Full text of Economic Quarterly (Federal Reserve Bank of Richmond) : March-April 1975, Vol. 61

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THE DISTRICT ECONOMY
IN PERSPECTIVE: 1974
The past year marked a period of intensifying economic problems for both the national and the Fifth
District economies.
Widespread unemployment and
layoffs, depressed consumer demand for durable
goods, and distress in construction markets were only
a few of the many developments that influenced the
pattern of economic behavior during 1974. Because
the District economy is widely diversified and broadly
based, it is usually more resilient than the national
economy to the effects of either a general economic
slowdown or isolated pockets of depressed economic
activity. This resilience helped to buffet the District
somewhat against the turbulence in the national economy during 1974. A closer look at the individual
sectors of the Fifth District economy will provide a
more complete perspective on developments over the
past year.
THE EMPLOYMENT

PICTURE

On a seasonally adjusted annual basis, nonagricultural employment statistics declined marginally in the
nation and the District during 1974. In December,
total employment in the District was down 0.3 percent from a year ago. The manufacturing sector felt
the brunt of the employment declines, posting 5 to 7
percent decreases in each state.
The District of
Columbia showed a 6 percent increase in manufacturing employment, but manufacturing is relatively unimportant in D. C. Results of the monthly survey1
of District business conditions suggest that decreases
in manufacturing
employment strengthened toward
year-end. Numerous respondents continued to report
investment cutbacks, elevated levels of finished goods
inventories, and declines in the volume of new orders
and order backlogs. All of these developments were
directly attributable to the general decline in economic activity.
Perhaps an equally important measure of activity
in the manufacturing sector is man-hours.
The District man-hour index suffered a sharp decline of 12.5
percent in December over a year earlier, with an
8.6 percent decrease in durables and a 13.6 percent
1 The
ducted
Bank
retail

Fifth District Opinion Survey of Business Conditions is conmonthly by the Research Department of the Federal Reserve
of Richmond.
Respondents
represent
manufacturing
and
industries throughout the District.

reduction in nondurables.
These figures reflect the
substantial contraction in the man-hour index that
characterized the second half of 1974, a contraction
of even sharper magnitude than during the 1971
slowdown in economic activity.
Year-to-year,
the
man-hour index in December was off 15 percent in
South Carolina, 14 percent in North Carolina, 10
percent in Virginia, 9 percent in Maryland, and 6
percent in West Virginia. The District of Columbia
registered a 1 percent increase. Reductions in nondurables man-hours were most prevalent in Virginia
and the Carolinas, while in West Virginia and Maryland declines were centered in durables industries.
An increasing number of survey respondents have
reported declines in hours worked per week since
mid-1974.
Of the firms surveyed in January, over
half reported shorter workweeks, with the textile
and furniture industries experiencing the sharpest
slowdowns.
Nonmanufacturing
industries fared better than
manufacturing over the past year, with average employment for the District up 1.7 percent. Only West
Virginia experienced a minimal decline in the nonmanufacturing
sector.
A closer look at the major
categories of nonmanufacturing
employment illustrates the relative strength of each.
Apart from
manufacturing, government is the leading source of
jobs in the District.
In December, Federal, state,
and local governments supplied 1,628.6 thousand jobs
or 22 percent of the District’s total nonagricultural
employment.
The 4.5 percent expansion of government employment during 1974 exceeded both the
1972 and 1973 gains. Individual advances in government employment by states were : 8 percent for South
Carolina, 6 percent for North Carolina, 5 and 4
percent, respectively, for Maryland and the District
of Columbia, 3 percent for Virginia, and 1 percent
for West Virginia, which showed a decline last year.
As the third largest source of nonagricultural
employment, the wholesale and retail trade sector accounted for 20 percent of the District’s employment
in December, off 0.3 percent from a year earlier.
State statistics ranged from a decline of 3.7 percent
in North Carolina to an advance of 2.4 percent in
South Carolina.

FEDERAL RESERVE BANK OF RICHMOND

3

The services sector, with 16 percent of the employment in nonagricultural industries, posted a 3.6 percent employment jump in December over a year
earlier.
Each state showed substantial increases in
service-related
employment except West Virginia,
which experienced a minimal decline.
There were significant pockets of unemployment
throughout the District economy over the past year.
Rates of unemployment in the District states varied
over a wide spectrum during 1974.2 State unemployment statistics for December were: North Carolina, 9.3 percent; South Carolina, 8.3 percent; West
Virginia, 7.3 percent ; Virginia and the District of
Columbia, 5.2 percent ; and Maryland, 5.1 percent.
Survey responses in January revealed growing unemployment and numerous plant closings across the
District, with the greatest slowdowns in the textile
and furniture industries.
Although no state rates
exceeded North Carolina’s 9.3 percent, several cities
and counties experienced unemployment in excess of
10 percent.
CONSTRUCTION

HIGHLIGHTS

Total new construction put-in-place in the U. S.
declined by 1.2 percent from December 1973 to
December 1974, with the small rise in the first half
more than offset by the decline in the second half.
Strong deposit outflows from thrift institutions contributed to reduced mortgage lending and skyrocketing mortgage rates during most of the year, although
improvement in both flows and rates was evident in
the fourth quarter.
The problem was compounded
by consumer resistence to escalating property and
construction costs, resulting in a 39.3 percent plunge
in U. S. housing starts during 1974. The level of
housing starts in December was the second lowest
for any month in the post-World
War II period.
As the factors of distress in the U. S. housing market
permeated the District over the year, the District’s
index of construction contract awards began to plummet. In December the index stood 10.4 percent below
a year earlier, with South Carolina suffering the
brunt of the overall decline.
Most District states
showed gains in nonresidential
construction ; only
South Carolina posted a decline. All states, with the
exception of the District of Columbia, however, registered declines in the residential sector over the year,
with the steepest decline in Maryland. Actual figures
for the change in the index of construction contract
awards by state for the year were -18.9 percent in
2 Because
state

4

of discrepancies
reporting and
rates are
completely

comparable.

procedures,

ECONOMIC

percent
trict

Carolina, -10.3
in Virginia,
in
Carolina, -7.3
in West
and -1.1
in Maryland.
DisColumbia registered
12.2 percent
AGRICULTURE

A

look at
shows a
in which
Fifth District
fared better
was charnationally.
While
to balance
own checkbooks
the face
mounting inflation,
farmers were
with sharply
fuel, fertilizer,
feed prices
unfavorable growconditions in
areas of
District.
But
farmers generally
not subjected
the
extremely
growing and
conditions
that
farmers in
other parts
the
nation.
the whole,
seems to
been a
good year
the District
markedly
better
many respects
the national
but not
repeat of
District’s banner
of 1973.
the many
that persisted
out 1974,
crop production
general averbetter than
in the
Sharply higher
prices combined
the slightly
production
to result
a 25
increase in
trict crop
in 1974
a year
State
increases
crop receipts
from a
of 38
in South
to a
of 19
in
North
The overall
in crop receipts
reflects a sharp advance in tobacco incomes, as tobacco prices soared and production levels increased
slightly. The gross sales value of the 1974 flue-cured
tobacco crop was the largest on record, topping the
1973 level by 27 percent.
In contrast to the crop sector, which fared well this
past year considering the general economic climate,
the livestock sector experienced a marked slowdown
during 1974. The prevailing factors that influenced
the District’s livestock market throughout the year
were the soaring price of feed and very low livestock
prices, which combined to cause a severe cost-price
squeeze.
District livestock slaughter (weight figures) rose sharply over the year, with hog slaughter
leading the increase.
However, the markedly lower
livestock prices more than offset these increases, resulting in a 6 percent decline in District livestock
receipts.
Each state experienced a decline in cash
receipts from the livestock sector, ranging from 3
percent in Maryland to 8 percent in South Carolina
and West Virginia.

