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JUNE 1961 PHIA BUSINESS REVIEW The Tradition to Adapt This is Our Housing Market BUSINESS REVIEW is produced in the Department of Research. J. Allan Irvine was primarily responsible for the article “ This Is Our Housing Mar ket.” The author will be glad to receive comments on his article. Requests for additional copies should be addressed to the Department of Public In formation, Federal Reserve Bank of Phila delphia, Philadelphia 1, Pennsylvania. THE TRADITION TO ADAPT* b y K a rl R. Bopp At the luncheon a year ago, President Alfred Hayes said: “Monetary policy can never be re duced to a static, inflexible set of rules in a dynamic market economy.” Mr. Hayes spoke from experience. I doubt, however, that even he anticipated how dramatically his words would be borne out again. In the year that has intervened, our dynamic market economy has given birth to new and unusual problems. These problems, in turn, have called for a reappraisal of the techniques of monetary policy. A year ago we were at a new peak in eco nomic activity; a year ago we could take some pleasure in observing that the danger of in flation had abated; a year ago we needed only to theorize on the possible impact that interest rate differentials among the countries of the world might have on our balance of payments and our gold supply. A year ago, when this group was convening, no one could have fore seen what challenges lay immediately ahead. Looking back, we can see now that the central bank and its policies have been taxed to the utmost. We have tried to protect our balance of payments while stimulating economic growth without inflation. The conjuncture of several events in the past year tested our ability to adapt our traditional ways of doing things to meet the new problems of the day. I think we have made headway, but many problems remain; the task is, as always, unfinished. The e co n o m y in the p a st y e a r I should like first to discuss with you some of the domestic economic events that led up to the * A talk given at the 58th Annual Convention, New Jersey Bankers Association, Atlantic City, M ay 18, 1961. complexities of the past year. As you may recall, great expectations were held for economic ad vance when the recession of 1957-1958 proved to be so short. The recession lasted only nine months— among the shortest recessions on rec ord. From mid-1958 to mid-1959, there was a general upswing in all categories of buying. Gross national product rose almost one-eighth, from an annual rate of $435 billion to $488 bil lion. Toward the end of the period, however, the rapid expansion was stimulated by an in ventory build-up in anticipation of the steel strike that came in the summer. During the steel strike in the latter part of 1959, we experienced a small decrease in over all economic activity. Producers could not buy all they desired and inventories were run down. Government spending also decreased somewhat and there was weakness in consumer demand for durables. Then the steel strike was settled and we moved into 1960. The year was ripe for expan sion, so everyone believed. Long-term fore casters had been painting the 1960’s as a new golden age; short-term forecasters saw a sharp recovery from reductions brought about by the steel strike. The timetable seemed assured when in the first months of 1960 the economy moved ahead vigor ously. The vigor came mainly from the private sector of the economy— consumers and business men, appropriately enough; the Federal Govern ment was curtailing its spending during the upturn; it was in process of shifting from a huge deficit, induced by the recession of 1957-1958, to a moderate surplus. But the advance, it soon became apparent, was founded primarily on business spending to 3 business review replenish inventories after the strike. Observers began to realize early in the year that the inven tory build-up could not continue indefinitely. It was hoped that something else would take its place as the year went on, but nothing else did take its place. In the next few months the spark flickered and the economy began to drift. After midyear, there was an actual downturn in gross national product. This and many other indi cators confirmed that we were going through our fourth postwar recession. The d ile m m a o f m o n e ta ry policy We felt that monetary policy could best con tribute to recovery by making reserves readily available in an effort to stimulate an expanding flow of funds into investment outlets. Indeed, monetary policy was shifted from restraint to ease early in 1960 while total output was still expanding, but while it also appeared that our economy was beginning to drift and that the in flationary danger had abated. The weakening of credit demands associated with the business de cline and the Federal Reserve policy of monetary ease resulted in a substantial decline in short term rates of interest. Meanwhile, the economies of most other in dustrial countries continued to expand. I hope, incidentally, that these diverse developments here and abroad will finally dispose of that oncepopular myth: “If the United States’ economy sneezes, the European economy will catch pneu monia.” In general, other