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(w<SLb i A £ ^ N O V -41971 FEDERAL RESERVE HANK DF fFBERSi RESERVE M M OF PHM BEIP’M SAN FRANCISCO Monthly Review In this issue The First Wira©#^ 0@^fs Q[n!m[pDO<g(o]i>n<§)ER!§ Precedents Housings Can if Last? September 1971 The First N inety Days: Im plications . . . The new economic policy will produce major changes in the climate in which business operates at home and abroad. The First N inety Days: Precedents . . . The history books record significant precedents for each of the major portions of the President's program. H®using: C a n It L a st? . . . Although the W est's housing market is very strong just now , population and financing trends pose questions about the future. E d i t o r : W illiam Burke M ONTHLY September 1971 REVIEW The First Ninety Days I. Implications he nation has embarked on a totally new 1972, those same factors, plus the personal in course o f economic policy— one that should come-tax speed-up, should again stimulate the produce major changes in the climate in which economy, although their effect will be partly business operates at home and abroad. In his his offset by the various Federal expenditure reduc tory-making announcement, the President said, tions. T "The range o f actions I have taken and proposed Several major econometric forecasters, who tonight— on the job front, on the inflation front, had previously been looking for gains o f 4-to-5 on the monetary front— is the most comprehen percent in real G N P in 1972, are now thinking sive new economic policy to be undertaken by in terms o f a 6-to-7 percent increase. They now this nation in four decades.” T o date, few eco nomists ( i f any) have seen fit to quarrel with see no more than a 2-to-3 percent rise in the that assessment. Most business forecasters, either o f the eco nometric or the garden variety, now look forward to a significant improvement in the economy because o f this breathtaking policy shift. A few experts, such as Nobel laureate Paul Samuelson, foresee little net stimulus because o f the way the Administration has offset its tax-relief measures with expenditure reductions, such as the cutback in Federal employment and the postponement o f a scheduled Federal pay raise. Other experts see things differently, however, because o f the stra tegic nature o f the fiscal stimulus to the auto and machinery industries, as well as the possible over-statement o f the expenditure cuts that will finally come out o f the budget-making mill. The stimulus from the Administration’s pro gram should be substantial over the next year or so. According to Brookings Institution esti mates, the net stimulus may reach $4.8 billion in the second half o f 1971 and $4.5 billion in the first half o f 1972, at annual rates. (However, those estimates may be on the high side.) Dur ing the current period the investment-tax credit and the auto-excise tax removal should both exert a significant impact. During the first half o f FEDERAL RESERVE BANK general price index (the G N P deflator), instead o f a price rise o f 4 percent or more— and per OF SAN F R A N C IS C O F re e ie m a y b rin g current-dollar G N P more into line with real G N P haps also a drop in the unemployment rate o f l/2 percentage point or more below earlier esti mates. Still, there is much ground to be made up; the gap between potential and actual GNP (in 1970 prices) was on the order o f $70 billion or so at midyear. Scenario, with numbers Most scenarios now being constructed would suggest substantial expenditure increases over the next year in consumer durable goods, busi ness fixed investment, and net exports. Allowing a certain number o f months for the tax credit to stimulate investment and for the dollar de preciation to stimulate the export sector, the rose over 10 percent for Federal spending and previously sluggish recovery should gain m o mentum in the fourth quarter o f 1971 and lead over 7 percent for state-and-local government to a stronger year in 1972. help government budgets substantially. Mean while, military sales abroad should be stimulated All sectors o f the economy can expect to see more acceptable numbers arising from this opti by the depreciation o f the dollar— but for the mistic scenario, but they should also expect to see a different kind o f numbers developing be cause o f the workings o f the wage-price freeze. If the freeze is successful in slowing wage and price increases to a creep from the now all-toofamiliar gallop, the dollar increases in GN P should be smaller— but much more real— than those recorded in the last several years. T o put this situation in context, the moderate advance self-same reason U.S. defense costs abroad should rise (perhaps by $200 million in fiscal 197 2 ), unless the military burden is taken over more fully by the countries concerned. in G N P posted during the second quarter amounted to $9 billion in real terms but to $20 Consumer receipts Consumers generally should benefit from the new policy, partly because o f the real and psycho logical benefits resulting from the general price freeze, and partly because o f the overall stimulus created by the personal income-tax reduction and billion in current-dollar terms. other elements o f the Administration’s fiscal Somewhat ironically, to the extent that the Administration’s anti-inflation stance is success package. Much now depends upon the general ful, government tax collectors will lose part o f results o f the Congressional debate over the the inflationary windfall generated because o f Administration’s fiscal package. In this connec the graduated nature o f the personal-income tax. (T he persistent inflation has helped push many taxpayers into higher income brackets, where they are subject to higher tax rates.) But at the same time, the government sector will benefit from the freeze because o f its holddown on in- 154 spending, so any improvement in that area will flationary purchases. In 1970, the price deflator nature o f the post-freeze controls, as well as the tion, Congress may be tempted to offset, in some way, the deflationary increase in social security taxes now scheduled to take effect on January 1. That increase in total would amount to a $7billion tax hike in 1972, according to the present House bill; specifically, for