REVIEW, MARCH/APRIL

1975

The declines in the livestock sector were more than
offset by gains in crop receipts, resulting in higher
cash receipts from total farm marketings in the District last year. The total cash receipts figure was up
10 percent above a year earlier, with South Carolina
leading the gain. One additional factor that should
lend encouragement
to District farmers is the fact
that during 1974 the value per acre of farm real
estate continued to climb throughout
the District,
though some slowing in the rate of increase was
evident during the latter part of the year.
BANKING

DEVELOPMENTS

1974 statistics for member banks in the Fifth
District clearly reflect the strong demand that characterized the year. The bank debits index rose 25
percent during the year, exceeding last year’s large
gain. Increases were reported in each state, ranging
from a low of 17 percent in West Virginia to a high
of 39 percent in Maryland. Unusually strong business
loan demand resulted in a dramatic increase in loans
and discounts by District member banks. At $23.6
billion in December, loans and discounts were up 11
percent over a year earlier, a figure that would have
gone much higher if business loan demand had not
abated somewhat in the fourth quarter. In the investment category, District banking activity was mixed,

with holdings of U. S. Government obligations declining 15 percent to $1.7 billion and other security
holdings climbing 9 percent to $6.2 billion,
Total
assets of member banks in the District were $38.2
billion in December, up 12 percent over 1973. By
states, total assets on the last Wednesday in December posted the following year-end increases : West
Virginia, 24.3 percent;
Maryland,
18.2 percent;
South Carolina, 14.6 percent; District of Columbia,
11.0 percent ; North Carolina, 10.8 percent ; and
Virginia, 10.0 percent.
District member banks also experienced sizable
deposit expansion during 1974. Total member bank
deposits in December were $31.2 billion, 12 percent
above a year earlier.
Total deposit gains by state
were 19.4 percent in West Virginia, 12.4 percent in
South Carolina, 12.3 percent in Virginia, 12.1 percent
in the District of Columbia, 11.4 percent in North
Carolina, and 10.1 percent in Maryland.
Demand
deposit volume spurted 11.6 percent over the year
while time deposit volume grew slightly slower at
9.7 percent. Demand deposit gains by state ranged
from a low of 7 percent in South Carolina to a high
of 22 percent in West Virginia ; time deposit gains
varied from the District of Columbia’s low of 6
percent to South Carolina’s high of 21 percent.

FEDERAL RESERVE BANK OF RICHMOND

B. Gayle Ennis

Medical Care:
Rising Cost in a Peculiar Marketplace
When told that he needed to be hospitalized for
approximately
two weeks and that a semiprivate
hospital room would cost $115 per day, the obviously
ill and elderly gentleman replied, “it would be
cheaper for me to die because they can bury me for
less than $1,000.”
This gentleman is joined by many other Americans who genuinely feel that they “cannot afford to
live” if it means paying for the steadily increasing
cost of medical care. Routine visits to the family
doctor now cost more than $10 in many metropolitan
areas ; one day of hospital care costs more than $100 ;
a thorough physical examination costs up to $125;
and an excess bed in the hospital-one
sometimes
used but one the hospital could do without-costs
a
hospital on an average of $18,250 per year to maintain.
According to preliminary figures, Americans spent
$62.7 billion on medical care in fiscal 1973, which

amounted to 7.8 percent of our total personal consumption expenditures (See Table I). The average
amount spent per capita for medical care was $298nearly $24 more than the amount spent in the previous year. The medical care component of the Consumer Price Index increased from the 1973 average
of 137.7 to 154.1 by midyear 1974, an increase of
10 percent.
As expected, the rapid rise in the cost of medical
care has produced strong pressure for a number of
palliatives.
Such palliatives have included a variety
of health manpower programs, incentive programs to
encourage managerial efficiency, hospital utilization
review programs,
a federally mandated program
in which physicians oversee the cost and quality of
care provided by other physicians, and, last but not
least, a national health insurance program. Proposals
for national health insurance plans have been put
forth by such groups as organized labor, the Ameri-

Table I

RATIO

OF PERSONAL CONSUMPTION
EXPENDITURES
FOR MEDICAL
TO DISPOSABLE PERSONAL INCOME AND TO TOTAL
PERSONAL CONSUMPTION
EXPENDITURES
UNITED STATES

*Includes
Source:

6

expenses
Survey

for

health

of Current

insurance.
Business, U. S. Department

of Commerce.

ECONOMIC

REVIEW, MARCH/APRIL

1975

CARE

can Hospital Association, the health insurance industry, the U. S. Chamber of Commerce, the President of the United States, various Congressmen, and
even the American Medical Association.
Most of
these proposals call for relieving the poor of all costs
of medical care. The proposals vary, however, on
such matters as participation by private insurance
companies, method of financing, control and operation by government, extent of coverage, and the
part of the bill to be paid by persons seeking medical
service.
Most of the sponsors of national health insurance
proposals agree that the present system of financing
medical care has glaring defects. The poor are inadequately covered despite Medicaid and Medicare ;
middle-income persons find it difficult to buy health
insurance that meets their needs and often end up
with coverage that encourages overuse of hospitals
and discourages preventive care ; and catastrophic
medical bills associated with prolonged or acute illnesses are inadequately covered by private health insurance and can bankrupt even those persons in the
higher-income brackets.
While the enactment of a national health insurance
bill may still be months away, if not years, the extensive discussion of the matter and the variety of proposals reflect a consensus on the need for an improved health care system. It may not be inaccurate
to say that Americans are healthier than ever, particularly if we take the steady aging of the population
into account. The fact remains, however, that many
families are threatened with bankruptcy in trying to
pay for prolonged illnesses; many people are forced
to pay $100 or more a day for hospitalization; many
persons are compelled to pay higher prices for drugs
under the brand name, when the equivalent drug can
be purchased at a lower price under the generic name
(See Table II) ; and many persons, mostly in the
lower-income brackets, are not covered by private
health insurance or one of the medical programs sponsored by the Government.
In purchasing most other
goods and services, the American consumer can police the market by shopping around, but this applies
far less to medical services. The average consumer
knows less about medical services than almost any
other service he pays for.
The rising cost of medical care is difficult to explain. Recent increases in the price of petroleum,
natural gas, coal, and sugar can be explained by the
simple analysis of showing that the rate of demand
for these items is increasing faster than the rate of
supply. In the case of medical care, however, such
factors appear less evident.
For example, if one
views the occupancy rate for hospitals as evidence of

Table II

WHOLESALE PRICES OF BRAND
AND GENERIC DRUGS*

NAME

*Average
wholesale
prices to pharmacist
and range
prices listed in Drug Topics Red Book, 1973 edition.
†Price

per

1,000;

other

prices

per

of

generic

100.

demand for hospitals, there is no question but that
the demand is decreasing.
Yet the price or charge
for a hospital room is increasing rapidly. Also, while
the occupancy rate in hospitals is declining, the
number of hospital beds is steadily increasing.
In
the case of physicians’ services, the marketplace is
equally difficult to explain. In the first place, physicians are able to determine the demand for their
own services. Also, experience shows that the price
for physicians’ services is steadily increasing despite
the increased supply of physicians relative to the
population (See Figure 1).
Ideally, the consumer-preferences
and supply capabilities interact in the free market to determine the
price and amount of the commodity consumed ; and
this reaction leads to the most efficient use of resources. In the case of medical care, however, distortions in the market occur because, on the demand
side, consumers are not always able to judge the
adequacy of the service, and on the supply side,

FEDERAL RESERVE BANK OF RICHMOND

7

Table

CONSUMER

PRICE INDEX

MEDICAL

CHANGES

Report

of the President,

January

1972, p. 136.

Table

KEY FACTORS

1 Adjusted
Source:

8

to account
“Hospital

for

the

Indicators,’

volume

of

Hospitals,

outpatient
midmonth

FOR MEDICAL

CARE SERVICES AND PHYSICIANS’

competition is often limited by restrictions on entry
into medical practices and hospital services1 Granted,
these restrictions may be intended to protect consumers, but they have the unfortunate side effect of
impeding the efficient utilization of resources.
In
addition, the dominant position of nonprofit organizations in the market for providing hospital services
raises other questions about whether incentives to
minimize costs are as great in medicine as in other
areas of the economy.
1Economic

III

IN HOSPITAL

CARE,

FEES

DEMAND

FOR MEDICAL CARE

Rising levels of education, widespread public information about progress in medical science, and the
desire to reflect a higher standard of living contribute
significantly to increasing general public awareness of
health and medical needs in America today.
This
awareness stimulates a growing desire for health and
medical care, and brings about growing realization
of the benefits achieved for individuals and the community by maintaining a high, rising level of health
through effective medical care and preventive health
measures.

IV

OPERATION,

1967-1973

visits.
issues and

ECONOMIC

unpublished

data

from

REVIEW, MARCH/APRIL

the American
1975

Hospital

Association.