countries followed monetary policies appropriate to their domestic economies. They tightened credit which in the face of vigorous demand for credit led to higher interest rates. The combination of rising short rates abroad and declining short rates here produced a widen ing spread. Short-term funds flowed from this 4 country to Europe in increasing volume. The continued outflow of gold served to focus atten tion on this problem. It thus became clear that the monetary policies appropriate for the do mestic economy were having undesirable effects on our international position. Our problem be came one of devising means to deal construc tively with both domestic and international developments. We started from several basic assumptions. The first was that unemployment of men, plant, and equipment is wasteful and undesirable. Affluent society or not, there is no question that in the world Struggle in which we are involved we should be using our productive resources to the fullest extent possible. Our second assump tion was that a free flow of trade is desirable; that the larger the flow, the better off we all will be in the long run. We wanted, then, to contribute to domestic recovery and at the same time to strengthen our international position. The first called for greater ease in capital markets; the second could not permit greater ease in money markets. The System has often taken the position that its policy is to lean against the wind. In 1960, the wind was blowing in different directions at the same time. C h an ge in open m a rk e t techniques The resolution of this dilemma was contained in an announcement by the Manager of the Open Market Account on February 20, 1961. The announcement read: The System Open Market Account is pur chasing in the open market U. S. Govern ment notes and bonds of varying maturities, some of which will exceed five years. Price quotations and offerings are being requested of all primary dealers in U. S. business review Government securities. Determination as to which offerings to purchase is being gov erned by the prices that appear most ad vantageous, i.e., the lowest price. Net amounts of all transactions for System ac count will be shown as usual in the condi tion statements issued every Thursday. During recent years transactions for the System Account, except in correction of dis uncontrolled inflation with all its injustices and hazards. Will these new techniques ultimately prove successful? The truth is that no one can be sure. Experience has little to tell us. But of this we can be certain: our evaluation will depend to a considerable extent on how much we expect. In fairness, our expectations should be tempered by the circumstances under which these new orderly markets, have been made in short term U. S. Government securities. Authority for transactions in securities of longer ma turity has been granted by the Open Market Committee of the Federal Reserve System in the light of conditions that have devel oped in the domestic economy and in the U. S. balance of payments with other coun tries. The purpose, as I have indicated, was to make reserves available to promote domestic recovery without depressing short-term rates which would aggravate our balance-of-payments difficulties. The action was in the tradition of the Federal Reserve System which is to adapt its policies and techniques to current developments. The change in technique most emphatically does not mean that the System is once again going to peg prices and maintain an inflexible pattern of yields. We have had sufficient experi ence with pegs to know that they aggravate rather than mitigate the swings in the business cycle. We know also that a booming economy, with seemingly insatiable demands for credit, will force interest rates up. We observe this not only in our own history but also, and particularly during the past few years, in other industrially developed countries, notably Western Germany. We know from experience that attempts to keep rates from rising' during a boom by creating sufficient reserves to keep them down result in techniques were instituted. One important circumstance was a general at titude that greeted the new methods. In many minds, the departure from “bills only” has un derstandably taken on the mantle of an experi ment. An experiment it certainly is; there is no denying the relevance of this word. It is an experiment in the sense that we are trying out a new method in the hope that it will have a de sired effect. I should like to point out, however, that in this sense every action in life is an experiment. In banking, installment and term loans were re cently, and perhaps still are, experiments. The entire Federal Reserve System was, at one time, an experiment. The term “experiment,” unfortunately, has some additional meaning. In the social sphere, though not in the physical, the very word is somewhat suspect. We speak of social or eco nomic experimentation as tinkering with useful and still serviceable traditions. We think of that classic failure in American legislation— “the noble experiment.” Webster defines experiment as a “trial made to confirm . . . something doubt ful.” We sometimes tend to think of an experi ment as something which, if