a $10,000 worker with a family o f four, the $175 social security September 197! MONTHLY REVIEW increase would more than offset the $80 he could mean an average cut in new car prices o f would gain from the income-tax speedup. around $200 per car, and proportional reduc Aside from this general impact, some con sumers will gain more than others from the tions in the cost o f used cars. And, since new and used cars are an important part o f the con workings o f the new policy. The strongest bene sumer price index, a reduction in auto prices ficiaries include those who received substantial should help hold down the index. wage increases prior to August 15, social secu rity recipients (with their retroactive benefit on the basis o f snob appeal rather than price Consumers who purchase foreign products increase), workers in the export trades, and competition may not be discouraged by the workers in the auto and associated industries. double-barreled increase in import costs. (Still, (Administration statistics suggest that 25,000 jobs are created for every increase o f 100,000 foreign cars will benefit from the elimination o f the auto excise.) But conversely, low-income in new car sales.) buyers who buy foreign products because they N ot so lucky are those who expected to gain represent the best available at the bottom o f the substantial wage increases after August 15. price line may be hurt by the rising prices o f Nonetheless, inequities o f this sort would be such goods. bound to arise, no matter what date was chosen for the wage freeze. Consumer purchases Consumers may encounter rising prices for Record-breaking boost The Administration’s program means a signi ficant boost to U.S. corporations. The investment tax credit, plus the recent A D R (asset-deprecia some raw agricultural products that are not cov tion range) measure, should mean a reduction ered by the price freeze. Also, for imported o f $8 billion or more in business taxes during goods, the combined effect o f the depreciation the next year alone— the largest reduction o f this and the import surcharge should raise the sales type in history. Even so, many businesses may price o f such goods, depending on the amount o f revaluation and on the amount absorbed by foreign suppliers or U.S. importers. But some reports indicate a boomlet for imports that were wait to see a boost in consumer demand— and a reduction in idle capacity— before they take ad vantage o f these tax incentives. on hand before August 15— especially imported cars, with their eligibility for the auto-excise refund. Consumers may be expected to look more favorably on Detroit’s products now than they have for some time. The excise-tax removal W ith over one-fourth o f the nation’s manu facturing capacity now unused, most industries do not need new plant investment just for the sake o f expanding production facilities. But with the 10-percent tax credit available for only one year, most would be tempted to replace their older equipment sooner than they otherwise would. Also, more o f that increased investment should now take place here rather than abroad, in view o f the dollar depreciation, the import surcharge, and the availability o f the tax credit only on U.S.-produced equipment. The Administration hopes to encourage the widest possible use o f modern machinery and equipment, to stimulate both the long-term growth o f productivity in manufacturing and the competitiveness o f U.S. producers in both do- 155 FEDERAL RESERVE BANK SAN FRANCISCO mestic and foreign markets. Modern production there may be 1.2 million ’72 models available techniques are, o f course, available to all in by the end o f September, or double the number ready by that date in any earlier year. dustrial countries. If the U.S. is to maintain its competitive position, its prices must remain low The petroleum industry may obtain a mild relative to those o f foreign competitors, and thus it must generate increases in productivity at boost from the expected prosperity o f the auto least sufficient to match its wage increases. But to accomplish this, U.S. manufacturers should industry, but at the same time, it faces a threat from the Organization o f Petroleum Exporting Countries to raise the price o f oil by whatever promptly apply the most modern and efficient amount their currencies appreciate relative to the production methods. Indeed, a high-income eco dollars in which they are paid. Steel industry nomy must remain innovative, as was seen by prospects, formerly dismal, are now brighter the President when he announced the beginning o f work on new tax proposals to stimulate in autos, but also for freight cars, farm equipment creased research and development. and other types o f equipment. Yet the short because o f the improved outlook not only for The Administration’s package o f international term steel outlook remains clouded by the over actions means more orders for U.S. exporters, as hang o f 12 million tons o f strike-hedge inven well as fewer domestic sales for U.S. importers, tories built up before the new labor contract including travel agents. The favorable impact was negotiated on August 1. o f these actions should be greatest for manu The more efficient o f the nation’s export in facturers o f products, such as chemicals and steel, that are mose sensitive to international dustries undoubtedly will be helped by the de price differentials. jet planes, heavy machinery, and farm goods The package o f domestic actions should bolster consumer confidence and, by persuading con sumers to rechannel their savings into the spend ing stream, should give an extra boost to retail sales. Reordering by retailers means a filling up o f manufacturers’ order books and thus an in crease in the factory operating rate. The higher operating rate, plus the relative stability o f wage costs, should then boost profit margins above should be able to expand their already large bridgeheads abroad as their products become relatively cheaper in those markets. In addition, certain industries which can help modernize the nation’s productive plant— machine tools and computers, in particular— should benefit from the expansion o f orders resulting from the in their present sickly state and encourage business men to set aside more funds for new investment. The