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DECEMBER 1964 IN THIS ISSUE The Government Sector of the Economy . . . 3 Perspective on Prices — A Further Note . . . 13 Annual Index to Economic Review . . 19 Additional copies of the E C O N O M IC R EV IEW may be obtained from the Research Department, Federal Reserve Bank of Cleveland, Cleveland, Ohio 44101. Permission is granted to reproduce any material in this publication. DECEMBER 196 4 THE GOVERNMENT SECTOR OF THE ECONOMY The government sector of the economy has been in the forefront of political-economic discussions in recent years—in fact, even more than usual. This is probably due largely to the significant change that has occurred in the role of government finance. The han dling of government receipts and expenditures at the Federal level has tended to take on a longer-term quality, and is now being direct ed more toward helping promote the nation's economic growth rather than being used only countercyclical^ to combat recessions. mented in March 1964, and in the earlier liberalization of depreciation allowances and the investment tax credit; it is also revealed in attempts to slant more Federal spending toward developing human resources. Some observers consider the recent shift in attitude toward the role of the government sector as a "fiscal revolution". In addition to changes in attitude toward the broad sweep of government activity in the economy, a number of major develop ments have occurred within the government sector itself. While most attention and analy Recognition of the need to rely more on the sis have been devoted to Federal activity, the private sector of the economy to keep the economy moving is indicative of this turn in thinking. The attempt to encourage the pri really dramatic developments have taken place in the state and local component of the total government sector. In short, the "m ix" vate sector through greater incentives for private spending and investment is revealed in the large-scale tax cut that was imple of government activity has undergone some striking changes. The nature of the changing mix is such that, in the past decade, the fastest 3 ECONOMIC REVIEW growing sector of total economic activity —in terms of contribution to Gross National Prod uct — is the state and local government sector. Rates of growth of expenditures, revenues, and employment of state and local govern ments have outstripped those of all other parts of the economy, public or private. Such growth, however, has not occurred without creating some serious financial strains for state and local governments. This has been evidenced, for example, in the crossfire be tween rapidly growing demands for increased and improved services that require substan tial additions to revenues, on the one hand, and growing opposition toward further in creases in state and local taxes, on the other. The combination of a change in attitude toward fiscal policy and a change in the mix of the government sector will have some im portant implications for the economy in the next few years —in the nature of public spend ing as well as in the utilization of revenues. Recent and possible future shifts from spend ing on goods to spending on services —educa tion, medical, highways, urban redevelop ment, poverty, mass transit programs, among others —as well as the possible return of some Federal revenues to the states (through shifts in use of tax resources, no-purpose grants, or specific grants) have possible far-reaching consequences at national, state, and local levels. It thus would seem instructive at this juncture to attempt to place in broad perspec tive the government sector of the economy, both in terms of its relationship to total eco nomic activity and its structure and composi tion. 4 GOVERNMENT SECTOR AND ECONOMIC ACTIVITY The total output of goods and services and the contribution of the major sectors of the economy during the postwar period are shown in the accompanying chart.1 Total economic activity, as measured by GNP, more than doubled between 1947 and 1963, despite the interruptions resulting from four recessions. The largest single sector within GNP is the consumer sector (personal consumption ex penditures). This sector has more than doubled since 1947, accounting for nearly two-thirds of GNP in 1963. Changes over time in the consumer sector have essentially paral leled changes in GNP. Consumer spending, however, has demonstrated less sensitivity to business recessions than other sectors of the economy. The business sector (spending by business for fixed investment, residential construction, and inventories) has demonstrated a behavior pattern that is much more volatile than the other major components of GNP, and as such is a major contributor to the cyclical swings in total economic activity. This sector in creased more than one-and-a-half times be tween 1947 and 1963; it accounted for about 14 percent of GNP in 1963, or roughly the same as in 1947. As the chart indicates, the ratio of the business sector to GNP has moved up and down in intervening years. The government sector (spending on goods and services by Federal, state and local gov ernments) is about one-third the size of the 1 The foreign sector of the GNP accounts (net export of goods and services) is excluded from the discussion mainly because of its relatively small size. DECEMBER 1964 1. GROSS N A T I O N A L PRODUCT B il l i o n s o f d o l l a r s 1000 800 R A T IO S C A L E B il l i o n s o f d o l l a r s 1000 800 600 500 600 500 400 400 300 2 00 PR IVATE DO MES TIC IN V ES T M EN T S o u rc e o f d a