not proved im mediately successful, will quickly be abandoned — and something in which the experimenters may not have much faith. Thoughts of this nature make success more 5 business review difficult. If people believe that the new techniques will soon be abandoned, their commercial trans actions in credit markets will tend to undermine Federal Reserve efforts. Let me emphasize, then, that there were good and sufficient reasons leading to the adoption of the new techniques. We were not merely “tinker ing” ; we were trying to meet a new and demand ing problem. The new techniques were thor oughly discussed and evaluated. I firmly believe they represent a hopeful approach. Let me say that we have consistently pursued these policies since the announcement on February 20. I might add that, as in the case of the installment and term loans, and the Federal Reserve System itself, some experiments become traditions. There was still another adverse circumstance surrounding the adoption of the new methods. About the same time as the announcement in late February, there began to appear some signs that the recession was reaching bottom. Since then, signs of recovery have multiplied. Given such conditions, people began to expect higher in terest rates and to act accordingly. Swimming against a tidal wave of adverse expectations— based either on the belief that the economy is headed upward or that the System will soon abandon its efforts— is extremely diffi cult. The difficulties should not be forgotten when we judge current open market practices. What, then, has been accomplished? It is very difficult to appraise the impact of our policies. There are many powerful forces at work and we can’t easily isolate the results of System efforts; we never will know what might have happened had we pursued other policies; in addition, as yet we do not have sufficient perspective to make the best possible judgments— it is still early. I should like, however, to cite some facts. It would appear that we have passed the low point 6 of this recession, and that economic activity is headed up. Last month’s rise in industrial pro duction was particularly encouraging. At the same time, long-term interest rates have not changed much from the levels in the latter part of February. Corporations and municipalities seem to be taking advantage of the current rates and meeting with success. The flow of funds into capital markets has accelerated. Moreover, banks have also contributed substantially to the general expansion of credit. Meanwhile the bill rate has been fluctuating around 2^4 to 2 ^ per cent; and the spread between short-term rates here and short-term rates in leading European countries has nar rowed considerably over the past year. In recent months, the net purchase of foreign short-term obligations has declined; and there have been other indications as well that the speculative out flow of funds has subsided. Our gold losses de clined considerably in February; since then we have actually gained gold. These developments, I believe, are significant. They represent substantial improvement. I would not by any means argue that the Federal Reserve System has singlehandedly brought them about. But I do think that our policies have been instrumental in ameliorating the problems and that they have been strategically correct. The c h alle n ge s a h e a d It would be a tragic error, however, to assume that our domestic and international economic problems are now solved or that monetary policy alone can ever solve them. Although the economy seems poised for recovery, we still have about 5 million people unemployed and a good deal of excess capacity in our industry. Although our balance of trade is exceptionally strong at the moment, with exports up and imports down, a business review significant part of the improvement seems to have been cyclical in character, a result of the boom abroad and recession here. We should be forewarned that gimmicks de signed to avoid the imperatives of international relations could set forces in motion that would weaken our present position. For example, the mere suspicion that we might raise the price of gold from $35 an ounce— in other words, de value our currency— would in all likelihood lead to a wave of speculative activity and a rapid flight of funds. The remedies we seek for our excess unem ployment and our balance-of-payments deficit should be consistent with the kind of world we and our friends and allies have been trying to create ever since the end of the war. We want a world with a maximum degree of freedom for international trade and international investment. Quoting Chairman Martin: One of the worst things that could happen to compound our balance of payments diffi culties would be to adopt a restrictive trade and investment policy. It would wipe out the hard-won gains of years of effort to pro mote freer international exchange. A free flow of international trade has many benefits. We all know of the powerful impact foreign competition has had in inducing our domestic automobile manufacturers to produce the kinds of products consumers evidently de sire. Their response demonstrates what our in genuity can achieve when “the chips are down.” Furthermore, there