October 14, 1980
Overview
With respect to current and prospective business activity,
reports from Reserve Banks this month are generally less optimistic
than they were last month. The recent deterioration in financial
conditions is seen as responsible for a slowing of economic activity
in several districts in September. The rise in interest rates is the
major reason many respondents have adopted a less sanguine view of
the strength of the recovery next year. The outlook for inflation is
about unchanged from last month, with some districts reporting an
easing of price pressures and others reporting a resurgence. While
commercial lending is up in several districts, mortgage lending has
slackened everywhere. Automobile dealers are "cautiously optimistic"
on balance about the prospects for the 1981 model year, although
there is widespread concern that the combination of high prices and
high financing costs will dampen new car sales. However, most
respondents agree that it is too soon to know if these factors will
significantly weaken car sales in the months ahead.
Business Conditions and Outlook
With few exceptions the recent rise
in interest rates apparently has stalled the recovery and caused
many respondents to revise downward their forecasts for 1981,
judging from Reserve Bank reports. Boston and St. Louis report
little change in business conditions since last month, while the
recession is still on in San Francisco. Defense spending is
mentioned as a source of strength by Boston and Dallas, but in the
latter case this is offset by an expected decline in construction
caused by rising interest rates. The effect of higher interest rates
on construction also has slowed the recovery in Minneapolis.
Philadelphia, Cleveland, Richmond, and Chicago say that business has
improved since last month, but Cleveland and Chicago are concerned
that the recent improvement in steel demand may evaporate if high
prices and interest rates weaken auto sales next year. Respondents
in New York do not expect the economy to improve significantly
before the middle of next year, and Atlanta and Kansas City note
that the rise in interest rates has caused growing concern about the
future in their districts as well.
Prices
Where mentioned, district reports indicate that price
pressures are about unchanged from last month. While Dallas notes
that lumber prices are off significantly from a year ago and
purchasing agents in Boston and Kansas City report a stabilization
of input prices in recent months, surveys conducted in Philadelphia
and Chicago indicated that industrial input and output prices are
rising and probably will continue to do so for the rest of the year.
Financial Developments
The most notable feature of district reports
was the widespread decline in mortgage lending due to recent
interest rate increases. New York and St. Louis report an increase
in the use of VRMs and RRMs; Atlanta notes that equity participation
mortgages issued by a Florida S&L have been well received. Auto
loans are available and rates and terms generally are unchanged from
last month. Business loan demand is strong in Philadelphia,
Cleveland, and St. Louis. Deposits are up in Kansas City and Dallas
but down in San Francisco.
Consumer Spending
Although retail sales are reported as steady or
up slightly (Boston, Cleveland, Richmond, St. Louis, Minneapolis,
Kansas City, Dallas), mixed (New York, Philadelphia), or sluggish
(Atlanta, Chicago, San Francisco), the overall tone of the district
reports indicates that consumer spending remains flat in real terms.
Hard goods are doing relatively well in Philadelphia, consumers
buying in advance of price increases have buoyed big ticket sales in
Richmond, catalog shopping is growing in Atlanta, price cutting and
sales are common in Chicago, St. Louis and San Francisco, and soft
goods are doing better than durables in Kansas City and Dallas. Auto
sales are the best in months in Cleveland and are up a bit in
Minneapolis, but other districts report car sales are flat or down
slightly. Chicago notes that auto loans are available at commercial
banks in the 14-16 percent range but that lenders are becoming more
selective; Cleveland and Kansas City note that in-house financing at
below market rates still is available for some makes; New York,
Atlanta, Chicago, and Dallas note that the high interest rates are
reducing dealers' desired inventories of new cars. High new car
prices seem to be at least as important as high interest rates in
explaining weak car sales. Most districts conclude that it is too
soon to tell what effect these factors will have on 1981 sales
volume, however.
Residential Construction
Conditions in the housing market have
deteriorated in the past month in all districts. Higher mortgage
rates are cited by all Reserve Banks as the cause of the downturn.
Rates have increased as much as two percentage points in some
districts (New York, Chicago, St. Louis, Kansas City) and mortgage
demand has dried up almost everywhere. Descriptions of the housing
market range from severely depressed (Chicago) to weak (Richmond)
with no district citing improved conditions.
Business Fixed Investment
The outlook for capital spending is
mixed. Cleveland, Chicago, and St. Louis see a continued gradual
downward trend in overall spending plans. Cleveland and Chicago also
note that order cancellations are becoming a problem, although not
as severe as in the last recession. On the other hand, Philadelphia
reports that increased capital outlays are planned at a third of the
firms they surveyed; Atlanta says that order backlogs at high
technology firms are the highest ever; Dallas cites an ongoing boom
in oil drilling, commercial building, and power plant construction;
and New York, Cleveland, and Chicago report strength in sales of
machine tools.
Inventories
Both retail and manufacturing inventories are described
as lean but generally acceptable by most districts. New York,
Chicago, and Minneapolis note that high carrying costs have reduced
desired inventories of some respondents, especially automobile
dealers.
Agriculture
The outlook for agricultural production and farm income
is mixed. Drought has reduced crop yields in Richmond, Atlanta, St.
Louis, and Dallas. The resulting price increases are not expected
fully to offset the decline in output in these areas, so farm income
probably will decrease further. Atlanta and Dallas also note a heavy
use of emergency credit in their districts. While Kansas City
expects meat supplies to tighten next year, San Francisco expects
them to increase. Chicago and Minneapolis are optimistic about the
corn and soybean harvests this year, both citing favorable weather
and high prices.
Academic and Financial Consultants
The academic consultants agreed
about the current state of the economy but disagreed about monetary
policy. Professor Houthakker believes the economy is stagnant and
will remain so for another year at least. He thinks the weak economy
has restrained price increases, and he expects a modest improvement
in the balance of payments and the exchange rate in 1981. Professor
Samuelson foresees a weak recovery during the coming year. It is his
view that the money growth targets for 1981 are consistent with this
outlook and probably will not induce additional weakness. Professor
Eckstein thinks the recession is over but that real GNP will expand
only 1.9 percent in 1981. He believes 1981 money growth targets may
be inconsistent with the prospective growth of the economy.
Professor Tobin thinks that the money growth targets for next year
are unrealistically low given the high core inflation rate and
probably will cause stagnation. He advocates an incomes policy to
alter wage and price behavior in addition to restrictive monetary
and fiscal policies.
The financial consultants urge the Fed to hit its money growth targets. Mr. Riefler argues that the Fed will gain credibility and reduce inflationary expectations only by hitting its announced targets. Mr. Schott believes that the recent round of interest rate increases is related to the deteriorating Federal budget outlook for next year. He thinks another crunch can be averted if the Fed stands firm now. Provided that Ml does not erupt again, reigniting concerns over further interest rate increases, Mr. Wojnilower expects a relatively strong recovery in 1981.