implications o f floating currencies will become clearer as the nations gain more experi Detroit's boost The auto industry will be a major beneficiary preciation o f the dollar. Producers o f computers, vestment-tax credit. Foreign exchange rates ence in freer foreign-exchange markets. Never theless, such experience will not serve as a reliable guide to the longer-run equilibrium o f the Administration’s new policy, and Detroit’s levels of exchange rates so long as controls re triumphs will be shared with its suppliers— steel, rubber, glass, copper, leather, and textiles. main on movements o f goods and investments. The free-market forces in foreign-exchange mar The auto industry could probably use such stimu kets will not reveal the proper exchange rela lus, since it had a record 1.7-million end-of-the- tionships until the U.S. removes both the import run models on hand August 1, and may soon surcharge and direct controls over foreign in vestment, and until other countries remove sim have a large number o f price-frozen ’ 72 models coming off the assembly line early. W ith a 156 OF smooth launching o f new-model production, ilar and related impediments to international economic activity. September 1971 MONTHLY Prolonged decline in trade balance helps explain dollar crisis REVIEW currencies in relation to the dollar and assumed a larger share o f the U.S. military and aid burdens. B il lio n s o f D o l l a r s Domestic interest rates In the monetary field, the new economic policy has relieved much o f the heavy pressure which had borne down upon the Federal Reserve dur ing the last several years. The burden has now been distributed more equitably among all the policy-making agencies. In a major expectational switch, market par ticipants are no longer disposed to believe that interest rates will inevitably move higher. Psy chological factors earlier had helped push rates upward, despite the sluggishness o f economic activity and the modest level o f credit demands. But then, with the announcement o f the Presi dent’s program, dropped from 90-day Treasury bill rates 5.40 percent to 4.90 percent within a month’s time, while in the long-term The President’s message suggested that basic market, Treasury bond rates dropped from 5.85 percent to 5.52 percent, and corporate bond rates changes are necessary in the international mone tary system. The major trading nations must from 7.71 percent to 7.42 percent. reach agreements about exchange-rate flexibility, the convertibility o f the dollar, and the future role o f gold and other reserve assets. In the o n g oin g discussion, P ierre-P au l Schweitzer, managing director o f the Interna tional Monetary Fund, proposed a three-step program o f monetary reform. First, major na tions would realign their currencies, define the role o f gold, and return to fixed currency parities fidence in the braking effect o f the wage-price freeze, capable o f reducing the inflation pre mium that lenders otherwise would tack on to their interest-rate demands. The dramatic drop The slide in rates reflected a general con with wider bands, while the U.S. would remove in bill yields, which went as low as 4.45 percent at one point, also reflected an upsurge in foreign buying o f bills and a tight supply condition o f dealers. As foreign purchases have begun to taper off, the bill rate has moved upward again, although it still remains far below the pre-crisis its 10-percent import surcharge. Second, creditor level. nations would help correct the U.S. balance-of- Heavy foreign buying o f Government secu payments deficit through more burden sharing rities— close to $20 billion so far this year— has and more effective capital controls. Third, the IMF would increase the available supply of acted as an indicator o f the accumulation o f excess dollars in the hands o f monetary autho liquid assets for world trade, perhaps through some new instrument resembling Special Draw rities abroad. This new development introduces a volatile factor into the Government-securities ing Rights. In reply to this plan, U.S. negotiators market, since it could lead to heavy market pres noted that the import surcharge would not be removed until creditor nations revalued their sures if substantial amounts o f foreign-held Treasuries were to be liquidated. FEDERAL RESERVE BANK OF SAN F R A N C IS C O The money supply, after a large jump in early the price rise, current-dollar G N P will rise more July, has since remained relatively flat. The stim slowly, and there will be a smaller need for ulus arising from the President’s program should money to underwrite normal business transac tions. require an accommodative growth o f the money supply. Yet, to the extent that the freeze brakes 10. Precedents Never before in the nation’s history has such The budget at the beginning o f that period a multi-faceted economic program been unveiled at any one time. Even so, the history books record would have generated a $ 13-billion surplus if significant precedents for each o f the major por tions o f the President’s program. The present attempt to stimulate growth nomy with a substantial amount o f unutilized through fiscal actions is reminiscent o f the policy human and material resources. Heavy expendi tures for defense, space, and civilian programs o f the early 1960 s. The policy o f freeing the helped reduce that surplus, however, and two dollar and encouraging realignment o f foreign tax-reduction measures adopted in 1962 pro vided a needed long-run stimulus to lagging exchange rates is reminiscent o f the actions o f wage-price spiral through direct controls is re private investment. The net effect o f new depre ciation guidelines (announced July 1962) and lated to a constant policy theme o f the past gen the investment tax credit (enacted in the Reve- the 1930’s. Moreover, the attempt to curb the eration. (Kremlinologists might note also that Lenin used the term N ew Economic Policy to describe his attempt to stimulate the Soviet eco nomy in the early 1920’s.) The various policy precedents differ somewhat in detail from their present-day counterparts. Nonetheless, they are worth examining to see what light they throw upon the likely direction o f policy in the 1970’s. G a p of the '60's One o f the major elements in the present pro gram is