital spending plans and reassessing factory schedules in expectation of a weak first quarter. A large furniture maker notes that attendance at a major trade show was down 20-25 percent from last year; aggressive firms fared well, but the weaker companies had very little business. A manufacturer of building materials also reports that demand has fallen off. Customers who normally stock up their inventories over the winter month are not doing so this year. This firm, which sells heavily to the rehabilitation market, believes that high interest rates will mean that much less rehabilitation will be done in 1980 than customarily occurs in recessions. Repair and rehabilitation activity is usually quite strong in recessions as contractors, who normally prefer new construction, accept less attractive rehabilitation jobs. Defense contracts continue to be a source of strength. A number of businessmen report that collections from customers have slowed.
In the financial sector, banking directors from northern New England have seen some softening in loan demand, primarily on the commercial side. However, a large bank from one of the southern states reports that after leveling off loan demand has picked up again. None of the business firms contacted was experiencing difficulties in securing funds. In addition, a survey of small businesses, conducted in the last two weeks of October by one of the area's large banks, found that most small firms were still able to get funds at or slightly above the prime rate. A majority of these firms expect funding to be more difficult to obtain in the future, but at the present time they still view inflation as the greatest problem. Home mortgage loans are still available. Institutions in the region are taking advantage of the secondary market to secure funds and are allowing the price to ration demand.
Professors Eckstein, Houthakker, Tobin, Solow and Samuelson were available for comment this month. Eckstein supports the "new monetary policy"; however, he believes the aggregates will not be fully under control until the economy itself is under control. "Having embarked on this course of controlling reserves, we should see it through, with the proviso that we watch the financial system closely. With the impending business slump there are risks of serious financial disturbances, especially for 'second tier firms Eckstein suspects that the "real crunch has yet to come." He hopes that the new policy will allow interest rates to fall as rapidly as they rose when business activity declines in late 1979 and early 1980.
Houthakker is pleased that the Fed is now concerned more about controlling reserves than controlling interest rates. He believes, for example, that a 15 percent funds rate is appropriate given today's market conditions, but the rate should be free to change when conditions change. He cannot fully endorse the new procedures, however, until he knows which concept of reserves is now under control and what reserve target the Fed is trying to achieve. Houthakker believes we have been in a recession since the beginning of 1979; the recession will be lengthy, but not deep. He expects the growth of GNP in the early 1980s will be much like that in the late 1950s--business activity will expand slowly and unevenly. Because the current consumer price index temporarily exaggerates the true inflation rate, fiscal and monetary policy could reduce inflation to 7 or 8 percent by the end of 1980 "without undue damage," but the unemployment rate may have to rise as high as 7.5 or 8 percent. In any event, Houthakker thinks the eradication of inflation will take years.
Tobin believes the benefits of the new control procedures have been exaggerated. Because his research shows little or no connection between short-term movements in reserves and money aggregates or total credit, he is not convinced the Fed's control of the money stock is now more reliable. Tobin believes that there is now a high probability of a recession in 1980 and that it is dangerous "to keep tightening until we see the whites of the recession's eyes. We should get our bearings before embarking on another round of restraint." The high inflation is not the fault of monetary policy, in his opinion. If OPEC raises prices again, he hopes the Fed realizes it cannot costlessly offset the inflationary shock. In the event of an oil price increase attainment of a satisfactory unemployment rate and inflation rate is impossible: higher real oil prices must either depress production or increase domestic inflation.
Solow has mixed feelings about the October policy. The higher marginal reserves on banks' "bought funds" is "unambiguously a good step." He believes the sharp increase in interest rates was exaggerated, however, perhaps to defend the dollar at the October 6 parity. He is not sure that this particular exchange rate is an equilibrium rate. He questions whether maintaining the exchange rate with high interest rates best serves our domestic needs or best serves the interests of German exporters and German monetary policy, a policy whose objectives certainly are not very sensitive to our domestic problems. Before Solow can fully evaluate the new control procedure, he must see it in action. To the extent that wider tolerance bands for the funds rate reduce wide procyclical swings in the money stock, the new policy is to be commended. To the extent that smoother growth of the aggregates destabilizes GNP and employment growth, however, the new policy is a "destructive step backwards." Solow argues that stable money growth may not be consistent with stable GNP growth; "the Fed needs to take a broad view in forming policy, especially now that the money demand function may have come loose at the seams."
Samuelson also has mixed feelings about the new monetary procedure. Now that interest rates may "float," in theory, the Fed may have more success in attaining its money targets. In practice, however, he notes that contemporaneous reserve accounting, among other reforms, must be adopted before the Fed can achieve this goal. Samuelson believes there are substantial dangers in any procedure that has no "safety-valve": the old policy, though it had its faults, could accommodate shifts in money-demand without disturbing GNP. Samuelson is worried that the Fed may make stable money growth—rather than high employment with low inflation—the ultimate goal of policy. Our experience of rising inflation does not prove that counter-cyclical monetary policy has been a failure, rather it suggests the trend rate of money growth has been too high. Now that the consensus forecast anticipates an imminent recession, it is prudent and rational to avoid further monetary restraint. "If our goal is zero growth, we have overshot the target, not by accident, and it is hypocritical to be surprised if we have a recession."