t a : U .S . D e p a r tm e n t of C o m m e rce consumer sector and slightly more than twice that of the business sector. Following a doub ling of government purchases of goods and services during the Korean War, this sector has shown a moderate but steady rise. Some relevant percentage increases are the follow ing: since 1947 the government sector has increased more than four times; since 1953, the high mark associated with the Korean War, about one-half. As a percentage of GNP, the government sector accounted for about 21 percent in 1963, which is approximately the proportion that has prevailed in recent years. It should be recognized that this concept of the total government sector measures only spending for goods and services, and thus represents the absorption by all levels of gov ernment of real resources such as labor of employees and goods and services purchased from business. This represents, therefore, the portion of economic activity that is directly allocated by government; it does not include transfer spending that is allocated by govern ment —such as the transfer of money to indivi duals for social security or unemployment benefits, or to other governments as grants-inaid, or as payment of interest on debt. Never theless, it is important to remember that these redistributed or transferred funds in turn also enter the spending stream —get into the GNP —through other sectors of the economy — consumer, business, or other government. Federal spending and state and local spend ing are shown separately in Chart 2 in order to illustrate the relative importance of each sector in the expansion of total government expenditures. Since the end of World War II, state and local spending for goods and ser vices has increased in every year, with the gains ranging from $2 to $4 billion per year, and with the higher figure predominating in 5 ECONOMIC REVIEW G O V E R N M E N T PURCHASES of GO ODS and SERVICES B illio n s of d o lla r s 200 B il l i o n s o f d o l l a r s ■ — .....1 200 R A T IO S C A L E 47 ’49 ’51 '53 ’55 S o u rc e o f d a t a : U .S. D e p a r tm e n t o f C o m m e rc e recent years. Total state and local spending has increased about four-and-a-half times since 1947, while Federal spending has in creased about four times. Putting it another way, while state and local spending accounted for two-fifths of total government spending in 1955, it had grown to 47 percent in 1963. Indications are clear that state and local spending will soon account for more than half of total government spending for goods and services. RECEIPTS AND EXPENDITURES In order to gain additional perspective on total government activity, it is necessary to consider the total spending and receipts of the sector, that is, direct spending for goods and services plus indirect payments. Table I presents the broad sweep of F ed era l g o v e rn m e n t expenditures and receipts for selected years beginning in 1954.2 In general, in 6 1963 about one-half of total Federal spending was for defense, about one-third for public welfare, and about 10 percent each for gov ernment operations and economic develop ment. The patterns that stand out in these total payments include the declining share of the total accounted for by defense.3 Defense spending represented about 60 percent of the total in 1954, compared with one-half in 1963. And this is so, notwithstanding the sharp increase in recent years due mainly to 2 These data as well as similar data for state and local governments are taken from the budget of the National Income and Product Account. This budget is designed to provide a measure of the direct impact of fiscal activ ity on the nation's current flow of income and output. 3 It should be noted that within the GNP accounts Federal government spending for defense accounts for the large bulk of Federal purchases of goods and DECEMBER 1964 eral salaries. Interestingly, spending for gen eral government has tended to be maintained at about 10 percent of total spending. The the space program and an increase in military activity overseas. (Compare, for example, the figures for 1960 and 1963.) The volume of military expenditures thus explains the cur rent high level of total Federal spending but not the rising trend. The substantial increase in the welfare cate gory also stands out in the figures —more than doubling since 1954 and moving up from approximately 20 percent of the total to about other two general categories are a mixture of welfare and economic development programs and are further indications of expansion in nondefense areas. The figures in general thus reveal quite clearly the importance of nondefense spending in total Federal pay ments to the public. The data on the Federal sector also suggest that the Federal government does a lot of reshuffling of money, or, in other words, the Federal government first taxes and then trans one-third of Federal cash payments. This has been due to increased emphasis on social and economic welfare programs, that is, to liberal ization of existing programs as well as to introduction of new ones. Spending in the general government cate gory has a built-in growth factor for a number of reasons, including the need to provide additional services for an expanding popula tion as well as the periodic increases in Fed- fers funds to other sectors of the economy. As a result, outside of the defense area a rela tively small amount of funds is expended by the Federal government in the direct pur chases of goods and services. At the same time, the bulk of all government services to TABLE I Federal G overnm ent Expenditures and Receipts C a le n d a r y e a r s — Billions of d o llars 1954 1956 1958 1960 1962 1963 National D e fe n s e ...................................................... 