While medical care is only one factor contributing
to health, it is often a critical factor-sometimes
a
matter of life and death.
Chronic illness and disability are increasingly regarded as avoidable and
death as postponable.
Thus society has come increasingly to the view that adequate medical care is a
basic right, neither to be denied nor treated as a
charity to those who are financially disadvantaged.
This attitude often raises the problem of distinguishing between the need for medical care and the
demand for such care. The need in this case may be
subject to individual assessment, but demand is a
measure of financial ability and willingness to meet
the needs.2
In a free enterprise system prices are often assumed
to reflect the conditions of demand and supply. Accordingly, one might assume that the rapid rise in
the price of medical care during the past several years
indicates a more rapid increase in demand for medical
services than in supply. Unfortunately
for purposes
of analysis, the demand for medical care cannot be
measured directly.
Consequently, most analysts use
data related to utilization of medical resources or
medical expenditures to measure demand indirectly.
Utilization data include factors associated with hospital care and services of physicians.
Medical care
expenditure is a function of the price of goods and
services used in medical care, range of services,
supply of facilities and personnel, and the state of
medical technology.
Neither the utilization of medical resources nor medical expenditures are measures
of demand in this case. Instead, they are the result
of the interplay of demand and supply.
In most instances, the demand for medical care
originates with the individual.
The decision to seek
care-which
usually begins with a visit to a physician
-will
depend in part on: (1) the person’s underlying state of health; (2) his perception of the need
for medical care; (3) the cost of obtaining the
care ; and (4) his resources to pay for such care.
Recently, this demand has been reflected by rapid
growth in hospital and nursing home expenditures,
with outlays for physicians’ services and other components of medical care rising more slowly as shown
in Table III.
I. Hospital Care Hospitals are the focal points of
medical science and medical services.
Many of the
advances in medical science are initiated and confirmed at hospitals.
Hospitals form the core of the
2 Markley Roberts, “Trends in the Supply and Demand of Medical
Care,” Study Paper #5. Materials for Consideration
by the Joint
Economic Committee, 86th Congress, 1st Session, November 10, 1959,
p. 49.

growing centralization
of medical practice because
physicians prefer the backup of the hospital’s resources for sophisticated diagnosis and treatment.
Also, American people increasingly demand hospital
services for diagnosis and treatment of disease, as
well as for preventive medicine and community health
education.
However, along with this growing utilization of hospital facilities, the demand for certain
hospital services appears to be associated with a
number of peculiar developments in the marketplace
for such services.
Utilization and Price
Although hospitals have
become the focal point of medical care services,
certain measures of the demand for hospital services
have shown a steady decline during the past several
years. The occupancy rate, for example, has declined
steadily since 1969; the average length of stay has
decreased each year since 1970; and the rate of
increase in the number of inpatient days has fallen
ever since the end of the initial impact of the Medicare program in 1966 (See Table IV).
Despite this apparent decline in demand for certain hospital services, the price charged for these
services has increased persistently.
Since the end of
World War II, the rate for semiprivate hospital
rooms has increased faster than any other item of
medical care and has been the only item that doubled
in price between the base year, 1967, and midyear
1974 (See Table V).

FEDERAL RESERVE BANK OF RICHMOND

9

Hospital care is often described as a necessity and,
as such, is considered to be very insensitive to price.
According to Feldstein, however, the substantial variation among areas in the rate of hospitalization and
in mean durations of stay for different diagnoses and
procedures
shows that most treatment cannot be
regarded as a technically determined necessity.
He
concludes that although admission to a hospital for
some diagnoses may be completely price inelastic,
admission for other conditions and the mean durations of stay for most case types are likely to be more
price elastic.3
Third-Party Payments
A commonly held position
in studies of hospital care is that the increase in
third-party
payments may be an important reason
for the rapid rise in the price charged for the use
of hospital facilities during the past several years.
Major insurers, including Blue Cross and the Federal
Government under the Medicare and Medicaid programs, generally reimburse the hospital for the actual
costs incurred in providing service to their subscribers (patients).
Consequently, it is sometimes
argued that this reimbursement
method gives hospitals no incentive to hold down either their payroll
or capital costs, since they are essentially guaranteed
payment no matter what the total costs may be.
Moreover, insurance is bought to avoid the risk of
unexpected expenditure,
but because it provides a
reduction in price at the time that the hospital care is
purchased, it has the concomitant effect of artificially
increasing the demand for such care and its price.4
In fiscal year 1950, patients paid about a third of
their hospital bill directly. By 1973, this proportion
was reduced to one-tenth, with government paying
the largest share at 53 percent, private health insurance paying 36 percent, and philanthropy making up
the remaining 11 percent.5
Many medical experts contend that the “cost-plus”
reimbursement methods used by private insurers and
Federal programs contribute to the rising cost in
hospital care by encouraging overutilization and misutilization of hospital facilities.
As evidence, they
point to the recent Charleston, West Virginia, experience, in which a panel of physicians, set up by
Blue Cross-Blue
Shield, estimated that patients
covered by that organization were hospitalized 549
days more than necessary during August-September
3 Martin S. Feldstein, “Hospital
Cost Inflation:
A Study of
profit Price Dynamics,”
American Economic Review, December
Vol. LXI. No. 5, p. 854.

Non1971,

1974. Using the average daily cost of Charleston
area hospitals, those 549 days cost $50,019.39. Blue
Cross-Blue Shield established the hospital utilization
review because it wanted to hold down costs and
lessen the prospects for another round of rate increases.6 Some analysts of health care have estimated
that 30 percent of all patients admitted to U. S.
hospitals could be treated outside the hospital.?
II. Physicians’
Services
Most studies on the
cost of medical care are limited by the paucity of
available data on services provided by physicians.
For example, little if any data are available on the
services rendered by physicians as salaried members
of hospital staffs or on services offered in private
offices.
Data on fees for physicians’ services are
particularly scarce.
Among the bits and pieces of
available information is the fact that outlays for the
services of physicians are the second largest expense
category in medical care.
Notwithstanding
the lack of data on physicians’
services, there appears to be sufficient information
available to show that the market for such services
does not behave as traditional
theory suggests.
Recognition of this factor is very important in any
analysis of the cost of medical care because the physician is the key to the entire health sector, particularly in the role of effective decision-maker in determining the use of hospital and ambulatory care resources, and in the role of prescriber of drugs.
Growth in Physicians’ Fees
Between 1966 and
1973, the physicians’ fees component of the Consumer Price Index increased faster than any other
item of medical care except hospital rates for semiprivate rooms and operating charges as shown in
Table V. At midyear 1974, the index for physicians’
fees stood at 152.3 compared to 138.2 one year
earlier. Physicians’ fees, like hospital charges, rose
substantially in fiscal year 1967, the first year of
Medicare. The rate of rise slowed somewhat in 1968
but the accelerating trend resumed the following year,
slowing down only during the Economic Stabilization
Program introduced in 1971.
Numerous factors have influenced the escalation in
physicians’ fees aside from increases in the cost of
maintaining their offices. One factor has been the
rise in the level of family income in the United States.
Another has been the increase in the number of
persons covered by health insurance.
The Medicare
and Medicaid programs, for example, have been

4 Ibid., p. 870.
5 Barbara
“National
February

10

S. Cooper, Nancy L. Worthington,
and Paula
Health Expenditures,
1929-1973.” Social Security
1974, Vol. 37, pp. 13-14.

A. Piro,
Bulletin.

ECONOMIC

6 Charleston

Gazette,

October

7 Washington

Post,

September

REVIEW, MARCH/APRIL

1975

26. 1974. p. 6.
18. 1974.

Table

MEDICAL

CARE COMPONENT

V

OF THE CONSUMER

(1967=100;

yearly

data

Medical

PRICE INDEX,

are annual
care

1940- JULY

1974

averages)

services

1 Includes charges to adult inpatients paying full rates for room and board, routine nursing care, and minor medical and surgical
supplies.
Source:

Monthly

Labor Review,

September

1974,

U. S. Department

credited with contributing significantly to the rise in
physicians’ fees, since both programs have increased
the demand for physicians’ services in the absence of
a meaningful
increase in the supply of general
practitioners
and a better distribution
of physicians’ services.8
A key factor in the influence of Medicare on the
rise in physicians’ fees is the program’s provisions
for the payment of “customary
and prevailing”
charges as the basis for reimbursement of physicians’
services. The term “customary charges” refers to the
amount the individual physician usually charges his
patients for a specific service in similar medical circumstances. Physicians have the option of accepting
“assignment’‘-what
the Medicare guidelines deem
reasonable--or
collecting from the patient and having

of labor,

Bureau

Statistics.

the patient in turn collect Medicare’s “reasonable”
payment.
The proportion of physicians accepting
assignment has been declining steadily in the past
few years-from
61 percent in fiscal year 1969 to 53
percent in fiscal year 1973.9
Determinants
and Utilization
of Services
A
widely held view about physicians’ services is that
the utilization and expenditures for such services are
determined by the patient and that information about
income, insurance coverage, and price is sufficient to
explain and predict changes in demand.
In their
study of this subject, however, Fuchs and Kramer
conclude that physicians-through
their availability
-can and do determine the demand for their own
services to a considerable extent.10 In other words,
9Cooper,

8 Loucele A. Horowitz.
“Medical Care Price Changes in Medicare’s
First Five Years,”
Social Security Bulletin, March 1972, Vol. 35,
No. 3, p. 20.

of Labor

Worthington.

and Piro,

p. 10.

