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Cleveland: August 1981

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Beige Book Report: Cleveland

August 11, 1981

Summary
Respondents in the Fourth District generally view the growth potential of the economy as strong and expect a quick rebound in real GNP if interest rates fall. Real retail sales are expected to show only mild gains over the next few months. Current interest rate levels, along with a slowdown in orders, have led to deferring of some capital spending projects and liquidating of inventories. District employment continues to slide toward the 1980 recession trough level. Effects of dollar appreciation on exports and imports are mixed, but few respondents expect exports to rebound. Large savings outflows at S&Ls continued in July.

<>>Output and Prices
Most respondents have scaled down their third and fourth quarter forecasts of real GNP, but the core inflation rate is expected to remain around 9%. A bank economist, who previously forecasted strong growth in real GNP for the second half of 1981, now expects only 1% growth in the third quarter and 2.5% in the fourth quarter. A steel economist and a retail trade economist see prospects for a negative third quarter and possibly fourth quarter, if interest rates do not fall. However, several respondents expect that tax cut incentives and declining interest rates will provide stimulus by September to support a positive third quarter. The fall in interest rates assumes that business loan demand weakens and monetary policy eases.

Inflation continues to be a major concern of respondents, with a widespread view that further moderation involves bringing down wage and employment cost increases. Also, several respondents are concerned that the effects of tight monetary policy on output will limit productivity gains that are necessary to reduce the core rate of inflation.

Consumer Goods
Some retailers expect sales, excluding autos, will grow at a slower pace the balance of the year than earlier this year, because of the slow growth of income and rising unemployment. An economist for a major department store chain projects a 2% increase in real retail sales of department store-type goods during the second half of 1981. A nondurable goods producer reports that sales volume has been soft in recent months, with year-over-year gains at 1-2%, rather than an anticipated 3-4%. While several department stores report small gains in real sales, a local chain store that caters to blue-collar workers reports declines in real sales. An area auto dealer reports new car sales rose slightly in the last 10-day period of July, partly because of a revised Ohio sales tax law that can reduce sales tax on new cars.

Manufacturing Activity
High interest rates and slackened final demand are contributing to some curtailment of inventories and deferment of capital spending. While most respondents report that inventories at the plant and customer level are generally lean, some spot excesses have occurred in recent weeks. Larger-than-desired inventories are apparent, especially in steel, petroleum, and construction supplies. A petroleum economist reports that refinery operating rates range between 66-70% because of an excess of crude stocks. A steel economist states that the moderate buildup of steel inventories in the second quarter of 1981, while low by historical standards, is in the process of being cut back. Steel orders generally have weakened as a result of unwanted inventories and rising imports. Order rates in the last few weeks are equivalent to only a 60% operating rate, compared to the current 75% operating rate. An official with a machine tool producer reports that new orders amount to 50% of capacity and that production, which has been at capacity, will be cut back by the end of the year even if orders rebound. Several respondents state that some capital spending programs are being deferred because of slackened demand and high interest rates. A steel economist expects business fixed investment to improve if the volume of sales returns, regardless of the interest rate.

Employment
Employment conditions in the District have been weakening steadily in recent months. Nonagricultural employment, which peaked in November 1980, is currently approaching the July 1980 trough level. Nonmanufacturing employment, especially government and construction, accounted for most of the decline from the November peak. Manufacturing employment has drifted downward since March, with declines concentrated in the auto industry. An auto economist reports that temporary layoffs are likely to continue throughout the third quarter as plants are closed for a week at a time. A steel economist expects that slackening in steel orders and production will cause shortened work weeks and some layoffs throughout the second half of 1981. The latest monthly Survey of Fourth District Manufacturing has shown a steady decline in rate of employment expansion since the end of last year, and virtually no change in hours worked since February.

Exports/Imports
Respondents acknowledge the difficulty in differentiating effects of dollar appreciation on U.S. exports and imports from economic weakness abroad. Several small producer/exporters in the District report little loss in export business despite dollar appreciation, while several others attribute the recent decline in their exports to dollar appreciation and softness in economics abroad. A machine tool builder reports growing competition for orders from foreign producers and estimates that 25% of his market is absorbed by imports. A manufacturer of pigments for appliance paints states that sales in Europe have been declining since mid-June and expects the decline to continue for the next few months. In contrast, a chemical manufacturer reports a 10% increase in sales during the first half of 1981 over the first half of 1980. Imports have been rising noticeably in the steel industry, according to a steel economist, but may partly reflect attempts to maintain production levels abroad as demand softens. A chemical manufacturer reports shifting to foreign sources of raw materials because of the price advantage.

Savings Flows
The heavy outflow of funds from S&Ls continued in July, as many area S&Ls look to new four-year certificates, "all- savers" certificates, and repurchase agreements for new sources of funds. Savings outflows, according to an economist for a regional FHLB in the District, were not as severe in the second 10 days of July, compared with the first 10 days, but were still massive by historical standards. S&Ls appear to be more aggressive in promoting the new four-year certificate and retail-repurchase agreements than banks. Some banks are apparently reluctant to make long-term commitments at present interest rates, but an S&L official states that the new saving instrument adds stability to their source of funds. A local S&L offers both a fixed and a variable rate on its four-year certificate. An economist for a large S&L expects the "all savers" certificate to be more helpful to the industry than the four-year certificate in attracting funds and should shift funds away from the money market certificates. Retail repurchase agreements are being promoted in several major metropolitan centers of the District, mainly by S&Ls.