42.1 41.3 45.9 47.1 55.6 57.6 Health, Education, W e lf a r e ,........................................ 13.8 15.9 23.0 25.5 31.1 32.8 Social Security and Special W e l f a r e ...................... 8.1 9.8 15.9 17.7 22.1 23.0 General Government................................................... 6.7 7.3 7.7 9.5 10.1 11.0 Agriculture and Natural Resources................................. 4.0 3.3 5.8 4.7 6.2 6.1 Commerce, Transportation and H o u sin g ...................... 1.5 2.2 4.0 4.7 5.7 6.0 International Affairs and Finance................................. 1.8 2.1 2.0 2.2 2.6 2.5 Less Government S a le s ........................................ 0.3 0.3 0.5 0.6 0.9 0.8 ............................. 69.6 71.8 87.9 93.1 110.4 115.2 Personal T a x e s .......................................................... 29.1 35.1 36.5 44.0 49.0 51.8 Corporate Profit T ax es............................................... 16.5 20.2 17.7 21.0 21.8 23.0 Contributions for Social S e c u rity ................................. 8.1 10.5 12.4 17.6 20.5 23.0 Total Excise Taxes...................................................... 9.0 10.4 10.5 12.2 13.1 13.8 Other T a x e s .............................................................. 1.1 1.3 1.4 1.8 2.0 2.0 Total R e c e ip ts .................................... 63.8 77.5 78.5 96.6 106.4 113.6 Total Expenditures Source: U. S. Department of Commerce 7 ECONOMIC REVIEW the civilian population is provided by state and local governments. This is reflected in the fact that spending by the Federal govern ment has grown more slowly than state and local spending in virtually every category excluding defense, which does not exist at the latter levels. And this is the case, even On the other hand, the major source of Fed eral revenue continues to be personal tax receipts. The behavior of personal and cor porate profits taxes is an indication of the rela tive pace of economic activity, and is reflected in their sources, i.e., personal income and corporate profits. The greater sensitivity of the business sector to swings in economic activity is suggested by the contrast between the receipts from these two taxes. Reductions in the excise tax category are under consideration for 1965 action. This would not necessarily reduce the relative share of the total provided by excise taxes as a source of revenue. As is the case with the income tax categories, the relationships will continue to depend on the nature of tax re ductions as well as the direction and pace of economic activity. As shown in Table II, s ta te and lo c a l g o v e r n m e n t general expenditures totaled $ 6 2 .0 though the Federal government has tended to preempt some of the major sources of revenue that are available to government in general. As indicated in Table I, despite the sub stantial growth in the total the relative shares of F ed era l reven ue contributed by the various categories have not changed appreciably in recent years, with the exception of social security contributions which have been the fastest growing source of funds. Social secu rity contributions now account for about onefifth of the total, compared with one-eighth in 1954. This rate of growth is due in part to increases in coverage and contribution rates. TABLE II State and Local Governm ent Expenditures and Receipts C alendar ye a rs— Billions of dollars 1954 1956 1958 1960 1962 1963 Edu catio n .................................................................. 10.1 12.4 15.2 17.8 20.7 22.4 Health and W e lf a r e ................................................... 9.1 10.4 12.5 14.2 16.2 17.3 Commerce, Transportation and H ousing...................... 5.9 6.8 8.8 8.9 10.0 10.9 General Government................................................... 3.8 4.7 5.9 7.0 8.1 8.9 Agriculture and Natural Resources................................. 1.2 1.4 1.7 2.1 2.3 2.5 Total Expenditures................................. 30.1 35.7 44.1 50.0 57.3 62.0 Property T a x e s .......................................................... 10.0 11.8 14.0 16.4 19.6 21.0 Excise T a x e s .............................................................. 6.5 8.0 8.8 10.9 12.4 13.4 Other T a x e s .............................................................. 6.0 7.2 8.1 9.3 10.8 11.5 Federal Grants-in-Aid............................................... 2.9 3.3 5.4 6.3 8.0 9.1 Income Taxes.............................................................. 2.1 2.9 3.2 4.5 5.2 5.5 Contributions for Social S e c u rity ................................. 1.6 2.0 2.5 3.0 3.5 3.9 Total R e c e ip ts .................................... 