10
Victor R. Fuchs and Marcia J. Kramer. Deteminants
of Ezpenditures For Physcians’ Services in the United States, 1948-68. Department of Health, Education, and Welfare,
DHEW
Publication
No.
(HSM) 73-30 13, p. 24.

FEDERAL RESERVE BANK OF RICHMOND

11

12

ECONOMIC

REVIEW, MARCH/APRIL

1975

FEDERAL RESERVE BANK OF RICHMOND

13

supply factors (technology
and number of physicians) appear to be of decisive importance in determining the utilization of and expenditures for physicians’ services.
Certain services provided by physicians in private
practice can only be consumed in hospitals.
Examples of such services are : (1) intensive diagnostic
work-ups and (2) most surgical procedures.
Thus,
to a limited extent, the services offered by hospitals
and by private practice physicians constitute a joint
consumption
product, namely hospitalized medical
care. With this development in mind, Fuchs and
Kramer contend that if for any reason the supply of
hospital beds influences the quantity of hospital care
people purchase, an increase in the number of beds
may effect the demand for physicians’ services as
well.11
The market for physicians’ services is characterized
by a lack of the patient’s orientation concerning the
need for medical services and the central roll of the
physician as an authoritative
advisor regarding the
use of such services. A patient may choose a physician because of the nature of his illness at one time
or a specialist of the wrong type because of a mistake
in early diagnosis; he may stay with this physician
in order to avoid inconvenience and uncertainty of
starting over again with another physician.
Often
the patient’s resources are too limited to permit him
to search for another physician even if he wanted to
do so ; or he may regard it as unseemly and indicative
of a lack of confidence in the physician on whose
goodwill he depends.12
Given these circumstances,
Fuchs and Kramer hypothesize that physicians are
able to generate a demand for their services without
lowering price.13
Irrespective of the real source of demand for physicians’ services, the number of visits per person to
the doctor has increased during the past several years
(See Table VI).
According to estimates in the
National Health Survey, Americans made 999 million visits to physicians during 1971.14
SUPPLY

OF MEDICAL

CARE

Despite the growth of third-party
payments in
hospital care, there has been considerable lessening
11Ibid.
12 Alfred C. Neal, “Health
Care Costs,” Hearings before the Subcommittee
on Consumer
Economics
of the Joint Economic
Committee, Congress of the United States. 93rd Congress, 1st Session,
May 15 and 16, 1973, p. 82.
13Fuchs

and Kramer,

PHYSICIANS AND VISITS BY PATIENTS
FOR SELECTED YEARS

Source:

Statistical

Abstract

of the United

States.

of pressure on the supply of hospital beds since the
middle 1960’s. Much of this lessening of pressure
has come about as a direct result of the increase in
the construction of hospital facilities, a development
encouraged by the availability of generous Federal
Government subsidies. The rest has been attributed
to such factors as the following: (1) the steady decline in the length of patient stay-which
in turn has
resulted from the concentration
of expensive and
effective diagnosis and treatment in the first few days
of a hospital stay ; (2) the trend to early ambulation
of maternity and surgical patients ; (3) the development of “progressive patient care” that moves patients from intensive care units to intermediate (less
intensive)
care units ; and (4) early transfer to
home care. In spite of such developments, however,
beds and the number of beds per 1,000 population
have continued to increase (See Table VII).
A
study commissioned by the Senate Health Subcommittee showed the nation with a total of 60,000 excess
beds in 1972, at an average annual cost of $18,250
per bed based on an occupancy rate of 81 percent.15
During this same period (July 1965-July 1974) the
charge for semiprivate rooms more than doubled, as
stated earlier.
Cost of Operation of Hospitals
The number of
hospital beds has increased despite the rising cost of
operation in hospitals.
Most of the rapidly rising
cost has been in nonpayroll cost items. In fiscal year
1973, nonpayroll expenses per adjusted patient day
rose 12.2 percent compared with a 7.1 percent increase in payroll expenses. The rising costs involved
outlays for new equipment and supplies, in addition
to expenditures for amenities such as television, air
conditioning, and a wider selection of food. But other
expenses also increased substantially.
These included
rent, depreciation, and interest.

p. 24.

14The National
Health Survey’s definition
of a physician
“visit”
includes any consultation
with a physician, either in person or on
the telephone. but excludes visits of physicians to their patients in
the hospital.

14

Table VI

ECONOMIC

Much
15
of this excess reflects the uneven geographical
distribution
of hospital beds. For details on this study, see Frederic L. Sattler
and Max D. Bennett, A Statistical Profile of Short-term
Hospitals
in the U.S. in 1972. Inter-Study,
1974, Minneapolis,
Minnesota.

REVIEW, MARCH/APRIL

1975

While not as prominent as nonpayroll cost, additional personnel and higher wages have played a
significant role in the ever-mounting cost of hospital
care. Growing organization among hospital employees has resulted in obtaining “catch-up” wages and
placing these employees on income levels comparable
to those found elsewhere.
Also, in response to expanding medical technology, more people with new,
specialized skills, such as medical technologists, radiologic technologists, and occupational therapists, have
been added to the hospital staff.
Internal Pressures In most hospitals the administration is under constant pressure to make “improvements”
that will inevitably
raise cost-perpatient-day.
The medical staffs of the hospitals demand more equipment, laboratory services, and professional staff with which to provide more sophisticated care to the hospital’s patients.
The nursing
staff requests more aides to increase patient comfort
and satisfaction.
Other groups in the hospital bureaucracy-from
the social worker department to the
dietitian-continually
seek additional resources to
increase the scope and quality of services in their
particular areas of responsibility.
All of these demands are in addition to the constant demand for
higher wage rates for current personnel.16
Shortage of Physicians?
Whereas the easing of
pressure on the supply of hospital facilities has been
very obvious during the past several years, the same
has not been so obvious with respect to the available
supply of physicians.
Indeed, the number of physicians per 100,000 population increased from 151 in
1964 to 174 in 1971 (See Figure 3). At the same
time, however, the average number of visits per
patient also increased from 4.3 in 1969 to 4.9 in 1971,
after declining between 1964 and 1967 (See Table
VI). Also, despite the growth in the total number of
physicians, there has been a decline in the proportion
of physicians who provide primary care (genera1
practitioners, pediatricians, and internists).17
The available statistics on the number of physicians, visits per patient, and price of physicians’
services do not facilitate the measurement
of the
adequacy of physicians, nor do they allow analysis of
how an increase in the number of physicians would
affect fees or the number of physicians locating in
ghettos and rural areas. Secretary of Health, Education, and Welfare, Casper W. Weinberger, believes

the nation has enough physicians to absorb even the
added demands created by national health insurance.18 Economist Michael Lynch, however, states
that “it now appears that there is currently a shortage
of physicians, and that it has become worse since the
middle 1950’s, or to put it another way, if we had
enough physicians in the middle 1950’s, then we have
too few now.”19
Irrespective of the debate over the sufficiency or
insufficiency of physicians in the United States, there
are factors pointing to current and future problems
in this area of medical services. For example, there
is agreement that the uneven geographic distribution
of physicians presents problems for sparsely populated rural areas and inner city areas. Also, the likelihood of having some type of national health insurance
portends a tremendous increase in the demand for
physicians services. A Rand study estimates that a
“full payment” type national health insurance program would increase the demand for treatment in
doctors’ offices by 75 percent ; and that such an increase would lead to delays in getting appointments,
18
Testimony before the Subcommittee on Consumer
Congress, 1st Session, May 15 and 16, 1973.
19
Michael
Lynch,
“The
Physician
Mirror,” The Annals of the American
January 1972, p. 83.

Table

17
Economic

Report

of the President,

February

1971. p. 135.

