Beige Book Report: Boston
January 28, 1981
Economic activity in the First District is largely unchanged since the last Redbook report, and most respondents do not foresee major changes for either better or worse in the next several months. Retailers are generally satisfied with Christmas sales. Final reports are not yet in but the consensus is that sales were late but fairly good. Among manufacturers there is a suggestion of a slight weakening since November; some of the smaller high technology companies are starting to see declines in orders. The well publicized shortage of natural gas in Massachusetts has passed; it does not appear to have had a major impact on business activity.
Retailers report that Christmas sales were vigorous, particularly in the final days. However, it will not be possible to know whether the 1980 season was profitable until final inventories are completed. Although the volume figures are encouraging, sales and markdowns were widespread. Retail inventories are under control with the possible exception of some consumer durables.
Surveys of New England purchasing agents suggest a slight decline in manufacturing production and new orders since November. Several sources have mentioned that some of the smaller manufacturers of computers and other high technology products are beginning to see declines in orders and backlogs. On the other hand, two large high technology companies in the instruments and electronic components industries report that orders in December were strong relative to the rest of 1980. However, these firms are still taking a cautious approach to early 1981. A large manufacturer of appliances reports that the demand for lamps and other small items has strengthened while the demand for large appliances remains weak.
Increases in the prices of industrial materials and components seem to have become more prevalent. The chief economist for one of the nation's largest manufacturers expressed concern that debt service has become such a large component of total costs for many firms that the short run effects of higher interest rates on business costs are likely to outweigh the favorable long term effect on inflation of a slack economy.
Professors Eckstein, Houthakker, Samuelson, and Solow were available for comment this month. All agreed that the Fed made a creditable effort to follow the new operating procedure in 1980. Houthakker would like the procedure to be pursued even more vigorously in the future. However, Eckstein, Samuelson, and Solow feel that if the new procedure results in extreme interest rate volatility, it may be necessary to rely more on policy makers' judgment and general understanding of the economy.
Professor Eckstein believes the new operating procedure has not been a success. "I'm not quarreling with the average level of interest rates during 1980, but the monetarist experiment caused real interest rates to swing from -6 percent to 7 percent." He believes interest rates are now too high. "If the Fed holds the federal funds rate at 20 percent until real growth is negative, it ought to be fired. A funds rate of 14 or 15 percent is sufficient to reduce growth without inviting a crash or sacrificing capital formation." In retrospect, "the experiment was expensive, but it's the tuition we'd pay for a more skillful monetary policy in the future. If the Fed has not learned to pay more attention to real interest rates, however, the experiment was a disaster."
Professor Houthakker is "mildly encouraged" by the first year of experience under the new monetary policy. Citing the fourth quarter spurt in real GNP, he believes the real effects of high interest rate volatility are not as large as some believe. Houthakker thinks the economy is receiving the right medicine from monetary policy but not from fiscal policy. He argues that a reduction in the deficit would permit interest rates to fall at the same time that money growth rates are reduced. Since M-2 is insulated from effects of NOW accounts, Houthakker advises the Fed to announce M-2 goals and suspend goals for M-IB until more evidence on the extent of substitution is available.
Professor Samuelson does not view the October 1979 change in operating procedure as an important reform. He feels that monetarists exaggerate the gains that would accrue from steady money growth. Nevertheless, he feels that the Fed "gave it a good try" in 1980, especially in view of the fluctuations in money demand that occurred during the year. Although Samuelson suspects the swings in money growth would have been reduced last year "if every member of the FOMC were tortured every time money deviated from its path," he remains unconvinced that close control of the aggregates is an important policy goal. With respect to goals for 1981, Samuelson also feels that it is not reasonable to worry about raising the M-1B range to recognize the effect of NOW accounts as long as M-2 will not be affected.
Professor Solow reads the new operating procedure as a distinct turn toward monetarism, but believes that common sense prevailed in the departures from the procedure that occurred since the new procedure was adopted. Solow thinks that the size of the swings in interest rates surprised the FOMC. He also believes they contributed to economic instability because of their disturbing effect on investment planning. For 1981, Solow argues that a unified economic plan encompassing both monetary and fiscal policy is necessary. He fears that massive tax cuts may render monetary policy impossible—the only way the Fed could resist the resulting inflation is by causing a severe recession. In his view, the burden of restraint should be borne more by fiscal than by monetary policy. Dismissing the credibility argument, Solow feels that the combination of "tight" fiscal and "easy" monetary policy is the best way to raise the share of investment in GNP.