29.1 35.2 42.0 50.4 59.5 64.4 Source: 8 U. S. Department of Commerce DECEMBER 1964 billion in 1963, more than double the amount spent 10 years earlier. This increase in ex penditure levels has been accompanied by different rates of growth for the various func tions performed by state and local govern ments. For example, while total expenditures increased 106 percent in the period under review, expenditures for education increased 122 percent. Despite the different rates of growth for individual functions, however, the proportionate allocation of total expenditures has not changed markedly in the past decade. Table II clearly demonstrates the impor tance of education, health, and welfare serv ices in state and local government spending patterns. For example, in 1963 these services accounted for nearly two-thirds of total ex penditures. Although spending for health and welfare appears to have leveled off, education expenses have continued to advance rapidly, accounting for an increasing proportion of the total. The nature of state and local expenditures in the years to come will depend on such factors as the pace of population growth with accompanying increases in the relative im portance of school age and aged segments of the population, the acceleration in urbaniza tion, and increased demands for a generally higher level of public services. The overall increase in general revenues of state and local governments has in most instances kept pace with expenditures. Fur thermore, as the table shows, the sources of state and local revenue did not shift signifi cantly during the period under review. The largest relative increase occurred in Federal grants-in-aid to state and local governments. The proportion of total revenue provided by grants-in-aid has been increasing steadily, and in 1963 accounted for more than 14 per cent of total revenue. Perhaps the most remarkable aspect of the distribution of revenue sources has been the performance of the property tax. Despite earlier dire predictions concerning its future, in 1963 property taxes provided one-third of total state and local government receipts, and were also the largest single source, or nearly 90 percent, of local government tax revenue. While local governments continue to rely heavily on property taxes, state governments have been steadily abandoning the use of such taxes.4 BUDGET IMPACT OF GOVERNMENT Aside from the obvious task of allocating spending among alternatives and developing sources of revenue to pay for such spending, the budget of the government sector can be used as an important element in helping to balance total economic activity. In fact, it has become almost traditional for the Federal 4 One of the most pressing problems of local govern ments in the immediate future is the ability of the prop erty tax to meet swiftly mounting expenditures. Most tax experts agree that real property ownership is no longer an efficient or equitable basis for determining ability to pay taxes, and with the current emphasis on industrial development many public officials are reluctant to recommend increases in property taxes that affect busi nesses. Thus, the residential real estate owner is caught in a squeeze that may prove to be intolerable. Further more, many major cities have discovered that the ability of residents to pay increased property taxes has dimin ished as higher and middle income groups move to the suburbs and, in turn, businesses follow these more affluent consumers to the suburbs. However, local gov ernments have found it difficult to adopt other tax sys tems because nearly all alternative systems are being used by either the state or Federal governments. 9 ECONOMIC REVIEW government budget to be used to dampen the business cycle. In other words, subject to con ditions such as the existence of inflationary pressures, etc., the Federal budget would be in surplus during expansion and in deficit during recession. When the budget is in de ficit it is an expansionary factor in the econo my, since the government is adding to eco nomic activity by spending more than it re ceives in revenue. The gap between receipts and expenditures is of course covered by borrowing, which means an increase in the public debt. On the other hand, a budget in surplus is restrictive to the economy, that is, the government is restraining economic ac tivity. A large part of the countercyclical behavior of the budget occurs automatically —on the receipts side in response to changes in economic activity and the level of income, and on the expenditures side mainly because of welfare programs. Much of the budget im pact is also discretionary, however, being effected through an increase or decrease in spending programs. Although swings in Federal budget figures have not reacted to the business cycle as quickly and as fully as desired, as indicated in Chart 3 there has been a general confor mance to countercyclical budget behavior, at least until the present advance in business activity. Recently, there have been almost continuous budget deficits, reflecting reduced emphasis on balancing the budget over short periods of time, and more stress on using the budget impact to stimulate the overall growth of the economy. Thus, the recent liberaliza tion of depreciation allowances and the in vestment tax credit represent attempts to en courage greater spending and investment by 10 the private sector. So too, even though it meant sizable deficits during an upswing in business activity, the tax cut last March repre sented an effort to produce greater growth by reducing the drag of the tax structure on the economy. That a drag did exist is evidenced by developments in 1963, when the budget was moving toward surplus (which would tend to restrict economic activity), while the economy had not yet reached a generally accepted level of full employment. Although there has been a conscious effort at the Federal level to use fiscal policy both countercyclically and, more recently, to en courage economic growth, state and local governments have not played an important 3. G O V E R N M E N T BUDGETS • National Income Concept B il l i o n s o f d o l l a r s +15 S E A S O N A L L Y A D JU S T E D A N N U A L RATES Surplus ■■■! -15 '54 '56 ’58 ’60 '62 ’64 B il l i o n s o f d o l l a r s +15 S E A S O N A L L Y A D JU S T E D A N N U A L R ATES Surplus ■I ’54 ’56 ’58 ■Mill! 60 ’62 S o u r c e o f d a t a : U .S . D e p a r tm e n t of C o m m e rce 64 DECEMBER 1964 part in economic stabilization, nor can they be expected to do so. Budget figures show that state and local governments in the aggre gate have been operating nearly in balance over the past 10 years. During recession periods there have been very small deficits while the current expansion has been char acterized by modest surpluses. This, however, should not necessarily be taken as an indication of what some people refer to as "fiscal responsibility" on the part of state and local governments. The fact is that these budget figures do not include all of the expenditures of state and local govern ments. A large part of the capital spending of state and local governments and the non guaranteed debt incurred to finance such spending is not included in the budget figures. Only the spending from the proceeds of bor rowing with guaranteed securities —those that are backed by the full taxing power of the issuing unit of government —is considered as part of state and local expenditures. Non guaranteed debt instruments, or revenue bonds, are obligations whose principal and interest are payable solely from pledged specific revenue sources (such as tolls col lected on a limited-access highway). Since they are not guaranteed by the full faith and credit of the issuing body, the spending of the proceeds of these securities is not included as part of state and local expenditures. Long-term nonguaranteed state and local debt grew from $ 9 .9 billion in 1954 to $32.4 billion at the end of fiscal year 1963. When expenditures resulting from nonguaranteed debt are counted as a part of their activity, it is evident that state and local governments incurred a constant deficit in the period under review. Thus, the aggregate spending of state and local government has actually provided a continuous stimulus to economic activity, and has performed in a countercyclical fash ion only during periods of recession. GOVERNMENT DEBT While various circumstances dictate wheth er a state or local government will issue a guaranteed security, a ll direct obligations issued by the Federal government are fully guaranteed, that is, backed by the full faith and credit of the United States government. The lender is assured of complete safety in his investment, knowing that the full taxing power of the Federal government guarantees that he will always receive both the con tracted interest payment, and the par value for his security when held to maturity. The greatest part of Federal (public) debt was incurred during World War II. The Federal debt stood at $ 4 8 .5 billion at the end TABLE III G overnm ent Debt in the United States (in billions of dollars) End of Fiscal Year State and Federal' Local 1954 271.3 38.9 1955 274.4 44.3 1956 272.8 49.2 1957 270.6 52.7 1958 276.4 58.2 1959 284.8 64.1 1960 286.5 70.0 1961 289.2 75.0 1962 298.6 81.0 1963 306.5 87.5 1Includes total gross debt and guaranteed obligations held outside the Treasury. Sources: U. S. Treasury Department and U. S. Department of Commerce 11 ECONOMIC REVIEW of fiscal year 1940, rose to a wartime peak of $ 2 7 9 .8 billion in February 1946, and settled back to $ 2 5 9 .5 billion at the end of 1946. Since that time most of the increase in the debt can be traced to the Korean War, a stepup in military preparedness during the cold war, and deficit spending to combat reces sions. In contrast, state and local indebted ness has been incurred mainly to finance capital projects, such as educational facilities, public housing, mass transit improvements, urban renewal, and roads and highways. Total state and local indebtedness rose by 122 percent between fiscal 1954 and 1963. During the same period, the Federal debt grew at a much slower pace, rising 11 per cent to a level of $ 3 06.5 billion on lune 30, 12 1963. (The Federal debt subsequently in creased to $ 3 12.5 billion by the end of fiscal 1964.) Although Federal debt has increased by relatively small amounts in recent years, the borrowing of new money and the refinancing of maturing issues for a debt of such size are bound to influence importantly the nature of economic conditions, particularly as they affect credit and capital markets and interest rates. This in turn involves the important association between the tasks of Federal debt management and Federal Reserve monetary policy as the former attempts to handle the large public debt and the latter attempts to maintain money and credit conditions consist ent with the broad objectives of the economy. DECEMBER 1964 PERSPECTIVE ON PRICES A FURTHER NOTE HE ARTICLE "Perspective on Prices," which appeared in last month's E c o n o m ic Review , included a discussion on price diffu sion indexes. It was pointed out in the article that diffusion indexes have been designed by the Bureau of the Census to aid in the early recognition of general movements in whole sale prices. It was also explained that the diffusion index of wholesale prices for 23 manufacturing industries tends to foreshadow changes in the Wholesale Price Index of total manufactures. T Observers who pay close attention to price developments are aware that a sharp rise in the diffusion index during 1963 was followed by only a modest firming in the prices of man ufactured goods. Because of this, a legitimate question may be raised as to whether the 1963 experience encroaches upon the reli ability of the price diffusion index. The pur pose of this article is twofold: first, to examine that question specifically and, second, to consider broadly the forecasting properties of the diffusion index of