the 1960-style attempt to use fiscal policy to eliminate the large gap between the nation’s potential output and aggregate demand. The main policy challenge a decade ago was to stim ulate the growth o f total demand, sufficient to catch up with the growth o f productive capacity. Fiscal policy met this challenge by generating an increase o f $21 billion in Federal expenditures and a reduction o f $16 billion in tax liabilities 158 the economy had been operating at full employ ment. This was quite inappropriate to an eco (from I960 rates) over the course o f the 196164 period. P isc a l p o lic y designed to close gap between actual and potential G N P September 1971 MONTHLY REVIEW nue Act o f 1962) was a $21/>-billion increase in all exports o f gold and required banks and other the annual cash flow o f corporations, plus an holders to exchange their gold and gold certifi appreciable increase in the after-tax rate o f re turn on new investment projects. cates for other cash. In breaking the old ties with gold, the President— who had become deter The expenditure increases and the tax reduc mined to raise the level o f domestic prices— ment surplus by late 1962. In 1963, however, was influenced by the arguments o f a prominent farm economist, George Warren. In the latter’s the aggregate demand generated by consumers, view, the price o f gold controlled the general businesses, and governments was not adequate to move the economy sufficiently close to the full- price level, and thus the only way to inflate was employment target, and the full-employment Accordingly, the President persuaded Con gress to accept the Thomas Amendment to the tions just about halved the original full-employ budget surplus widened sharply again. Conse by raising the price o f gold. quently, Congress passed the Revenue Act of Agricultural Adjustment Act, which authorized 1964 and reduced tax liabilities by $11 billion on individuals and $3 billion on corporations. him "to fix the weight o f the gold dollar . . . This legislation helped generate a 41/2-percent rise in real GN P in 1964, whereas the increase without those tax cuts probably would have been below 3 percent. Fiscal policy provided a further stimulus in 1965 with a reduction in excise taxes, mostly affecting consumer durable goods. These reduc at such amounts as he finds necessary . . . to stabilize domestic prices or to protect the foreign commerce against the adverse effect o f depre ciated foreign currencies.” (W hen informed of the abandonment o f the old parity price, Budget Director Lewis Douglas intoned, "This is the end o f Western civilization,” and Bernard Baruch added, "Respect for law and order is gone.” ) tions amounted to about $3l/2 billion in the The London conference that spring became a 1965-66 period. The excises were wartime emer gency taxes, so they were considered long due center o f the struggle between the American for termination. Appropriately, then, when the Vietnam war flared up, further reductions sched uled for auto and telephone excises were shelved, and tax rates remained unchanged throughout the late stages o f that conflict. international financial arrangements, it may be bloc. The French and other European central banks tried to push through a plan for stabilizing exchange rates by adhering to the gold standard, but the President (to the applause o f John May nard Keynes) denounced this plan and called upon the conference instead "to cure the funda mental economic ills” o f the world economy. The conference broke up at that point, but it was doomed anyway, because o f the essential d if instructive to review the turbulent period which preceded the Bretton W oods arrangements. In ference between those for whom the domestic price level was important and those for whom the dark days o f the early 1930’s the world scene was marred by a number o f competitive tariff the traditional ties with gold were crucial. increases and exchange devaluations. Against Reaching $35 an ounce Turmoil of the '30's In analyzing the current negotiations to alter this backdrop, an activist new Administration came to power in Washington. The Emergency Banking Act of 1933 (M arch) empowered the President to regulate or prohibit transactions in gold or foreign exchange. Under that authority, President Roosevelt embargoed economic nationalists and the European gold Acting under the authorization o f the Thomas Amendment, the President initiated a gold pur chase program in late 1933, usually setting the price at some arbitrary figure, in a generally fruit less attempt to push up the domestic price level. In early 1934, however, a new arrangement was FEDERAL RESERVE BANK established with the passage o f the Gold Reserve OF SAN F R A N C IS C O British economist John Maynard Keynes devel Act o f 1934. This legislation permitted the Presi oped a far bolder plan for a Clearing Union that dent to set the price o f gold at 50 to 60 percent would have no assets o f gold or securities but o f the old parity— that is, between $41.34 and would consist o f an extensive system o f clearing $34.45 an ounce— and he thus set it, "tempo rarily,” at $35.00 an ounce. credits to settle international imbalances. The W ith the U.S. gold price settled in this man ner, other currencies gradually aligned them selves with the dollar. In particular, the French the W hite and Keynes plans, was hammered out at the Bretton W oods Conference in the sum final plan, which was somewhat an amalgam o f mer o f 1944. devaluation o f 1936 provided the occasion for a T o discharge its obligations to maintain the tripartite (American-British-French) agreement over the foreign-exchange situation. N o definite value o f the dollar under the Articles o f Agree ment o f the IMF, the U.S. undertook to buy and parities were set, but each nation agreed to con sult on future moves so as to avoid competitive sell gold freely at $35 an ounce with foreign central banks in exchange for dollars. The par depreciations, and also agreed to use stabilization values for other currencies were then established funds to smooth the course o f exchange rates. in terms o f relative gold content and in terms o f This arrangement lasted until W orld W ar II. the dollar. (The U.S., with its reserve currency, did not have the same flexibility that other coun