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August 6,1976 No Double Digits? Some pessimistic analysts argue that inflation will approach double-digit figures again in 1977, as underlying cost and capacity pressures in man ufacturing industries push upward against the price indexes. In con trast, the consensus forecast is that inflation rates will remain in the neighborhood of 5-6 percent dur ing the year. According to this line of thought, strong cost-push and capacity pressures may arise in a number of industries—especially the basic materials industries—but these conditions will not be perva sive enough throughout the econo my to push the overall inflation rate to the double-digit level. Prices rose at a slower pace in the first half of 1976 than at any time since 1972, when wage and price controls hid the actual cost pres sures underlying the economy. The GNP deflator, the broadest measure of price change, rose at a 3.2percent annual rate during the January-March quarter and at a 4.7percent rate during the April-June period—quite moderate rates in the context of the past several years. The unexpectedly low firstquarter figure reflected declines in food and energy prices, and the second-quarter rise came about as food prices rose again and energy prices leveled off. The wholesale price index obvious ly decelerated during the first half of this year. Industrial commodities, which account for more than threefourths of the total index, rose at a 3.0-percent annual rate during the recessionary first half of 1975 and at Digiti zed for F R A S E R a 9.4-percent rate during the earlyrecovery period of second-half 1975, but the rate then decelerated to 3.4 percent as the recovery con tinued over the first half of 1976. At wholesale, consumer food prices actually declined at a 3.6-percent rate over the past half-year, and finished non-food consumer goods prices rose at only a 1.4-percent rate—thereby indicating considera bly reduced pressures on retail con sumer prices. And despite highly publicized price increases in certain industries, such as steel and nonfer rous metals, countervailing forces in other industries have acted to moderate the overall rate of infla tion in industrial prices. Moderate labor pressures Reductions in labor cost pressures help account for these favorable developments. Unit labor costs in manufacturing, which rose sharply during the recession, have declined at a 2.6-percent annual rate since the early-1975 trough in business activity. By now the trend is upward again, but even so, the annual rate of increase in the second quarter of this year amounted to only 3.2 percent—just a fraction of the in creases recorded in 1974 and early 1975. This improvement can be traced to solid growth in productivity, with hourly manufacturing output per worker rising at a 10.3-percent an nual rate since the spring 1975 re cession low. Although productivity growth has recently slowed, output per hour still rose at an annual rate of 7.8 percent during the second (continued on page 2) Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Rank of San Francisco, nor of the Board of Governors of the Federal Reserve System. quarter—far higher than both the strong first-quarter pace and the long-term trend of productivity growth. Labor-settlement increases during the recovery meanwhile have de celerated, holding down the rate of increase in hourly compensation. When 1976 opened, large settle ments seemed in prospect as organ ized labor sought to compensate for the prior decline in its real wages attributable to sharply rising living costs. Moreover, the likeli hood of strong cost-push pressures seemed particularly great, in that major contracts covering 4.4 million workers were up for renegotiation, compared with the 2.5 million in volved in 1975 contracts. As it turned out, contracts negotiat ed in the second quarter called for first-year wage increases averaging 8.2 percent, somewhat less than the settlements reached during the first quarter and far less than the 10.2percent first-year rise granted in contracts negotiated during 1975. Despite the “ uncapped” cost-ofliving escalator in the new Team sters contract, that settlement and the equally important electricalworkers settlement set a relatively moderate pattern, which may be copied in the autoworker and other important upcoming contract ne gotiations. Apparently, with infla tion decelerating, fewer pressures have arisen for big wage settle ments and—another aspect of this beneficent spiral—fewer automatic wage increases have resulted from slowly rising price indexes. Digitized for F R A S E R Moderate capacity pressures Capacity restraints still represent little threat to the overall price level. By the second quarter of this year, the rate of capacity utilization in the manufacturing sector had risen to 73 percent—substantially above the cyclical low of 67 percent but still more than 10 percentage points below the peak reached in 1973, when shortages and produc tion delays generated intense up ward price pressures. In the materi als industries, the operating rate was somewhat higher on average— 81 percent—with some industries such as paper and steel producing at around 90 percent of effective capacity. But the overall operating rate for this group of industries was also well below the prior peak of 93 percent reached in 1973, and sever al industries—such as copper— were known to be operating well below the group average. Nonetheless, the potential does ex ist for significant price