is a cliche in the lexicon of American politics: “The tariff is the mother of trusts.” I think our recent experience has shown that foreign competition is both a healthy stim ulant to American business and a powerful silent partner of the Anti-Trust Division of our De partment of Justice. Presumed remedies, advocated by some, could be dangerous. Direct controls including higher tariffs, quotas, and exchange controls— all de signed to promote American exports and dis courage imports— would move us away from free, multilateral trade and the increased welfare associated with large volumes of trade. And, of course, our trading partners could retaliate. Be cause we now have a large export surplus, we have more to lose than to gain in such a contest. We know that changes in comparative ad vantages between nations can cause unfortunate dislocations and personal hardships. We should certainly find remedies to ameliorate the eco nomic hardships of these dislocations. But we should not in principle seek a remedy in arti ficially restricted trade. This will not solve our unemployment problem, nor, for that matter, improve our balance-of-payments position. Domestically, as well as internationally, we must eschew rigidities. We shall find our hap pier solutions, I think, in retraining our work force to meet the demands for labor that are currently being made and, generally, in im proving the mobility of both labor and capital. It is my opinion that rigidities in policies and practices throughout our American enterprise system are luxuries that we cannot afford in our dynamic economy. They represent, perhaps, the most serious difficulties we face. In some re spects they underlie the gold outflow, excessive unemployment and even the seriousness of the Soviet menace. The world is changing fast. When we do not adjust to change, we are left behind or act as a drag on the course of events. Policies of in dustry and labor unions— including price and wage policies— may have to be adapted to the changing world society in which we live. Tax and expenditure policies of governmental units 7 business review also can become too unbending. Many policies and practices in use today grew out of responses to the problems of yesterday. Meanwhile, the problems, though they may not all be solved, have changed in form and char acter. All segments of our society should ex amine themselves to see that they have truly adapted to the world as it exists in 1961. Conclusions Let me summarize now some of the points I have been trying to make. The System has been faced with unusual problems in the past year. The System has moved with flexibility toward ameliorating these problems. We have had, we believe, some success. But problems still remain. And the problems that remain are not within the System’s power to solve alone. If we have learned anything in the past ten years it is that monetary policy is not a panacea. It cannot substitute for intelligent decisions elsewhere in the economy— intelligent decisions by Govern ment and by private individuals and groups. Monetary policy is, however, an important com plement to intelligent decisions made elsewhere in the economy. It can reinforce and magnify 8 them and speed the attainment of our goals. I raised a point at the beginning of this talk which I wish to bring up in closing. I said that the past year has tested our ability— the ability of the Federal Reserve System— to adapt its tra ditional ways of doing things to meet the new problems of the day. The System is an organiza tion with traditions that extend deep into our past and, indeed, deep into the past of the Western World. Some critics have complained that these traditions have controlled our outlook and our policies beyond the period of their rele vance and usefulness. At the other end of the pole, some have complained that we have adapted too easily to the irrational pressures of the day. The record in meeting the new com plexities of this year does not support either of those arguments. The fundamental fact that historians and biol ogists alike have pointed out is that all institu tions and all species must adapt if they are to make a contribution— indeed, if they are to sur vive. Adapt, yes, but in accordance with our convictions. We must, in other words, play heads-up ball. We hope that this, too, is one of our traditions. THIS IS OUR HOUSING MARKET Encouraging signs of mild recovery are appear ing in several sectors of the local economy. The important housing market is one such area. We have talked with builders, realtors, and lenders operating in the Philadelphia Federal Reserve District, listened carefully to their analy ses of the current market, and asked the ques tion: “What are 1961 housing prospects in our area?” These same businessmen who predicted a more or less limited market in 1960 now say they look for modest improvement during the current year. But, so far, they see little in the picture to make 1961 another of those wellremembered years of boom activity in home building and home sales. S o m e p ro b le m s a re b e in g resolved As those in the building fraternity see it, some but not all of the problems present at this time last year are in the process of being resolved. Mortgage