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January 30, 1976 Economy Up. . . Deficit Down ? Despite their sober tone, the Ad ministration's two basic economic documents—the Federal budget and the President's Economic Report—make for somewhat cheerier reading than their prede cessor documents of a year ago. According to the Economic Report, the nation's economy is "steadily growing healthier" although it will still take "several years of sound policies to restore sustained nonin flationary growth." Here are the key elements of the forecast: . • • • Real GNP, after two back-toback years of 2-percent de cline, should rise by a healthy 6to-61/2 percent in 1976. Price inflation should deceler ate from 9 percent last year to 6 percent in 1976. The unemployment rate should fall almost a full percentage point, close to a 71/2-percent average for this year. According to the Budget report, expansion at this rate should bring about an 18-percent increase in Treasury receipts next fiscal year. The result would be a reduction in the Federal deficit from around $76 billion in fiscal 1976 to $43 billion in fiscal 1977, if Congress accepts the Administration's tax and expenditure proposals. (Inci dentally, the fiscal '76 deficit was first estimated at $52 billion a year ago.) The deficit is expected to be cut in half again in fiscal 1978, and the red ink is projected to give way to black in the 1979 budget. This would represent only the third Treasury surplus since 1960. In terms of its impact on the econo1 my, the budget is expected to shift from stimulative toward re strictive over the next year or so. Economy: towards recovery In its general outlines, the recov ery is seen from Washington as being steady and consistent, rather than vigorous or exuberant. Considering the fact that the longrun sustainable rate of growth in real output (at full employment) is generally estimated at about 4 percent, the stronger growth of the 1976-77 period will not make up all of the ground lost in the past two years. The recovery to date has depended almost entirely upon the con sumer, and the Council of Eco nomic Advisers expects continued stimulus from that source in 1976. Because of inflation's in roads, consumer after-tax purchas ing power fell nearly 5 percent between late 1973 and early 1975, but it then rebounded sharply, as the Federal tax cut and an upsurge of nearly V/i million jobs reinforced a near-halving of the late-1974 inflation rate. Another factor helping to support the belea guered consumer was an increase in net wealth positions, largely because of the recovery in the stock market. The consumer re sponded with a will to this upturn in his fortunes, so that real spend ing increased 4 percent last year. With conditions continuing to improve in 1976, the Council expects a somewhat higher 6percent gain, with autos and other durable goods showing consider able strength. (continued on page 2) Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco, nor of the Board of Governors of the Federal Reserve System. Housing and business spending should contribute at least modestly to the 1976 upturn, in the Coun cil's view. Homebuilding's drastic shakeout meant a 62-percent decline in new housing starts from the early 1973 peak, and the 1975-76 recovery may offset only a p or tion of that decline because of rapidly rising construction costs and over-building in some areas. Still, with mortgage-lending insti tutions bulging with funds and with after-tax income increasing on modernization of equipment rather than spending for struc tures. (In contrast, a recent Commerce Dept, survey indicated a continued decline in real plantequipment spending this year.) Spending should be concentrated among manufacturers of nondu rable goods, such as food, chemi cals and petroleum—and also among utilities, where long-term capacity needs appear to be substantial. perhaps 11 percent, new starts Budget: balancing act could rise from 1.3 million to 1.75 million units over the course of the year. The improvement should be centered in the now-depressed multi-family sector of the market. The major item of interest in the President's Budget—and possibly the chief source of contention with Congress—is the proposal to balance a $28-billion tax cut with an equal reduction from the spending level that earlier trends would indicate. This would mean only a 51/2-percent growth in Federal expenditures—about half of the past decade's average rate of increase. Most of the slowdown would show up in nondefense programs, which nearly doubled in cost between 1972 and 1976. Businessmen ran off inventories at a record rate in 1975 and the use of industrial plant languished accordingly. Then, as the inventory-liquidation process ended, the utilization rate in manufacturing rose from about 65 percent at the lowpoint to 70 percent by year's end. This was still well below the "preferred" or most profitable rate of operation — about 85 percent — but with production expanding and with operating profits rising 25 percent in 1976, corporations may feel growing pressures to boost capital spending. In the Council's view, plant-equipment spending could rise 4 to 5 percent in real terms in 1976, compared with last year's 10percent decline, with the emphasis 2 The proposed tax changes are fairly direct in their intent. These changes are designed to take effect next July 1, upon the expiration of last year's tax-cut bill. The reduc tions would be partially offset by $6.5 billion of increases resulting from boosts in social-security taxes and in employer-financed unem ployment taxes. Of the total tax- reduction package, consumers would gain $22 billion and corpo rations $6 billion. Consumers and corporations The tax cuts for individuals would take the form of an increase in the personal exemption, the substitu tion of a (higher) flat standard deduction for the low-income allowance, and a reduction in tax rates. The obvious intent is to place more after-tax income in the hands of consumers, to give added strength to a sector which has been the mainstay of the recovery. In addition, the Administration pro poses a tax deferral on long-term ownership of common stock (7 years), to induce broader owner ship of equity securities and presum ably to encourage more corpora tions to finance through the equity route. For corporations, the Administra tion proposes making permanent the tax-rate reduction and invest ment tax credit enacted in the 1975 legislation. Additionally, it pro poses reducing the top corporate tax rate from 48 percent to 46 percent, and granting tax relief to electric utilities, which have expe rienced grave problems in obtain ing funds from either internal or external sources. Apart from these explicit tax reductions, the Budget contains a number of proposals—“ tax ex penditures/' or incentives to en courage economic activity in specific sectors—which would also result in reduced taxes for individ uals and corporations. One of these is a new tax credit for financial institutions against interest in come received on residential mortgages. This proposal resembles the tax deferral for individuals who hold common stock long term, in that it would broaden a specific segment of the capital market. Another incentive is de signed to foster the construction of new facilities or the expansion of old facilities in areas of high unem ployment, utilizing accelerated depreciation and the investment tax credit. This type of tax expendi ture would involve an initial loss in Federal tax revenue in order to create jobs and reduce unemploy ment over the long-term. Altogether, 1976 may be a rela tively easy year to forecast, since the consensus is for continued re covery and the differences in outlook are concerned only with the speed of expansion. The Administration forecast may be towards the top of the present range of forecasts; nonetheless, it appears to be readily achievable. The fate of the Administration budget may be more uncertain, since seldom do budgets leave Capitol Hill in precisely the same form that they went up. There is still much truth to the aphorism that “ The Administration proposes and Congress disposes." Herbert Runyon 3 l— =3 uoiSujqsEyVX • qeif) • uoSaJO • EpEA9|\| . oqepi MEM EH . E |U J O p |B 3 . EUOZUy • IQPJ * jf;|E 3 'O D S p U E J J UBS ZSL ON IlW H d aivd 3DVlSOd s r i HVW SSV1D LSHIJ BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT (Dollar amounts in millions) Amount Outstanding 1/14/76 Change from 1/07/76 Loans (gross, adjusted) and investments* Loans (gross, adjusted)—total Security loans Commercial and industrial Real estate Consumer instalment U.S. Treasury securities Other securities Deposits (less cash items)—total* Demand deposits (adjusted) U.S. Government deposits Time deposits—total* States and political subdivisions Savings deposits Other time depositst Large negotiable C D ’s 89,166 65,540 1,048 23,625 19,669 10,322 10,938 12,688 89,774 24,888 487 63,011 7,738 22,965 29,133 14,726 595 516 - 459 + 32 18 + 17 18 61 - 1,448 - 420 169 435 + 12 + 348 - 424 832 Weekly Averages of Daily Figures Week ended 1/14/76 Selected Assets and Liabilities Large Commercial Banks 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 year ago Dollar Percent + + + + + + + + + - 2,057 2,231 561 1,140 448 363 4,634 346 5,256 1,378 155 3,689 221 4,566 865 1,791 Week ended 1/07/76 + + + + + + + + + - 2.36 3.29 34.87 4.60 2.23 3.64 73.51 2.65 6.22 5.86 46.69 6.22 2.94 24.82 2.88 10.84 Comparable year-ago period 1 0 1 + 97 0 97 + 960 + 708 + 1,653 + 481 + 703 + - - 12 21 9 977 "“Includes items not shown separately. ^Individuals, partnerships and corporations. 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) 397-1137. B>|S E|V
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