increases in those industries where market con ditions will be strong enough to support higher prices, and where a higher rate of return is required to finance necessary expansion in plant and equipment. Many firms are still trying to overcome financial problems generated by the reces sion. The basic materials industries, especially the metals, were among the hardest hit during the reces sion, because the demand for their products was adversely affected not only by a slowdown in consump tion but also by a huge wave of inventory liquidation. For example, steel-mill product shipments dropped 28 percent during 1975, and nonferrous metals experienced similar declines. Despite an appreciable decelera tion in cost increases during 1975, these industries were still unable to improve their profit margins or rates of return on investment, and the slippage for some continued into 1976. During the first quarter of 1976, profits per dollar of sales in primary-metals industries were only 3.5 cents, while their return on stockholders' equity was only 7.1 percent—in both cases, less than one-half the levels reached in mid1974. The recent series of price increases in steel and nonferrous metals thus can be understood in terms of their attempt to recover from a severe profit squeeze. More action in ’771 Looking towards 1977, industry ob servers visualize a rise in the cost of some basic materials such as steel, and consequently a rise in the price of many manufactured goods in which those materials are utilized. This does not mean, however, that the overall inflation rate will accel erate significantly next year. To date, supply conditions in only a few manufacturing industries seem tight enough to generate bottle neck pressures over the next year or so, while the outlook is also favorable for significant labor pro ductivity growth, ample food sup plies and relatively stable energy prices. Private nonfarm productivity should continue rising at a good 3 Digitized for F R A S E R pace—especially if capital-goods production begins to pick up, fore stalling incipient capacity pressures and boosting the rate of real eco nomic growth. In fact, the behavior recorded during comparable stages of previous recoveries suggests that the growth of private nonfarm pro ductivity should continue to exceed the long-term trend value of 2-3 percent for several more quarters. Eventually, as the recovery matures, productivity growth could moder ate, but with labor compensation rising slowly as it has this year, in creases in unit labor costs should not rise much beyond recent bounds. Increases in farm-product prices also may be held to a relatively low rate. Despite drought conditions in certain parts of the nation, total supplies of grain and other crops should be ample to meet demand, even if exports remain strong. Simi larly, large supplies of livestock could help hold prices down in that commodity group. In view of the OPEC cartel's recent decision to hold prices stable throughout 1976, energy prices also may increase at a relatively slow pace. In summary, given the present lack of bottlenecks and the moderate pace of activity in the U.S. econo my, cost pressures may continue to remain relatively weak. Thus, it seems difficult to make a case for a resurgence in 1977 of the double digit inflation rates witnessed dur ing the 1973-74 period—unless pressures are generated in the rest of the world through the higher cost of internationally traded goods. Yvonne Levy ucnSujqsEM • L|Bjfi . uoSaJO • epeAON • ogepi M BM BH . B J U J 0 ;P | B 3 . B U O Z IJy • E > |S E |V •|i|E3 'oaspuejj u es I S L ON ilW ltfd a iv d d D v is o d nvw SSV1D s n IS HU P©IUfflpTB<dI®(Q[ Hpjn8©8®^[ BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT (Dollar amounts in millions) Selected Assets and Liabilities Large Commercial Banks Amount Outstanding 7/21/76 Loans (gross, adjusted) and investments* Loans (gross, adjusted)—total Security loans Commercial and industrial Real estate Consumer instalment U.S. Treasury securities O ther securities Deposits (less cash items)—total* Demand deposits (adjusted) U.S. Government deposits Time deposits—total* States and political subdivisions Savings deposits O ther time deposits:): Large negotiable C D ’s 88,577 66,685 1,411 21,984 20,211 11,266 9,607 12,285 89,520 24,945 574 62,289 6,012 26,450 27,237 12,070 Weekly Averages of Daily Figures W eek ended 7/21/76 Member Bank Reserve Position Excess Reserves Borrowings Net free(+)/Net borrowed (-) Federal Funds—Seven Large Banks Interbank Federal fund transactions Net purchases (+)/Net sales (-) Transactions of U.S. security dealers Net loans (+)/Net borrowings (-) - Change from 7/14/76 + + + + - 264 207 48 194 45 48 41 16 484 852 314 256 103 96 168 343 Change from year ago Dollar Percent + + + + + + + + + + + - + 3.46 + 3.88 +106.59 - 4.90 + 3.09 + 12.40 + 15.21 - 6.11 + 5.67 + 8.15 +124.22 + 3.74 - 7.48 + 27.36 - 6.10 - 21.64 2,959 2,491 728 1,132 606 1,243 1,268 800 4,807 1,880 318 2,243 486 5,682 1,770 3,333 W eek ended 7/14/76 Comparable year-ago period - 18 1 19 + 46 3 43 - + 92 + 845 + 1,462 + 259 + 679 + - 1 6 7 223 ■ “ Includes items not shown separately. ^Individuals, partnerships and corporations. Editorial comments may be addressed to the editor (William Burke) or to the author. . . . Information on this and other publications can be obtained by calling or writing the Public Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120. Phone (415) 544-2184.
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