tries did to alter its declared parity.) The initial subscription o f the Fund was less than $9 bil lion— substantially below the $35 billion that Keynes had in mind. Spiral of many decades Comparisons with the present attempt to halt the wage-price spiral through direct controls are scattered throughout the history o f the past halfcentury. Since Bernard Baruch’s W ar Industries Board in 1918, wage-price controls have had quite a checkered career, but their heyday came during W orld W ar II and the Korean conflict. In July 1942, under the National W ar Labor Board’s Little Steel formula, wage increases were permitted up to 15 percent above January 1941 wage levels— and after October 1942, no wage increases were allowed without W LB approval. Nonetheless, wages and (especially) fringe benefits drifted upward throughout the war. During the early stages o f the war, the Treas ury initiated plans to prevent monetary chaos in the postwar world. Treasury planner Harry D ex Meanwhile, in the field o f commodity prices, the OP A Maximum Price Regulation (A pril 1942) ter W hite conceived o f a United Nations stabili zation fund that would stabilize exchange rates highest March 1942 prices for any commodity, and promote liberal trade policies, and would 160 stipulated that sellers could not exceed their without express OPA approval. These wage-price regulations continued in e f act to halt the spread o f restrictive exchange fect until after V-J Day, but the wage line was controls and bilateral currency arrangements. broken effectively by February 1946 and the price September 1971 MONTHLY line by June 1946, as an economy fueled by a massive accumulation o f liquid funds sought to make up for a four-year-long repressed demand for consumer goods. The 1945-48 period thus REVIEW Three in fla tio n a ry p e rio d s occur within past two decades In d e x (1 9 5 8 = 1 0 0 ) was dominated by an upsurge o f demand-pull inflationary pressures, significantly different from the recent type o f cost-push pressures; during that period, consumer prices jumped by onethird and wholesale prices even more. Case study: Korea The Korean W ar inflation ran its course within a fairly brief period, being confined mostly to the period mid-1950 to early-1951. Sharp price pressures in this interval were attributable only partially to expanded demand or to supply short ages, but instead largely reflected expectational factors. Increases in raw-material prices antici pated future shortages and price controls, while increases in consumer buying anticipated future scarcity o f consumer durables. The initial policy response was the quick en The principal price-control mechanism used actment o f the Defense Production Act o f 1950 by the Office o f Price Stabilization (after the and o f tax increases on individuals and corpora tions. (Corporate excess-profits taxes were levied ups for each commodity. The objective was to during the Korean War, as during both o f the remove the principal distortions o f the freeze by two W orld W ars.) The Federal Reserve also imposed controls on mortgage credit and con sumer durable goods purchased at that time. Selective wage-price controls were instituted in late 1950, and these were followed by a general price freeze (January 1951) and by wage restric tions under the W age Stabilization Board. A fairly rapid restoration o f price stability was achieved even in the face o f the continuing war restoring the original relation between each man ufacturer’s cost for labor and materials and the price existing in the pre-Korea base period. As a longer-run solution, the Economic Stabi lization Administrator directed OPS (A pril effort, which reduced the unemployment rate to policy ensured the absorption o f cost increases a very low 2.5 percent. Substantial producer sup plies o f many types o f commodities, plus retailer so that they would not form the basis for future price increases. overstocking in anticipation o f continued scare Wages were controlled by the W age Stabili zation Board, which set to work in January 1951 by freezing wages, salaries, and other compensa buying by consumers, helped to stabilize prices during the war period. Altogether, consumer prices jumped at a 14-percent annual rate in the first six months o f the war, increased about 41/2 percent more during 1951 (after the imposition o f the General Ceiling Price Regulation), and then leveled off. initial freeze) was to set fixed percentage mark 1951) not to permit any general increase in ceiling prices for any industry unless its pre-tax profits were below 85 percent o f its profits in the three best years o f the 1946-49 period. This tion at existing levels. Thereafter, the Board refused to permit payments o f any raises without prior W SB approval. However, some 2 million workers had obtained raises under major wage contracts just prior to the freeze, probably be- 161 FEDERAL RESERVE BANK SAN F R A N C ISC O cause o f the Administration’s discussion o f forth o f guideposts. These guides were unveiled in the coming controls, and some attention had to be CEA’s 1962 report: paid to smoothing out the resulting inequities. "The general guide for noninflationary wage Thus, in February 1951, the WSB permitted behavior is that the rate o f increase in wage 10-percent raises for those who had not obtained rates (including fringe benefits) in each in them at the first o f the year, and on top o f that, dustry be equal to the trend rate o f over-all pro allowed ductivity increase. General acceptance o f this previously negotiated cost-of-livin g raises in excess o f 10 percent. (T h e then-Council guide would maintain stability o f labor costs per o f Economic Advisers suggested that produc unit o f output for the economy as a whole— tivity allowances, on the order o f 2-to-3 percent though not, o f course, for individual industries.’ ’ annually, should be included as part o f the stabilization program.) behavior calls for price reduction if the indus Case study: new inflation As price stability returned in 1952, OPS began to reduce controls on certain commodities (such as consumer items) where market conditions permitted, and the incoming Eisenhower Adm in istration dropped the whole panoply o f controls in February 1953. But then, around the middle o f the decade, a new type o f inflation began to "The general guide for noninflationary price try’s rate o f productivity increase exceeds the over-all rate— for this would mean declining unit labor costs; it calls for an appropriate in crease in price if the opposite relationship pre vails; and it calls for stable prices if the two rates o f production increase are equal.’’ These guideposts were based on the assump tion that the economy would work more effici ently if discretionary price and wage decisions develop. Its causes were a major investment o f powerful firms and unions were brought more boom, sharp rises in food prices because of supply difficulties, and in particular, a sharp rise in unit labor costs as factory worker costs ex ceeded productivity gains. into line with the results expected in competi tive markets. The same viewpoint dominated a number o f the Council’s reports after 1962, despite variations in detail. The original 1962 statement provided no precise measure o f long term productivity trend to serve as a basic guide. The 1964 statement, however, was much more specific, citing the now-famous 3.2-percent figure — the 5-year moving average o f output per man hour in the private economy— as the standard During this period, labor and other costs apparently produced inflationary price increases even under conditions o f less-than-full employ ment and a lack o f excess demand. More and more observers came to stress the monopoly power o f big corporations and big unions as the real forces behind the inflation. They also noted that the inflationary bias imbedded in the eco for average wage increases. nomy through the existence o f rigidities o f this Away from 3.2 type could not easily be overcome by standard monetary and fiscal policies. Thus, a new type throughout the next several years, despite the o f problem confronted the Kennedy Administra tion when it took office in the midst o f reces development o f several complications which eventually led to the discarding o f the guidepost sion in 1961. approach. The 5-year average in 1966 actually The guideposts would have yielded a 3.6-percent guidepost, but even that figure would have provided little gain in real wages because o f sharp price increases in The new Administration was forced to seek new measures to restrain wage and price in162 OF creases, and the answer it adopted was a system The Council clung to this 3.2-percent standard food and services— two areas not reached effec tively by guideposts because not governed by M ONTHLY September 1971 major industry and union decisions. Thus, in 1966 and 1967, unions tried to obtain wage set tlements which effectively equalled the original 3.2-percent guidepost plus the amount necessary to offset the rising trend in consumer prices. REVIEW tember 1967), argued that wage and price changes were smaller with guideposts than they would have been without guideposts. Moreover, according to Perry, smaller-than-anticipated wage increases occurred more notably in "visible” in The Council, in a 1968 restatement, admitted dustries— that is, the mass-production industries that many sellers o f commodities and services most susceptible to guidepost pressures. (The have no discretion over their prices, that many "visible” industries, which account for roughly wages are not set by collective bargaining agree 10 percent o f total employment, include metals, ments, and that prices o f imported goods and machinery, electrical equipment, and transporta farm products are determined by other factors than the domestic wage level and the discre tion equipment.) tionary decisions o f large firms. Nonetheless, it periods 1954-57 and 1963-66, Perry found that argued that " I f the guideposts were essentially the average wage increase in "invisible” indus In comparing wage movements during the observed by those firms and unions that possess tries declined from 4.3 percent in the first period discretion with respect to prices and wages, the inflationary bias inherent in a high-employment to 3.8 percent in the guidepost period— but that economy should be largely overcome.” from 5.0 to 2.9 percent. Even after adjustment the increase in "visible” industries dropped for changes in employment patterns, this test How effective? H ow effective were the guideposts during the strongly indicates a much greater differential in wage behavior in those industries most suscep relatively short period in which they were tried ? tible to guidepost influence. Experts disagree about both their validity and their effectiveness, and statistical tests o f wage The overall record shows that, at one time or another over the past several decades, Americans and price behavior have not actually proven that have gained a great deal o f experience stimulat they were effective over this period. Still, the tests are consistent with the hypothesis that guideposts contributed— along with the more in tensive competition from imports— to the rela tive wage-price stability o f the early 1960’s. ing inadequate demand, confronting turmoil in the foreign-exchange markets, and overcoming inflations o f the cost-push variety. N o doubt, as 1971 comes to an end, they will gain greater familiarity with problems o f this type, and hope fully with their cures as well. William Burke The Brookings Institution’s George Perry, writing in the American Economic Review (Sep Publication Staff: Karen Rusk, Editorial Assistant; Janis Wilson, Artwork. Single and group subscriptions to the M onthly Review are available on request from the Administrative Service Department, Federal Reserve Bank of San Francisco P.O. Box 7702, San Francisco, California 94120 163 FEDERAL RESERVE BANK OF SAN FRANCISCO Western Digest Bank Credit Expands Total credit at large District banks rose 0.9 percent on a seasonally adjusted basis in August, but this offset only part o f the 1.4-percent decline registered in July. . . . Loans expanded at a brisk 3.1-percent pace in August, more than offsetting the previous month’s modest decline, and far outpacing lending activity elsewhere in the nation. August’s strength primarily reflected heavy borrowings related to the foreign-exchange crisis. . . . District banks’ security holdings fell sharply— 6.6 percent for Government securities and 3.1 per cent for other securities. (These reductions were