manufacturers' whole sale prices in an attempt to improve under standing of its behavior. Price changes in manufacturing tend to spread from firm to firm and from industry to industry. Cyclical peaks and troughs in in dividual price series, however, are not ran domly distributed over time; instead they tend to cluster. A diffusion index attempts to depict the prevasiveness of price changes by measuring the percent of price series rising or falling over selected periods of time. The record of the price diffusion index, beginning with 1948, is shown in the accom panying chart, together with the WPI of total manufactures. Diffusion indexes computed on 1-month and 6-month spans are illustrated, since each of these has certain advantages in the analysis of price behavior.1 Short-term changes in the direction of price movements are revealed by the 1-month span diffusion index. Since month-to-month price changes often are irregular, it is helpful to use a span of six months, which both avoids emphasis on 1 These indexes are published monthly in Business Cycle Developm ents, U. S. Department of Commerce. The chart follows the convention established by the Bureau of the Census of centering the 6-month span diffusion index in the middle of each interval over which the change is measured. (The index could be plotted on the terminal month of the span.) 13 ECONOMIC REVIEW W HOLESALE PRICE INDEX of MANUFACTURED GOODS and DIFFUSION INDEXES of WHOLESALE PRICES for 23 M AN U FAC TU R IN G INDUSTRIES '4 8 So u rc e of d a t a : 50 '5 2 '5 4 ’5 6 erratic monthly movements and reveals more clearly cyclical elements. It should be noted, however, that while the 6-month span diffu sion index shows what is happening o v er suc cessive 6-month intervals, it does not reveal price movements w ith in the intervals. BEHAVIOR OF THE DIFFUSION INDEXES AND MANUFACTURERS’ WHOLESALE PRICES IN RETROSPECT The sequence of major swings in the diffu sion indexes and corresponding movements in the WPI of total manufactures can be seen in the chart. During 1948, sharp declines in the diffusion indexes, both 1-month and 614 ’5 8 '6 0 ’6 2 '6 4 U .S . D e p a r tm e n t o f C o m m erce month spans, preceded by six months a sig nificant decline in the WPI of total manufac tures. The diffusion index on a 1-month span began to increase during the last half of 1949; on a 6-month span it moved up steadily from 6.5 percent in luly 1949 and crested in 1 9 5 0 —early 1951 between 9 5 .7 percent and 100.0 percent. Those developments were underway b e fo re the outbreak of the Korean War in lune 1950 and b e fo re manufacturers' wholesale prices began to spiral upward in May 1950. As the WPI of total manufactures approach ed a cyclical peak early in 1951, more and more components of the diffusion index began DECEMBER 1964 to decline. Early in 1951 the downswing in the 1-month span diffusion index signaled a change in the direction of prices while the 6-month span diffusion index was still on a high plateau. When both diffusion indexes fell below the 50 percent level, the WPI of total manufactures began a decline that lasted almost two years. The rate of decrease in the aggregate price index was slowed down, however, when the diffusion indexes turned upward during the last half of 1951. After that upswing carried both diffusion indexes above 50 percent in late 1952, the aggregate price index bottomed out and began to firm early in 1953. The period of stability in the WPI of total manufactures during the 1953-54 recession was accompanied by fluctuations in the dif fusion indexes around the 50 percent level. A sustained advance in the 6-month span diffusion index, beginning in September 1954, foreshadowed the inflationary episode that began in mid-1955. Between May 1955 and April 1956, the diffusion index on a 1-month span remained above a level that showed two-thirds of the series rising, while the diffusion index on a 6-month span was above the 67 percent level from November 1954 to November 1956. During the 1957-58 recession, the 6-month span diffusion index was declining, but hold ing within the 67 percent —50 percent range for the most part, while the rate of increase in prices of manufactured goods was retarded. Between April 1958 and November 1958 the 6-month span diffusion index rose sharply from 28.3 percent to 80.4 percent and then remained above 8 0 percent through May 1959. The WPI of total manufactures, however, increased only 1.2 percent from October 1958 to May 1959. The behavior of both the diffusion index and the aggregate price index in the 1958-59 period approximates the ex perience of 1963 and early 1964. RECENT BEHAVIOR OF THE DIFFUSION INDEX AND MANU FACTURERS’ WHOLESALE PRICES A decline in the 6-month span diffusion index during 1962 anticipated a softening in the aggregate price index from 101.1 percent in September 1962 to a cyclical low of 100.00 TABLE I Recent m ovem ents in the diffusion index of w h o le sa le prices for 23 m anufacturing in d u s tries and in the WPI of total m anufactures Diffusion Percent Rising Index WPI, Total During 6-month Span Centered On Manufactures Nov. '62 100.4 Feb. '63 '62 100.2 30.4 Sept. '62-Mar. '63 Dec. Oct. '62-Apr. '63 Jan. '63 100.0 Mar. '63 Apr. '63 45.7 Nov. '62-May '63 Feb. '63 100.4 May '63 54.3 Dec. '62-June '63 Mar. '63 100.8 June '63 52.2 Jan. '63-July '63 Apr. '63 101.0 July '63 50.0 Feb. '63-Aug. '63 May '63 100.8 Aug. '63 58.7 Mar. '63-Sept. '63 June '63 100.7 Sept. '63 71.7 Apr. '63-Oct. '63 July '63 100.9 Oct. '63 76.1 May '63-Nov. '63 Aug. '63 100.9 Nov. '63 73.9 June '63-Dec. '63 Sept. '63 100.9 Dec. '63 