93rd

The Economists’
of Political Science,

VII

TRENDS IN HOSPITAL BEDS AND AVERAGE
DAILY CENSUS FOR COMMUNITY HOSPITALS
IN THE U. S.; 1963-1972
Hospital
Year

1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
Note:

16 For a review of how these increased costs affect the hospital’s
demand function
and occupancy
rate, see Martin
S. Feldstein,
“Hospital
Cost Inflation:
A Study of Nonprofit
Price Dynamics,”
American Economic Review. December 1971, Vol. LXI. No. 5, p. 853.

Shortage:
Academy

Economics,

Source:

beds

Average

Number

Per 1,000
population

698,000
721,000
741,000
768,000
788,000
806,000
826,000
848,000
867,000
884,000
897,830

3.7
3.8
3.8
4.0
4.0
4.1
4.1
4.2
4.2
4.3
4.3

Number

530,000
550,000
563,000
588,000
612,000
630,000
651,000
662,000
665,000
664,000
679,718

daily

census
Per 1,000
population

2.8
2.9
2.9
3.0
3.1
3.2
3.3
3.3
3.3
3.2
3.2

The hospital
data exclude
new-born
infants,
nursery
accommodations,
psychiatric
and tuberculosis
hospitals.
The
population
data refer to the civilian
resident population.
Source Book of Health Insurance Data, 1973-1974,
Health
Insurance
Institute,
(New York, New York), p. 57, and
the American
Hospital
Association.

FEDERAL RESERVE BANK OF RICHMOND

15

Table

VIII

PRICES OF MEDICAL CARE UNDER THE
ECONOMIC STABILIZATION
PROGRAM

1 The decrease is due to the annual adjustment
in the medical
index for the price of health insurance,
which is not shown
component
of the index but is a factor
used in calculating
monthly
index.
Source:

Consumer

Price Index,

Bureau

of

Labor

care
as a
the

Statistics.

longer waits at the doctors’ offices, reductions in the
time a doctor spends with patients, and visits from
patients who are not really sick.20
It is interesting to note that the ratio of physicians
to 100,000 population in the United States (171) was
lower than that for Israel (2.50) and the Soviet
Union (237) in 1972.21
INFLATION

AND PRICE CONTROLS

Immediately after World War II, medical care
prices began to increase more rapidly than prices for
other goods and services.
During the 1950’s, the
price of medical care rose at an annual rate of 3.9
percent-nearly
twice the 2.1 percent annual rate
reported for consumer prices in general.
For the
first half of the next decade, there was a perceptible
decline in the rate of increase for all consumer prices.
The composite Consumer Price Index (CPI)
increased at an average annual rate of only 1.3 percent
during this five-year period, and the price of medical
care slowed down to an increase of 2.5 percent. The
upward trend resumed, however, during the second
half of the 1960’s when prices for goods and services
rose at an annual rate of 4.2 percent, and medical
care prices increased at the rate of 6.1 percent.
20 This study was entitled, Policy Options and the Input of National
Health Insurance, and was written by Joseph P. Newhouse, Charles
E. Phelps, and William B. Schwartz.
21 Testimony
by John A. Cooper, president
of the Association
of
American
Medical Colleges, before the Subcommittee
on Consumer
Economics of the Joint Economic Committee, Congress of the United
States, 93rd Congress, 1st Session, May 15 and 16, 1973, U. S.
Government Printing Office.

16

ECONOMIC

Price Controls
When Phase I of the Economic
Stabilization Program was announced in mid-August
1971, prices for consumer goods and services as a
whole had increased at an average annual rate of
4.8 percent during the previous five years. During
the same period, the medical care component had increased at an average annual rate of 6.5 percent ; physicians’ fees at 7.1 percent ; and charges for semiprivate hospital rooms at 12.8 percent. To assure that
the Federal Government’s approach to helping solve
the crisis in the cost of medical care would be concerted and integrated, the Secretary of Health, Education, and Welfare was made a member of the Cost
of Living Council.
Under Phase II, the resulting moderation in medical care inflation turned out to be the most successful
aspect of the price control program. In fact, for the
first time in memory, the annual increase in the price
of medical care was lower than the increase in the
overall Consumer Price Index. The price of goods
and services in general increased at an annual rate of
3.6 percent during the 14 months of Phase II, while
the index for medical care increased at an annual rate
of only 3.4 percent.
The charge for semiprivate
rooms under Phase II was held to a 5.4 percent
annual rate of increase, and the increase for physicians’ fees was slowed to 2.4 percent, as shown in
Table VIII.
Although charges for semiprivate hospital rooms
and physicians’ fees were held down during the Economic Stabilization Program, hospital expenses per
adjusted patient day continued to rise. The average
annual rate of increase for the period 1971-1973 was
close to 11.4 percent. In fiscal year 1973, the expense
per adjusted day in community hospitals rose by 9.3
percent, the smallest rate of increase in the past
several years. This figure, however, was still almost
double the CPI rate for semiprivate room charges.
For enlightenment on the persistent rise in hospital
expenses during Phase II of the Economic Stabilization Program it may be profitable to review an exchange between Congressman Clarence J. Brown and
Deputy Assistant Secretary of the Department of
Health, Education, and Welfare, Stuart H. Altman,
during hearings before the Subcommittee on Consumer Economics
on medical policies and cost.
Earlier during the hearings, Mr. Altman had stated
that expenses per patient day had climbed at an
annual rate of 11.6 percent during the 1971-1972
period.22
22 “Medical Policies and Costa,” Hearings before the Subcommittee
on Consumer Economics of the Joint Economic Committee, Congress
of the United States, 93rd Congress, 1st Session, May 15 and 16,
1973, pp. 116-117.

REVIEW, MARCH/APRIL

1975

Representative Brown: That is, if you would
break out the details in the hospital costs increasing
at the rate of 12.8 percent. Do you have a detailed
breakdown there? I would like to know why hospital costs are so much higher. Now, there are a
number of possibilities that occur to me.
One is
that hospital care is a labor intensive business,
more so than others. Are labor costs a significant
percentage of the 12.8 percent, or are we receiving
more sophisticated medical care in terms of the
machinery that is attached to the patient and therefore has to be financed by the hospital?
Mr. Altman: Yes. In the 1971-72 period, the expenses per patient dayRepresentative Brown: That is 11.6 percent in
the figures you have given here.
Mr. Altman: That is right. Of that, 5.7 percent
were due to buying the same amount of labor and
the same amount of material, but just the increased
general price levels.
Representative Brown: You are talking now
about the custodian that comes in and washes the
floor in the patient’s room, the same kind of qualifications, the same kind of service that was provided?
Mr. Altman: That is right.
Representative Brown: That has gone up how
much?
Mr. Altman: 5.7 percent of the 11.6, or less than
50 percent of the 11.6, was due to wage increases
and price increases for the same service-A little
over 50 percent was due to improvements in or
changes in service-more
labor and more capital.
The major increase was due to more capital ; 10.1
percent” increase-this
includes new plant and
equipment.
New machinery, different types of
machinery. So over 50 percent of that 11.6 was not
due to wage or price increases.
Representative Brown: So you are saying that
in fact there was a better delivery of health service
for which the patient is paying an additional fee?
Mr. Altman: In some sense, it is. The problem
we have and the problem everyone has is to differentiate in that 50 percent how much of it was due
to the fact that this industry has been a cost-plus
industry, where someone sits behind them with
essentially a blank check, providing funds for new
equipment. Now, it is a very difficult thing to
decide how much of that increase was marginal at
best in terms of improved medical care. We have a
feeling, and so do most experts that have looked at
this problem, that there is a significant amount of
so-called fat. That is one of the areas that has
been pared down. I think it is a terribly telling
figure that if one looks back one step to the period
just before the economic freeze, when expenses per
patient day were going up by almost 15 percent14.8-6.6 of that was due to these changes in new
equipment and more hiring. One often hears the
fact that this industry’s rising costs are simply due
to the fact that we have introduced minimum wage
laws or had to raise the level. That is just not true.
Representative Brown: It actually is the increase
of services that the patient is getting that contributes a great deal.
Mr. Altman: Well, it is increased manpower and
increased equipment. Whether it all comes in the
form of increased services is another question.