money is in ample supply, so arrang ing a loan is a relatively simple matter for any one who can qualify for home ownership. Interest rates are becoming more attractive to prospective borrowers on conventional lending. And, what were considered prohibitively high discounts on federally underwritten mortgages are diminishing and some cases have largely dis appeared. . . . others re m ain The basic demand pattern, however, has not changed significantly. Prospective homebuyers still are much too casual. This remains a buyer’s market, say the builders, with lots of lookers, too many of whom go right on looking— almost indefinitely, it seems. In their opinion, this year’s sales market again may depend more heavily on those seeking to upgrade their housing accom modations than on the demand from first-time buyers, much of which originates from newfamily formation. The pace o f n e w -h o u se sa le s is a little faste r Although sales volume has increased somewhat in recent weeks, most builders say the gain is hardly more than seasonal. And the market still is a little spotty, with some operations moving quite well, while others are on the sticky side. Each succeeding weekend, however, brings out more prospective buyers to sample-house loca tions, and an increasing number of sales agree ments to prove that some are more than just interested spectators. Our builders say they car ried few completed houses unsold over the winter, so they are not facing an inventory problem. Over-all, their situation is a healthy one— and they seem determined to keep it that way. 9 business review D e m a n d fo r e x istin g h ouses is im p ro vin g Activity in the used-house market also is gaining some ground. To be sure, just how fast these properties sell depends on location and on the asking price. In all except the older neighbor hoods, where relaxed zoning regulations have permitted commercial enterprises, the demand for existing houses has become seasonally active. The main problem in this area of the market is said to be price. Some owners, in no special hurry to sell, still place an unrealistic value on their properties. Many times, these houses are taken off the market after a short time— an indi cation that sellers as well as buyers are taking a leisurely pace in today’s housing market. Most builders tell us that new-house sales are not being seriously delayed by the sale of an old house, as was the case over much of last year when these properties were experiencing some financing difficulties. Rental d e m a n d is fa ir ly stro n g Relatively few houses are on the rental market this spring, according to most realtors. Some of them speak of a shortage of such listings, with those that are offered being taken up promptly. But this is not the case with apartments, where a somewhat wider choice is offered this year. We have had a lot of apartment house building in the past several years and this market has grown more competitive. Occupancy, however, still is not a serious problem and rents have been well maintained. About the only reports of a weakening rate structure come from agents of converted apartments, particularly in some of the older neighborhoods. Lenders call it a complete turnaround. Conven tional loans still account for the bulk of current lending but the volume of FHA mortgages is in creasing. VA loans are said to be regarded with growing favor, also. Most builders say they are in a position to offer all three types of financing. At present, savings and loan associations and savings banks appear to be the most active among large lenders. Private lenders in some areas also are reported to be making more loans. In the secondary mortgage market the greatest activity seems to be in loans for immediate to 60-day delivery. Futures still are moving slowly. The price of m o r tg a g e m o n e y is low er Rates on conventional loans, which as recently as last fall were quoted in a range of 5% to 6 per cent, have come down to a 5 ^ to 5% per cent range. Brokers speak of the strong pressure of funds seeking investment, particularly in metropolitan areas, but they are not looking for any further easing of rates in the near future. The situation also has improved considerably with respect to discounts on federally insured and guaranteed mortgages. Points charged on FHA loans have all but disappeared where new construction is covered and they are said to have declined sharply on existing properties in good locations. However, the Government order effective May 29 reducing the maximum interest rate on these loans from 5 % to 5^4 Per cent is expected to result in some return to discounting, at least for a time. Lower discounts also are re ported in the case of VA mortgages, particu larly on new houses and those not more than five years old. M o r t g a g e m o n e y h as gro w n plentiful Construction costs still a re risin g Easing in the local mortgage market has been an uninterrupted development during the past year. The trend of building costs continues upward, although less sharply than in some other recent 10 business review years. We hear less now about material prices than we do about wages, land costs, and how expensive site development has become. Average prices