January 29, 1980
Respondents in the First District still see very few signs of a downturn. If there has been a change in the level of economic activity during the past month, it has been for the better. Retail sales seem to have picked up in the few days before Christmas and preliminary January figures have been quite good compared with a year ago. An important exception is northern New England which is suffering from a lack of snow and consequently a lack of tourists. Manufacturing activity remains at a high level; in several cases December was stronger than expected. In the banking sector, the movement from savings deposits to money market certificates is continuing. Loan demand is holding steady; in northern New England delinquencies seem to have increased.
Respondents from the retailing sector report that sales in the last few days before Christmas were good. This pick up plus relatively strong sales in the first weeks of January means that the Christmas season was relatively successful. To a large extent the vigorous sales before Christmas were attributable to very large markdowns. This had the effect of bringing inventories under control and while it cut profit margins, a firm's inventory position seems to have more influence on its short-run purchasing behavior than do profits. In general retailing in New England had a much stronger Christmas than seemed likely a couple of months ago. An important exception, however, is the ski areas of northern New England. There has been virtually no snow in New England and this has adversely impacted not only the ski resorts themselves but also all the hotels, stores, restaurants and specialty manufacturers which are associated with them. Even if snow does come there is no way that the losses can be fully made up. Even real estate has been affected as developers of second homes rely on skiers coming up to see model homes.
The level of manufacturing activity remains high. One diversified manufacturer in the high technology area reports that December was very good in all categories; even areas which had been doing poorly picked up. A manufacturer of measuring equipment used in the process industries finds that orders are continuing at a strong pace and backlogs are high; if the present order rate continues this firm's 1980 plan will be revised upward. For a large producer of aircraft and parts, backlogs are rising steadily. A manufacturer of high quality sportswear has record spring orders. An exception to the generally favorable picture came from a firm in the furniture area; attendance at trade shows is low and price cutting is fierce. Moreover, even those respondents who are very pleased with their current level of business expect a fall-off later in the year. Prices do not seem to be softening, although there have been some improvements in delivery lead times.
Several firms which are active in the defense business were asked whether the industry could handle a large increase in spending. The industry as a whole has been below capacity; so physical capacity is not really a problem. The exception is in the manufacture of semi-conductors and chips; the lead times for these are already long and with a substantial increase in defense demand they could become "unbelievable." The other major bottleneck is labor; there are not enough people with the necessary skills, especially programming. While an increase in defense spending over what was already planned will have some effects in 1980, the real employment impact will not occur until 1981 and after.
Banking directors report that loan demand is holding steady at a relatively high level. Two respondents from northern New England have observed an increase in delinquencies and as a consequence they are adding to their reserves for bad debts. This increase in overdue loans is thought to be independent of the problems caused by lack of snow. All see a steady conversion of savings deposits to money market certificates.
Professors Eckstein, Houthakker, Samuelson, Solow, and Tobin were available for comment this month. Houthakker, Solow, and Tobin favor leaving the long-term monetary growth rate targets unchanged, Eckstein favors significant tightening, and Samuelson favors something in between.
Solow argues that continuation of the present 5 to 8 percent target rates for M2 provides ample room for monetary deceleration should that prove warranted. After analyzing the various reasons for the drop in the savings rate, he noted that they are all probably transitory factors; further decline should not be expected and a sharp reversal is also possible. Tobin argued that if the objective of policy is to produce a mild recession, a continuation of present policies is sufficient to achieve that goal. However, he questioned the strategy of seeking a mild recession which, he feels, will do little to reduce inflation very soon. He had hoped for but not really expected a more vigorous incomes policy. Houthakker argues that by the best available measure, the GNP fixed-weight deflator, inflation has been holding steady at about 10 percent. Thus, real interest rates are positive—short-term rates significantly and long-term rates slightly—and are “now about right.” Despite the wild gyrations in the price of gold, Houthakker notes that the dollar has performed well and speculative activity has not spilled over into other markets. He continues to believe that the appropriate gold policy would be a major (5 million ounce) sale.
Eckstein favors a 4 to 7 percent target range for M2. He argues that "we need a recession to reduce inflation. He has revised his real GNP forecast upward because of higher defense spending and "momentum." If the first quarter growth is positive, he feels another round of tightening will be unavoidable. He feels policy should be geared primarily to interest rates since the aggregates are currently impossible to interpret.
Samuelson favors "token tightening" simply to short-circuit the ideological contention that we must show determination to counter inflation. In fact, the growth recession we are now in is producing the appropriate amount of slack and a serious recession would be counter-productive. If the economy strengthens, we should move to the low end of the target range and run on the high side if it weakens. The possibility of a war is the most serious reason to expect the economy may strengthen. Samuelson also urged paying little attention to sharp variations in metals prices which are not a matter of national interest. If the dollar should weaken, Samuelson would welcome some overshooting on the downside, to generate a little "excess competitiveness" for traded U.S. products.