Post-Price
Controls
When the time came to
review the price control program, in view of its
April 30, 1974, expiration date, the Administration
attempted to retain authority to control prices of

medical care. Congress, however, permitted the Economic Stabilization Act to lapse.
Lobbyists for
practitioners, hospitals, and nursing homes assured
Congress they would exercise restraint.
In May, the first month after controls expired,
the price of medical care rose at an annual rate of
14.4 percent; and moved up at an 18 percent rate in
June. For the same two months the rates of increase
for physicians’ fees rose 15.6 percent and 21.6 percent; and the rate for charges for semiprivate rooms
increased from 18 percent to 24 percent. All of these
exceeded the annual rates of increase for the composite CPI, which increased to 13.2 percent in May,
and then declined to 12.0 in June (See Figure 2).
OUTLOOK

As stated earlier, although medical care is only one
factor contributing to health, it can be literally a
matter of life and death. Self denial because of high
prices is not the same in this situation as in rationing
one’s income when purchasing cars, clothes, or television sets. Medical costs can claim an excessive
share of a family’s income, even that of middle-income
families who usually have insurance. In view of this,
it is unfortunate that few, if any, forecasts project
stable prices for medical care.
Some observers contend that relief from the high
cost of medical care will not come until national priorities are directed to increasing the supply of medical
services.
They contend that priorities so far have
focused on factors that increase the demand for
medical services and have ignored the factors that
would increase the supply of services such as the
number of physicians in general practice and increase use of paraprofessionals.
Other analysts, however, do not agree that an increase in the number of
physicians would reduce the cost of medical care. In
their study, Determinants of Expenditures for Physicians’ Services in the United States, 1948-68, Fuchs
and Kramer suggest than an increase in the supply
of physicians would at best have limited impact on
price, although the increased supply would result in
substantial increase in the availability of physicians’
services.23 Another researcher in the field of medical
care, Martin S. Feldstein, maintains that “the market for physicians’ services does not behave as traditional theory suggests ; that there appears to be a
persistent excess demand for physicians’ services and
price does not seem to vary systematically with
changes in excess demand.”24
23 Fuchs and Kramer,
24 Martin

S. Feldstein.

FEDERAL RESERVE BANK OF RICHMOND

P. 3.
p. 861.

17

Prospects for relief in the cost of hospital care
appear just as dim as those for the price of physicians’ services. A national health insurance program
of some type appears certain to be a reality sometime
in the near future, which is likely to intensify the
impact of third-party
payments on the demand for
hospital facilities.
Further, there is little hope for
abatement of the internal pressures that result in increased expenses for hospitals ; and until some means
are devised for curbing the current inflation, the rise
in such hospital expenses as rent, interest, equipment,
supplies, and wages is likely to continue its present
course.

18

ECONOMIC

With the continuation of these rising prices for
medical care, consumers may likewise expect a continuation of the peculiar marketplace for medical
care services.
This means, for instance, that the
supply of hospital beds is likely to expand even
further, despite the declining relative utilization of
such facilities, and that the price of physicians’ services is likely to accelerate further, despite efforts to
increase the supply of these key decision-makers in
the chain of medical care services.

REVIEW, MARCH/APRIL

James F. Tucker

1975

AGRICULTURE:
OUTLOOK
FOR 1975 IS CLOUDY
This year’s prospects for the nation’s agriculture, outlined by leading analysts of the
U. S. Department of Agriculture in early December, have recently been revised.
A brief rundown of their new forecasts follows.

Many uncertainties
cloud the outlook for agriculture in 1975. Weather, as always, is a major unknown. The cost-price squeeze will likely continue;
how tight it will get is the question. There seems to
be little doubt that production costs will go up.
Moreover, prospects regarding the level of farm
prices are not at all clear. Supplies of some farm
inputs-notably
fertilizer-are
unsure. And the demand outlook, both domestic and foreign, is hazy.
Income and Expenses
Farm income prospects
have weakened considerably since early December.
Consequently, it now looks as if the nation’s farmers
will wind up 1975 with less cash in their pockets than
they had at the close of 1974. Farmers’ net earnings
in 1975 could, in fact, show a sizable downturnpossibly even greater than the one last year. Any
such decline would follow on the heels of nearly a
16 percent drop in 1974, leaving realized net farm
income far short of the record level set in 1973.
Farm production expenses can be expected to shoot
upward again. But the 1975 increase may not be as
large as that experienced last year. Feed costs are
not likely to be quite as high. Moreover, fuel and
fertilizer prices are not expected to rise as dramatically as they did in 1974.
Crop output will be a key factor in determining
the level of farmers’ net income in 1975. Major
crop prices have weakened in recent months and are
expected to remain highly sensitive to supply and
demand developments throughout the year. Significantly larger crop production than in 1974, accompanied by reduced demand, could lead both to lower
farm prices and to much lower net farm income. But
crop output in the neighborhood of last year’s level,
coupled with high demand, would tend to shore
up prices and maintain net farm income.
Demand factors will, of course, play a major role
in determining farmers’ 1975 net farm income. Both
the domestic and foreign economies continue to sag.
With the general economic climate here at home,
unemployment has risen dramatically and inflation,
while apparently easing, remains only slightly below
the double-digit level. Consumers’ real purchasing
power has, so far, continued to deteriorate.
Unless
the general economic situation rights itself, some

further erosion in the strength of domestic demand
could occur. On the other hand, should proposed tax
cuts be enacted and contribute to a turnaround in the
general economy at an early date, domestic markets
could be bolstered significantly.
The worldwide economic slump has softened the
foreign demand for U. S. farm products.
Furthermore, recent shifts and cancellations in commodity
purchases by the Soviet Union and the People’s Republic of China have added still more uncertainty to
the export outlook. Export volume of the major bulk
commodities in fiscal 1975 is currently expected to
drop more than 15 percent below the tonnage shipped
last season, with much of the decline occurring in
grains, soybeans, and cotton. Higher prices for many
farm products, however, will more than likely offset
the decline in volume and push export value into the
neighborhood of $22 billion, up slightly from the
record set in fiscal 1974.
Farm Finance Outlook
Because of wide differences in the incomes of crop and livestock producers
last year, the financial positions of farmers at the
beginning of 1975 also varied widely. Crop farmers
in general were better off than they were at the same
time last year, but livestock producers were much
weaker financially. Little change in their respective
financial positions is anticipated this year. Farmers
and lenders alike will be faced with some tough financial decisions.
Some farmers, particularly livestock
producers, are going to be hard pressed to repay their
old debts. Still others will need to carry over a large
amount of short-term debt.
Demand for operating loans is expected to remain
strong. There may be some slackening in the need
for intermediate-term financing, however, since farmers’ purchases of capital goods are expected to ease.
The weakened demand for farmland and the slowdown in the advance in farm real estate prices will
reduce the need for new money for farm-mortgage
loans. Much of the demand for operating loan funds
will stem from farmers’ needs to finance the higher
costs of planned crop production.
Since farmers will need to borrow heavily in 1975,
the important question is : “Will farm lenders be able
to provide the loan funds?,’ Overall, it appears that

FEDERAL RESERVE BANK OF RICHMOND

19

farmers’ borrowing needs can and will be met. Most
commercial banks are experiencing an increase in
their farm lending capacity.
Some banks, however,
are hesitating to provide additional loans to those
farmers who have had to renew last year’s production
loans and who are showing a deteriorating financial
position and prospects.
Lenders with access to national money markets-the
Federal land banks, for
example-and
individual farmers who sell their own
farms are expected to expand their lending significantly.
Some easing in farm loan interest rates is anticipated during the first half of the year. It appears
unlikely, however, that rates will fall more than onehalf to 1 percentage point below the 1974 level, since
rates at many rural banks, as well as at the Federal
land banks, did not follow the sharp rise in 1974 that
occurred in short-term rates generally.
However,
farm borrowers from large banks, and perhaps PCA
borrowers also, may experience a significant reduction in their borrowing costs compared with last year.
Food Price Prospects
The nation’s homemakers
will be unhappy with the outlook for food prices, for
they will need to find ways to stretch their family
food budgets still further in 1975. Retail food prices
are expected to climb higher during the first half of
the year, but the increase is likely to be much smaller
than was expected just a few months ago.
By midyear, higher retail prices are likely for both
crop- and livestock-related foods. Biggest price gains
during the first quarter will show up in crop-related
food items, while slightly sharper increases for red
meats and poultry will follow in the second.
Many uncertainties surround the outlook for food
prices this year. Among them, these three stand out :
l The impact of the current economic recessionits length and severity-on
consumer demand.
l The rate at which beef cattle with limited grain
feeding are slaughtered to increase smaller supplies
of grain-fed beef, pork, and poultry products.
l The weather and its impact on farm production,
both here and around the world.