of building materials at the national level turned downward in the spring of last year. The long decline seems to have ended in March, with prices near the levels prevailing during the first half of 1958. Our builders tell us essentially the same thing has happened; that material prices locally have been very sensitive to the demand, with the result that this market has seen some fairly wide fluctuations in recent weeks, but little over-all increase. It was quite a different story when builders spoke of the other cost components— wages, land, and building site development. Pressure for higher wages has shown little letup, and many builders in this area are either in the process of negotiating new contracts or will be doing so shortly. Land— that is, desirable land near some of our metropolitan areas— is said to be grow ing scarce and prices are reacting accordingly. Perhaps one of the most persistent cost increases in recent years has been for the development of building sites, which involve cutting through streets, grading, and installing sewer, water, and utility lines. This appears to be about the most difficult area of the cost complex in which to effect economies. B u ild e rs’ p la n s a re fle x ib le A larger supply of mortgage money at lower rates than prevailed last year and a relatively small carryover of unsold new houses seem to have encouraged many builders to draw up plans for starting more houses this year than in 1960. But, based on their experience in the past, they have incorporated into these plans about as much flexibility as can possibly be achieved. Most builders say they have sufficient land to permit a fairly high rate of activity in coming months and are not thinking of adding to their holdings at this time. Implementation of these plans will depend entirely on their market. Projects under way at present are small in nearly all cases, consisting of a sample and maybe a half dozen or so partly finished houses on which work can be speeded or slowed as the sales picture develops. All builders shy at de veloping new sites much in advance of actual construction needs. They say they can increase their rate of output about as fast as any con ceivable situation might warrant. But in the meantime, caution is their watchword and build ing close to the market their established proce dure. MONETARY POLICY: DECISION MAKING, TOOLS, AND OBJECTIVES A new pamphlet published by the Federal Reserve Bank of Phila delphia, is available on request. It is a collection of articles dealing with such topics as the relation between government and the central bank, how policy decisions are made, guides to monetary policy, ad ministration of open market operations and the discount window, and the problem of conflicting objectives. Requests for copies should be addressed to the Department of Public Information, Federal Reserve Bank of Philadelphia, Philadelphia 1, Pennsylvania. ii FO R TH E R E C O R D . . . Third Federal Reserve District Per cent change SU M M A RY mo. ago year ago A p r. 1961 from mo. ago year ago - 2 — 1 0 0 — - C O N S T R U C T IO N * * —1 3 -25 4 mos. 1961 from year ago — — 6 8 5 7 - 3 7 6 5 3 + 3 — 4 - 6 — 6 - 6 Per cent change Apr. 1961 from + Check Payments Stocks Per cent change Apr. 1961 from Per cent change Apr. 1961 from Per cent change Apr. 1961 from i — 5 + 2 — 8 + 4 — 2 + 3 - + 1 0 -12 -15 - - 7 0 — 4 + — 4 + 2 - + + + + + + 6 4 10 1 1 10 2 + + + + + + + 1 1 + 2 0 + 2 + 2 + 1 - 3f + + + + + + 6 + 6 6 + 8 5 + 3 5 + 4 3 + 1 9f + 5t 1 0 + 1 0 + 2 + 2 + 1 -10 ot + •Production w orkers only. ••Value of contracts. •••Adjusted for seasonal va ria tion. It + 2t ]20 C itie s 0 - 5 1 — 1 - 3 - 0 - 6 + 4 - 2 — 13 — 3 - — 2 - + 1 +26 2 — 4 - + 6 + 6 4 10 M 7 4 0 + 1 f Phila de lphia Trenton ........ - 5 1 -1 3 3 - 5 1 — 9 - 2 1 + 3 2 - 1 + 9 6 + 17 - 2 — 1 - 4 - 6 - 1 - 4 -1 5 - 2 - 9 4 - 2 - 1 + 6 2 — 5 - II - 1 - 7 -1 4 + 1 — 2 -1 6 Wilkes-Barre . - 2 - 6 - 1 - W ilm ington .. 0 - 8 - 2 — 4 York ............ - 1 - 3 1 + + + - 2 + 8 -II 4 - 9 + 4 2 + 2 P R IC E S 0 0 2 - Scranton ..... — 19 0 — 4 - Reading ..... —1 9 Lancaster .... Philadelphia . — 4 3 0 year ago — 10 + — 2 — 7 — 2 — 8 T RA D E*** Department store sales . . . Department store stocks .. Per cent change Apr. 1961 from LOCAL CHANGES Sales 7 C O A L P R O D U C T IO N W h o le s a le ....................... C o n su m e r ....................... Payrolls mo. year mo. year mo. year mo. year mo. ago ago ago ago ago ago ago ago ago M A N U F A C T U R IN G Production ......................... Electric power consumed. Man-hours, total* ........... Employment, total ........... W a g e income* .................. B A N K IN G (A ll member banks) Deposits ............................. Loans ............................. Investm ents .................... U.S. G o v t, securities ___ O th e r ........................... C h e ck p a y m e n t s .............. Department Storet Employ ment Per cent change 4 mos. 1961 from year ago A p r. 1961 from Fa cto ry * United States +29 2 — 4 - — 8 + 8 + 2 + 19 1 + •N ot restricted to co rp o ra te lim its of cities but cove rs areas of one or m ore counties. tA d ju ste d for seasonal variation. 8
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