considerably greater than those recorded nationally.) District banks now hold fewer Government securities than they did at the beginning o f the year (seasonally adjusted basis) . Lockheed Financing Signed A $750-million financing program to rescue financially troubled Lockheed Aircraft Corporation has been formally approved by the Federal Government and representatives o f a 24-bank lending consortium. The Government will guarantee $250 million in new bank loans to support the L1011 TriStar program. The loan will cost Lockheed an 8-percent interest rate, with the Government getting 2.3 percent o f that amount and the banks getting the rest. O f the 9,200 employees laid off during the company’s financing crisis, the company has rehired 4,400 since June 1 to work on the TriStar. The first deliveries o f the planes are scheduled for next April. Aerospace ... Improvement? After many months o f declining payrolls, aerospace employment in California showed a 2,700 increase in August, as workers were rehired to work on the TriStar program. In contrast to the strengthening in California, aerospace payrolls continued to slip in the Seattle area. As a result, the unemployment rate for that area remained above 14 percent. Dock Strike Continues President N ixon may intervene to stop the W est Coast’s three-month-long dock strike if it isn't settled soon, according to Administration officials. Contracts for East and G ulf Coast longshoremen meanwhile expire September 30; should the strike become nation-wide the President could order striking employees back to work under the "national emergency” provisions o f the Taft-Hartley law. Hawaii and Alaska are both feeling the effects o f the W est Coast strike, combined with the current price freeze, as they make other and often more costly arrangements to procure necessary supplies. September 1971 M ONTHLY REVIEW Housing: Can it Last? T he recovery in homebuilding which began in mid-1970 has gained considerable m o reasons, therefore, questions are now being asked about the sustainability o f the boom into 1972. mentum — aided by a record flow o f savings into mortgage-lending institutions, by a sharp decline Stronger in the W est in the cost o f mortgage credit, and by an expan sion o f various government programs designed to The recent housing boom, like its 1961-63 counterpart, has been stronger in the W est than "help housing.” In the West, the recovery has in the rest o f the nation. Through July o f this been particularly impressive. On the heels o f a year, the housing pace in the W est as a whole modest decline from 324,000 units in 1969 to 310,000 units in 1970, housing starts in this was about 50 percent above the 1970 average, region soared to a 478,000-unit annual rate in July was running 30 percent above the 1970 January-July 1971, and far outpaced the previous (1 9 6 3 ) record in doing so. Twelfth District were record numbers o f new mobile homes — states accounted for about 90 percent o f the re shipments reached a 70,000 annual rate during gional total. N ow , however, increasing numbers o f observ ers are asking just how long the current pace o f Western homebuilding can be maintained. The population trend is one major factor; the recent housing boom has taken place in the face o f a sharp reduction in population growth, to a level only about half that o f the early 1960’s. (Despite a huge population inflow and ample supplies o f mortgage credit, builders got so far ahead o f the market in 1963 that the boom col lapsed fully 2 l/2 years before money became tight in 1966.) High unemployment is another question mark; serious structural problems in the regional econ omy, mainly tied in with the fortunes o f the aerospace industry, have caused jobless rates in the West to rise more than one full percentage point above the national average, and thus have limited demand for the products o f the regional building industry. The credit market is a third factor; continued availability o f record levels o f mortgage funds cannot be guaranteed as the national economy begins to expand. For several while elsewhere in the nation, activity through average. N ot included in the Western statistics the January-July period, considerably above last year and more than double the pace o f the 1963 period. Recent housing boom stronger in W est than in rest of nation T h o u s a n d s o f S t a rt s FEDERAL RESERVE BANK Housing activity has increased substantially this year in almost every District state. Alaska, OF S A N FRANCISCO Boom relleefs earlier improvement in vacancy rates, financial terms Nevada and Idaho have been running about 20 percent above the 1970 pace, while California and Utah have scored 40-percent gains, and A ri zona and Oregon, 55 percent or more. Hawaii alone has recorded a decline, largely because o f an adjustment from last year’s high level o f condominium construction. Even W ash ington has scored a slight gain — despite a sub stantial decline in homebuilding in the Seattle area caused by the present high rate o f unem ployment and the significant overbuilding in Seattle’s 1964-68 upsurge. Notwithstanding the substantial (35 percent) declines this year in both Seattle and Honolulu, the regional housing boom has continued to be an urban phenomenon; some 13 metropolitan areas account for threefourths o f all the new homes built in the District. Los Angeles-Long Beach, with 50,000 starts (annual rate) during the first half o f 1971, re tains its position as the nation’s first-ranking metropolitan housing market. Its performance nonetheless lags far behind earlier levels; in 1963, for example, L.A. builders put 140,000 units on the market. As a consequence, South ern California now accounts for only about 40 percent o f all the starts in the District, whereas it recorded over half o f all homes built in the District in the lush days o f the early 1960’s. Heavy demand ... In the W est’s 1971 boom, the construction o f The current housing boom in the W est (as in multiple units (apartments, duplexes, and the the nation) reflects the accommodation o f some like) has continued to expand, although this sector has not dominated the market as much pent-up demand that was held in restraint during as it did in 1970 or, for that matter, in 1963. (In the earlier boom, all o f the net gain in