Developments relating to these uncertainties could
alter current food price prospects considerably as the
year unfolds. On the one hand, they could bring a
substantial slowdown in food price increases. On the
other, they could lead to further sharp upturns in
food prices.
Commodity Summary The Department
of Agriculture’s analysis of the outlook for principal Fifth
District commodities shapes up in this manner.
20

ECONOMIC

Tobacco: Further gains in U. S. cigarette output
and strong foreign demand holding leaf exports near
recent high levels are in prospect for the current
marketing year. Supplies of domestic tobacco are 3
percent below last season’s level because of lower
beginning carry-over.
And with tobacco use during
the current marketing year likely to exceed marketings of the 1974 crop, another decline in carry-over
stocks can be expected in mid-1975.
Marketing quotas for flue-cured and burley have
been increased for 1975 in order to provide adequate
supplies of tobacco to meet rising market demands.
Compared with last year, the effective flue-cured
quota is 18 percent higher, while quotas in effect for
burley are up about 12 percent.
With larger farm
quotas, growers are expected to harvest more tobacco.
Tobacco price support levels, determined by legal
formula, will average about 12 percent higher than in
1974. Cash income from tobacco marketings should
rise, but grower costs will probably increase further.
Soybeans and Peanuts:
Supplies of soybeans are
down 13 percent from last season’s record, but a big
boost in supplies is likely if the nation’s farmers carry
out intentions to increase spring plantings by some 3
million acres.
This potential boost in supplies is
coming at a time when soybean usage is falling from
the heavy pace of recent years.
Because of weakened demand for soybean oil and
meal, the processing industry is running at only twothirds of its capacity, and soybean exports are lagging
behind last year’s rate by more than 10 percent.
Based on current indications, soybean crushings this
season may fall about 9 percent from year-ago levels,
and exports may drop some 12 percent.
Major
factors behind this slackening demand are the decline
in consumers’ real purchasing power, reduced feeding
and production in the livestock and poultry industries, and larger world supplies of competing fats and
oils. These same factors affecting the U. S. market
are also affecting our soybean markets overseas.
Farm prices for soybeans have dropped from over
$8 per bushel in October to less than $6 in February.
Should the recession deepen and prospective 1975
production seem favorable, prices could drift lower.
Peanut supplies, at record levels about a tenth
above a year earlier, are in excess of requirements for
both edible and farm use. Use of peanuts is declining
in all major edible categories-salted
peanuts, peanut
butter, and peanut candy-and
is currently running
about 8 percent below a year ago. Crushings of peanuts for oil and meal are also down and for the
entire season may run 15 percent below the previous
year. Export demand is strong, however.

REVIEW, MARCH/APRIL

1975

Peanut marketing quotas and acreage allotments
for 1975 are at the minimum levels permitted by law.
Cotton:
The slowdown in the textile industry,
reflecting the poor health of the general economy, is
having a major impact on the cotton situation and
outlook. Demand for textile goods, especially cotton
products, is extremely sluggish, both at home and
abroad. Moreover, foreign inventories of both raw
cotton and textiles are large. Domestic mill use this
year may total only about 6 million bales, in contrast
with 7½ million last year, and exports are expected
to fall to about 3¾ million bales, down from last
season’s 6.1 million. With prospective mill use and
exports adding up to around 9¾ million balessmallest disappearance since the turn of the centuryyear-end carry-over this summer is likely to be substantially larger than at the beginning of the season.
Faced with sagging demand, low cotton prices
and high production
costs relative to competing
crops, cotton farmers on March 1 indicated that
planting this spring would be sharply lower than in
1974. Nationally, farmers plan to cut 1975 cotton
acreage 29 percent. A
cutback of 55 percent is
planned in the District.
Poultry and Eggs:
Last year was disappointing
for poultrymen, and prospects going into 1975 have
improved little. Feed supplies will continue to be
tight and feed prices high well into the year.
Although feed prices have dropped from their highs last
fall, they remain above a year ago and well above the
levels of other recent years. Expectations are that
producers will hold production of eggs, broilers, and
turkeys at reduced levels through midyear.
Egg
output may trail year-earlier levels by some 4 to 6
percent ; broiler production
will probably slump
around 8 percent; and turkey output is expected to
be sharply lower.
As production lags, look for these developments
on the price front. Egg prices can be expected to
remain strong during the first quarter but will likely
decline as usual in the spring.
Broiler prices will
probably be bolstered by smaller supplies of broilers,
turkey, and pork. But larger supplies of beef and
the erosion of consumer purchasing power will moderate broiler price increases.
Turkey prices may
improve slightly in coming months; however, price
gains will be limited by the large cold storage holdings of turkey meat and large supplies of beef.
Meat Animals: Sharply reduced pork supplies will
keep hog prices on the high side in 1975. Based on
inventories
of market hogs last December, hog

slaughter and pork supplies in the first half are likely
to be the smallest in nine years. Moreover, hog farmers cut breeding stock inventories sharply last fall
and have reported plans to reduce sow farrowings
this spring to the lowest level on record. These indications point to a 14 to 16 percent reduction in hog
slaughter in the second half.
Hog prices are expected to strengthen throughout
most of the first six months of 1975 as slaughter dips
below year-ago levels and are likely to remain strong
in the second half. Large beef supplies and demand
uncertainty will temper the advance in hog prices,
however.
Huge cattle inventories are threatening to keep
cattle producers in a financial bind again in 1975.
Winter cattle slaughter is expected to remain large,
running about 10 to 15 percent above a year ago as
cows and nonfed steers and heifers continue to offset
smaller fed cattle slaughter.
Cattle feeders’ profits
this winter will be marginal at best, and placements
of cattle in feedlots will continue low. Should total
cattle slaughter decline seasonally as expected, even
though remaining large, cattle prices could strengthen
later in the winter. The smaller supplies of pork and
poultry may also provide some price strength for
cattle in the spring.
Slaughter supplies in the last half of 1975 could
be record large, exceeding a year earlier by a wide
margin. Should this potential slaughter materialize,
cattle prices could weaken. Range conditions, feed
prices, and prospects for the 1975 feed grain harvest
will help to determine the direction of prices in the
second half.
Dairy Products: Dairy farmers will probably continue to be plagued by cost-price problems early in
1975. Milk output may hold about even as dairymen
cut back on feeding high-cost grain and concentrates
and reduce dairy herd culling. Commercial stocks of
dairy products are large, however, so dairy supplies
should be adequate for consumers.
With the recent
increase in support prices for manufacturing
milk
and the action bringing minimum Class I prices
under Federal milk orders in line with the boost in
price supports, farm milk prices may rise slightly. A
milk price increase, coupled with the recent easing
in grain prices, could bring about some slight improvement in the milk-feed price ratio.
Cheese sales are facing stiff competition from large
supplies of other high-protein foods.
But butter,
which reversed its long-term sales slump in 1974,
continues to be priced favorably relative to margarine.

FEDERAL RESERVE BANK OF RICHMOND

Sada L. Clarke
21

FINANCIAL FORECASTS: 1975
The views and opinions set forth in this article are those of
various forecasters. No agreement or endorsement
by this Bank or by the author is implied.

Conditions in financial markets were extremely
volatile during 1974, primarily as a result of unforeseen developments in the economy. Last year was a
very bad year for forecasters, but who would have
anticipated double-digit inflation, the worsening energy problem, and the sharp fall in output and increase in unemployment in the fourth quarter.
Because many of these factors that played havoc with
the 1974 forecasts must still be dealt with in 1975,
this year’s forecasters are justifiably reticent about
the soundness of their predictions.
It is for this
reason and in the interest of dependability that the
predictions used for this “consensus” were limited to
those compiled after mid-January of this year, after
some of the major uncertainties were clarified. Forecasts compiled before the fourth quarter GNP figures
were announced, before the latest deficit estimates
were available, or before the President’s economic
package was unveiled would obviously be premised on
the wrong set of economic variables, thus rendering
them obsolete.
Apart from the other problems, the energy situation makes any forecast, financial or otherwise, uncertain at best. Fiscal and monetary policies will be
geared to adjust to developments as the year unfolds.
The key for policymakers in 1975 should be flexibility.
FUNDS

RAISED

Table

CONSENSUS

I

FUNDS FORECASTS*

IN 1975

The total volume of funds raised, without regard
to maturity, is expected to register roughly $167
billion in 1975, somewhat lower than the $172 billion
raised in 1974 (Table I). The decline should affect
all maturity lengths to some degree, but the severest
impact of the reduction is expected to be felt in the
short-term sector of the market, where volume should
drop from $93 billion in 1974 to an anticipated $88
billion in 1975. The decline in the long-term market
should be negligible, with volume remaining close to
last year’s figure at $79 billion.
Some downward
adjustment in short-term rates should occur during
the year; long-term rates might also decline slightly
but to a lesser degree than in the short-term sector.
Four categories of borrowers that must be examined
22

in any discussion of the funds markets are: banks,
business, consumers, and government.
The past year
saw an unprecedented demand for bank credit as the
spread between the prime rate and the commercial
paper rate moved out of traditional alignment. Total
bank loans were roughly $34 billion this past year,
exceeding the figure for 1973, which was also high
by historical standards. The demand for bank credit
eased during the fourth quarter of 1974, and for 1975
as a whole bank loans should total a more moderate
$13 billion. In conjunction with this, the prime rate
is expected to continue to decline to a level more in
line with other short-term rates during 1975.
The volume of business loans is expected to vary
dramatically both in size and composition during
1975, with the emphasis shifting from the short-term
to the long-term market. In 1974 the business sector
raised approximately $28 billion in long-term funds;
this figure is forecast to increase only slightly to

ECONOMIC

*These numbers represent
on estimate
of the consensus forecasts
of many well-known
economists;
all forecasts were compiled
after
the President’s
economic
package
was revealed
in mid-January.