69.6 July '63-Jan. '64 Oct. '63 101.3 + Jan. '64 23.9% Aug. 26.1 '62-Feb. '63 <- 67.4 Aug. '63-Feb. '64 Nov. '63 101.1 Feb. '64 67.4 Sept. '63-Mar. '64 Dec. '63 100.9 Mar. '64 73.9 Oct. '63-Apr. '64 Jan. '64 100.9 Apr. '64 67.4 Nov. '63-May '64 Feb. '64 100.8 + May '64 60.9 Dec. '63-June '64 Mar. '64 100.8 June '64 50.0 Jan. '64-July '64 Apr. '64 101.1 July '64 60.9 Feb. '64-Aug. '64 May '64 101.0 Aug. '64 63.0 Mar. '64-Sept. '64 June '64 101.2 Sept. '64 ’64 101.4 Apr. '64-Oct. '64 July U.S. Department of Commerce Oct. '64 63.0 Source: 15 ECONOMIC REVIEW percent in April 1963. Beginning in Decem ber 1962 the diffusion index turned upward. Table I presents the monthly details of that advance, which culminated in the 6-month span diffusion index ranging between 67 percent and 76 percent for an 8-month period (shown by the broken bracket). That is to say, for each of the months on which the diffusion index is centered from July 1963 through February 1964, between two-thirds and threefourths of the 23 manufacturing price groups were registering higher prices as compared with the levels of each preceding six months. Prices of manufactured goods increased 1.3 percent from April 1963 to January 1964. Between April 1963 and May 1964, which is the entire period embraced by the diffusion indexes centered within the bracketed area, the net increase in the WPI of total manu factures was only 0.8 percent (see pointers in Table I). The data in Table II help to explain the TABLE II Changes in W holesale Prices of 23 M anufacturing Industries over Selected Periods Net Change in Points Apr. '63 Jan. ’64 Relative to to to Importance* Jan. ’64 May '64 May '64 Lumber and wood products........................................ 3.23% +2.0 + 2.8 +4.8 Furniture and other household d u ra b le s ...................... 5.04 +0.3 + 0.2 +0.5 Nonmetallic mineral p ro d u c ts.................................... 3.64 — 0.4 +0.2 — 0.2 Iron and steel.............................................................. 6.00 3.56 + 1.7 + 3.2 +0.1 + 1.8 Nonferrous m etals....................................................... + 2.5 + 5.7 Fabricated structural metal products .......................... 2.41 + 1.4 — 0.3 Fabricated nonstructural metal products...................... 2.21 +5.5 — 1.1 + 1.1 +4.4 + 1.4 +0.7 — +0.3 + 1.0 Apr. '63 Durable Goods General purpose machinery and eq u ip m en t.............. 2.50 Miscellaneous m achinery............................................ 1.70 + 1.4 Electrical machinery and equipment............................. 5.87 —0.1 +0.8 +0.7 Motor vehicles.............................................................. 6.33 — 0.4 Miscellaneous products............................................... 4.12 +4.6 + 1.4 — 5.4 — 0.8 + 1.0 Nondurable Goods Processed foods.......................................................... 17.68 + 3.2 — 3.1 + 0.1 Tobacco products and bottled beverages...................... 3.16 +3.2 —0.3 + 2.9 Cotton products.......................................................... 2.54 + 1.2 — 1.7 —0.5 Wool products.......................................................... .55 + 2.4 —0.4 +2.0 Manmade fiber textile p roducts................................. 1.69 +0.9 + 1.3 +2.2 A p p arel..................................................................... 4.75 + 1.0 +0.4 + 1-4 Pulp, paper and allied products................................. 6.06 +0.8 — 1.1 —0.3 Chemicals and allied products.................................... 8.23 — +0.4 +0.4 Petroleum products, re fin e d ........................................ 5.12 — 1.6 — 4.4 — 6.0 Rubber and rubber products........................................ 1.75 —0.4 — 1.1 — 1.5 Hides, skins, leather, and leather products.................. 1.89 — 1.8 + 2.0 +0.2 Total Manufactures Price Index............................. — + 1.3 — 0.5 + 0.8 *As a percent of the 23 manufacturing industries’ total. Sources: U. S. Department of Commerce; U. S. Department of Labor. DECEMBER 1964 moderate firming in manufacturers' whole sale prices at a time when the 6-month span diffusion index first rose sharply and then hovered at a high level for eight months. It should be noted that, between April 1963 and May 1964, the 1-month span diffusion index was above the two-thirds level for only two months. In contrast, previous high levels of the 6-month span diffusion index were ac companied by significant periods of high values in the 1-month span (see chart). Price changes in the 23 component series are grouped into three periods in Table II. Over the first period, April 1963 to January 1964, sixteen price series increased, one series was unchanged, and six series de clined. Most of the price increases were mod erate, i.e., 2 percent or less. The weighted effect of price declines on the WPI of total manufactures was less than —0.2 percent. Price Groups With Net Declines Weighted Effect From April ’63 to January ’64 of Price Declines2 Petroleum products, refined...................... — .082% Hides, skins, and leather products . . . . —.034 Motor vehicles........................................ —.025 Nonmetallic mineral products.................. —.015 Rubber and rubber p ro d ucts.................. —.007 Electrical machinery and equipment —.006 . . . T o ta l........................................... —.169 was unchanged, and ten series declined. The weighted effect of price declines on the WPI of total manufactures was —1.2 percent. Price Groups With Net Declines Weighted Effect From January ’64 to May ’64 of Price Declines Processed foods........................................ ..... — .548% Petroleum products, refined........................... — .225 Miscellaneous products............................. ..... — .222 Pulp, paper and allied products.................... — .067 Cotton p ro d u c ts .................................... ..... — .043 Fabricated nonstructural metal products . . — .024 Rubber and rubber p ro d ucts.................. ..... — .019 Tobacco products and bottled beverages . — .009 Fabricated structural metal products — .007 . . . Wool products........................................ ..... — .002 T o ta l................................................. — 1.166 Exclusion of the above ten price groups from the aggregate would have resulted in a 0.7 percent increase in the WPI of total manu factures from January 1964 to May 1964 in stead of the actual 0 .5 percent decrease. If only one group—processed foods—were excluded, there would have been virtually no change in manufacturers' wholesale prices. Over the entire period, April 1963 to May 1964, seventeen price groups showed net price increases and six groups showed net price declines. The weighted effect of price declines on the WPI of total manufactures was —0.4 percent. Exclusion of the above six price groups from the aggregate index would have resulted Price Groups With Net Declines Weighted Effect From April ’63 to May ’64 of Price Declines Petroleum products, refined...................... Miscellaneous products............................. — .307% —.033 Over the second period, January 1964 to Rubber and rubber p ro d ucts.................. —.026 May 1964, twelve price series increased, one Pulp, paper and allied products.............. —.018 in a 1.5 percent increase in the WPI of total manufactures instead of the actual 1.3 per cent increase. 2 Derived by multiplying net change in percentage points times the relative importance of the item. Cotton products .................................... —.013 Nonmetallic mineral products.................. — .007 T o ta l............................................ — .404 17 ECONOMIC REVIEW Exclusion of the above six price groups from the aggregate would have resulted in a net increase of 1.2 percent in manufacturers' wholesale prices from April 1963 to May 1964, instead of the actual increase of 0.8 percent. CONCLUSION The foregoing discussion illustrates several possible shortcomings in the forecasting properties of the diffusion index, at least as based on experience during recent years. First, each price group has an equal weight in the diffusion index, although there are wide disparities in the relative importances of the individual groups.3 Second, in comput ing the 4iftusion index very s m a ll price increases (e.g., 0.1 percent) are counted as pluses. As previously noted, exclusion of those price groups that actually declined would have added only a small amount to the rise in the aggregate price index; in other words, although price changes were large in 3 A computation by this Bank of a 6-month span diffusion index, weighted by the relative importance of each price group, gave values above 67 percent for only two of the eight high-level months bracketed in Table I; the values for the remaining- six months ranged between 53 percent and 64 percent. 18 number they were small in magnitude. Third, there is no published aggregate price index that corresponds precisely to the diffusion index, although the WPI of total manufac tures is a close approximation. Commodities such as iron ore, scrap metals, hides and skins, and natural rubber are e x clu d e d from the WPI of total manufactures but are i n c lu d e d in the 23 groupings of the diffusion index. Price subgroups such as hardware, plumbing and heating equipment, agricul tural machinery, construction machinery, and metalworking machinery are in c lu d e d in the WPI of total manufactures but are e x clu d e d from the components of the diffu sion index. Since the diffusion index contains some of the more sensitive commodities, it will often respond more easily to price move ments than does the WPI of total manufac tures. Despite the limitations that have tended to converge recently, the diffusion index has a longstanding ability to anticipate changes in wholesale prices. Thus, movements in the price diffusion indexes, both on 1-month and 6-month spans, will continue to merit careful consideration by analysts of price develop ments. ANNUAL INDEX TO ECONOMIC REVIEW- 1 9 6 4 MONTH ARTICLE TITLE JAN U ARY Foreign Capital Borrowing in the United States Financial Position of Consumers FEB R U A R Y Inventories in Perspective External Financing by Fourth District Industries, 1953-1963 M ARCH The Aluminum Industry: Its Problems and Progress APRIL A Tale of Three Tax Cuts Thoroughbreds in Kentucky MAY Repurchase Agreements N egotiable Time Certificates of Deposit JUNE Investment Characteristics of N ew Foreign C apital Borrowed in the U. S. A Further Note on City Industrial Patterns JULY Industrial Development in O hio— The Food Processing Industry Recent Economic Developments in Selected Foreign Countries Spotlight on Savings Flows AU G U ST Personal Income— Patterns and Trends in the Fourth District U. S. Merchandise Trade by Geographical A rea, 1950-1963 SEPTEMBER A Look Ahead at M anpow er Utilization Electric Power as a Regional Economic Indicator OCTO BER Call Loans An Economic Profile of Cincinnati NOVEM BER Perspective on Prices Manufacturing Investments in O hio— 1954-1962 DECEMBER The Government Sector of the Economy Perspective on Prices— A Further Note 19 Fourth Federal Res erve District
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