REVIEW, MARCH/APRIL

1975

about $31 billion in 1975. The composition of this
borrowing
should shift, however, so that in the
coming year there would be a jump in corporate bond
volume up to $28 billion, with stock volume sliding
down to roughly $3 billion. A subsequent dramatic
shift in short-term business borrowing is expected to
accompany the realignment in the long-term market.
Short-term financing in the business sector, which
jumped to an astounding $50 billion last year, should
fall off to only $22 billion in 1975. The forecast for
sharply lower bank loan volume accounts for most
of this contraction.
Consumer demand for funds in 1975 is expected
to be very light. Net borrowing by consumers is
forecast to amount to only $38 billion, off from $46
billion this past year. The decrease is wholly attributable to an anticipated $7 billion decline in shortterm consumer credit-installment
loans-as automobile and consumer durables sales remain at low levels.
The volume of privately-held mortgage funds should
total approximately $35 billion in the coming year,
Even though inflows at thrift institutions are expected to continue throughout the year, mortgage
demand is likely to be weak. Mortgage money should
be more readily available in 1975 than in the past
year, but the nominal cost is expected to remain high
by historical standards.
The most dramatic development in the funds markets this year should be the anticipated record level
of government borrowing.
Forecast at $76 billion,
the volume of funds raised by the Federal Government, state and local governments, and the Agencies
would account for 45 percent of the total funds
raised in 1975. This dramatic upsurge in government
borrowing is attributable to the anticipated sharp
jump in Federal Government borrowing from $10
billion in 1974 to an expected $54 billion in 1975.
These figures are subject to a wide degree of fluctuation, and the forecasts for Federal borrowing range
from a low of $41 billion to a high of $65 billion,
Whatever the figure might turn out to be, the Federal
Government will definitely need a large supply of
funds to finance the proposed “economic” and “energy” packages.
In other sectors of the government market, the
volume of funds raised in 1975 is expected to decline.
The Agencies who were frequent borrowers in 1974,
should need only $9 billion in 1975, less than half
last year’s total.
State and local governments are
forecast to borrow $13 billion in the coming year,
slightly below their 1974 level of borrowing.
Although there is currently a great deal of serious
debate on the subject, the consensus of the forecasts

*These numbers represent an estimate
of the consensus forecasts
of many well-known
economists;
all forecasts
were compiled after
the President’s
economic
package
was revealed
in mid-January.
3-month
†

maturity.

predicts that there will be enough funds available to
satisfy all borrowers in 1975 at current or lower
levels of interest rates. One opinion holds that the
massive Government borrowing necessary to support
the anticipated 1975 budget deficit will overwhelm
the markets, causing a dearth of funds for the private
sector. This opinion is premised on the assumption
that in 1975 the borrowing needs of the private
sector will be stronger than is usually characteristic
of a recessionary period. There are two main reasons
for this assumption : (1) heavy financing of oil consumption both at home and abroad, and (2) large
external financing needs of business because of generally tight liquidity positions. The opposing opinion
speculates that although business borrowing is expected to remain firm in the long-term sector, shortterm business borrowing will abate. This fact, combined with sharply lower anticipated
levels of
consumer and Agency demand for funds, should
free-up abundant funds for other potential borrowers,
thus averting any credit crunch.
The consensus of
the forecasts seems to agree with this latter argument.
THE INTEREST

RATE OUTLOOK

Interest rates are undoubtedly the most volatile
part of any financial forecast.
The past year was a
bitter experience for most rate forecasters, and as a
result, most predictions for 1975 mention rates only
briefly, if at all. It is impossible to predict the behavior of interest rates without knowing other variables such as money supply growth. A small change
in the rate of growth of the money supply can permeate rate structures and alter rate relationships and
behavior patterns.
For this reason, there is necessarily a wide margin for error in interest rate forecasting. The consensus view, as shown in Table II,
is that short-term rates will continue to decline from
the levels prevailing at the end of 1974. The decline

FEDERAL RESERVE BANK OF RICHMOND

23

Federal

Reserve

Bank of Richmond

P. O. Box 27622
Richmond,
Address

Virginia

Correction

23261

Requested

will be moderated and may be reversed if intensified
inflationary fears begin to pervade financial markets
later in the year or if the economic recovery is unexpectedly strong.
But such factors as a decreased
demand for short-term funds combined with the expectation of a less stringent monetary policy may
exert downward pressure on short rates. Long-term
rates may continue to exhibit strong inflationary
premiums throughout 1975 if some strong evidence
of easing pressure on prices is not clearly visible.
These rates are expected to move slightly lower,
however, as a minimal decline in the long-term volume and an improved economic outlook help to ease
some rate pressures.
The downward movement in
long-term rates will lag short-term rate declines, and
the movement should be far less volatile.
Toward
the close of 1975, rates may move up in both longand short-term markets as the economic recovery
gets under way and especially if money supply growth
is too rapid and inflation is refueled. A closer look
at the anticipated behavior of some individual rates
may produce a clearer picture of 1975 predictions.
Short-term rates As Table II indicates, the consensus rate on three-month
Treasury bills is expected to decline some 100 basis points by the close
of 1975 to a level of 6.00 percent. Anticipated heavy
Treasury activity in the short-term market combined
with a reduced demand for short-term funds account
for the predicted downward pressure on bill rates.
In the market for 3-month, dealer-placed commercial
paper, the rate declines are predicted to be more
dramatic. By the close of 1975 the CP rate should be
at 6.75 percent, dropping lower early in the year and
then moving back up to this level. This rate is 250
basis points below the year-end 1974 figure and even
more sharply below the 1974 high. Closely related
to the commercial paper rate is the rate charged
prime bank borrowers-the
prime rate. After rising
to a whopping 12 percent in 1974, the prime rate is
24

ECONOMIC

forecast to end 1975 at 8.00 percent ; a rate below this
level is forecast for the first half of the year. Such
an adjustment would bring the prime rate into more
traditional alignment with the commercial paper rate,
although the spread would continue to be slightly
wider than normal.
Long-term rates The consensus forecast for 1975
shows long-term rates declining only slightly from
rates at the end of 1974, with no dramatic movement
expected.
The rate on new issue Aa utility bonds
should fall to 9.40 percent, 10 basis points below
1974, while the rate on Aaa corporate bonds is expected to close 1975 at 8.80 percent, again only 10
basis points below the level at the end of 1974. The
pattern of rate behavior in the long-term sector could
shift dramatically if forecasters have underestimated
corporate financing needs for 1975 or if due to factors
outside the corporate market, inflationary expectations become re-entrenched in the second half.
MONETARY

POLICY

The behavior of the monetary aggregates plays a
critical role in shaping conditions in financial markets.
The conflicting forces of slowed economic
growth, inflation, reduced productivity, and high unemployment will be pulling against each other in the
coming year, each exerting an influence on the course
of monetary policy. The consensus of the forecasts
shows that a policy of relative ease is anticipated with
moderate growth in the aggregates. A money supply
growth rate in the range of 6.5 to 8 percent is the
consensus forecast, with the caution by forecasters
that the monetary authorities must move toward a
policy that allows the aggregates to expand at a pace
consistent with balanced economic growth and long.term price stability, carefully avoiding the rekindling
of inflationary fires.

REVIEW, MARCH/APRIL

B. Gayle Ennis
1975