homebuilding occurred in multiples.) T o a consider able extent, however, the 1971 statistics have been distorted by California, which has been having a boom in single-family construction. Because o f developments in the California market, single-family building District-wide has increased about twice as fast as multiple con 166 Salt Lake City, and San Diego — construction o f multiples recently has outpaced single-family housing. In other markets, where multiples have long been the major source o f strength, that dominance has been maintained; in Los AngelesLong Beach, the largest regional market, multi ples still account for almost 70 percent o f all new units. the tight-money period o f 1969 and early 1970. Even so, the level o f housing activity was sur prisingly high during that tight-money period, probably because o f such factors as continued population growth, a tight supply o f housing, and a general stability o f non-price terms o f mortgage lending. (In the West, average loan maturities and loan-to-price ratios exceeded the national averages by a fair margin throughout the period.) struction over the past year. Nevertheless, in Housing demand also received some support some local markets — such as Portland, Phoenix, in 1970 from a net decline in home prices. In September 1971 M ON THLY REVIEW the West, the median price o f new homes had o f the pool o f household savings. The personal jumped 36 percent between 1963 and 1969, but it then fell 5 percent in 1970, from $25,300 to $24,100. (The decline reflected a decline in aver saving rate nationwide has exceeded 8 percent age home size as well as the elimination o f such "frills” as garbage disposals.) M ore recently, home prices have edged upward again, as have period. Moreover, these household funds have tended to move into thrift institutions rather than into other channels, because o f an early-1970 throughout 1970 and 1971, while it averaged only about 6 y 2 percent during the 1965-69 rents and homeownership costs, but these factors shift in the structure o f interest rates, specifi have been outweighed by the vastly increased availability and lower cost o f mortgage credit, cally a decline in market rates at a time when thrift-institution ceiling rates were being raised. which have enhanced the ability o f new buyers to enter the housing market and o f other buyers For example, 90-day Treasury-bill yields ex ceeded 8 percent in early 1970 — far above the to "m ove up.” rates payable by thrift institutions on their basic The turnaround in the mortgage market over the past year has been perhaps the most spectacu passbook accounts (4 percent by banks and 5 lar on record, sustained as it was by a mammoth percent by S&L’s) — but the bill rate fell con siderably below thrift-institution rates by early inflow o f savings funds. District banks and sav- 1971. ings-and-loan associations together sustained a $3.5 billion net outflow o f time-and-savings ... easier money deposits during the five quarters covering 1969 and the early months o f 1970, but they then District banks and S&L’s vigorously expanded recorded a $15.5 billion net inflow during the their mortgage lending during the next five quarters. In the first half o f 1971 alone, months o f 1971 — a record $970 million for District S&L’s recorded a larger inflow than they banks and a record $2.6 billion for S&L’s. These did in the entire record year o f 1963. The increased inflow o f funds into the thrift institutions reflects the recent sharp expansion increases were accompanied, at least until late Massive infflew of savings funds helps sustain mortgage lending W ith their savings inflows rising so sharply, first seven spring, by declining mortgage rates. The average rate on conventional new-home loans on W est ern housing, which had dropped from 9.40 per cent to 8.75 percent over the course o f 1970, fell further to 7.65 percent this past spring, while the prime mortgage rate on new single-family homes briefly reached 6.75 percent this spring. Rates have firmed again in recent months; con ventional-loan rates have risen to about 7.90 per cent and the going prime rate is now 7.50 per cent. This rebound reflects heavy mortgage-loan demand, a slowdown in savings (especially at the banks), and an increase in the cost o f funds to the lenders themselves. So far this year, almost 90 percent o f the S&L’s net savings inflow, and over 50 percent o f the banks’ inflow, have occurred in the higher-yielding savings accounts. ... and government help The homebuilding boom, regionally as well as nationally, has been bolstered by various gov- FEDERAL RESERVE BANK ernment programs designed to "help housing.” The most notable o f these are the FH A Section 235-236 "direct assistance” programs, which utilize direct subsidies to reduce the mortgage SAN FRANCISCO early 1971. On the other hand, many corpora tions are likely to re-enter the capital market, and not simply rely upon their improved cash flow, to finance the increased machinery-equipment borrowing costs and rental payments o f lowincome families. (In the San Francisco Bay Area, purchases expected as a consequence o f the re a four-person family cannot qualify under these psychological atmosphere, consumers too may newed investment-tax credit. In the improved programs unless its income falls somewhat under borrow more and save less. Should they do this, $ 8 ,000 . ) they could seriously affect thrift-institution funds, The total number o f Federally subsidized since they allocated a whopping 85 percent o f starts, nationwide, jumped from 160,000 units their financial saving to time-and-savings depos in 1968 to 430,000 units in 1970, and is likely its during the first half o f 1971. to reach 525,000 units or more this year. Starts W ith developments such as these in mind, sev under these programs thus have accounted for eral agencies have attempted to sustain the hous about 25 percent o f total housing starts during ing boom by moving to ensure the continued the 1970-71 period, and starts under other Fed availability o f mortgage funds at moderate rates. eral programs — especially "regular” FHA and V A programs — have accounted for 10 percent The Federal Home Loan Bank Board reduced more. Secondary-market operations o f the Fed 7.5 to 7.0 percent, and thus released up to $800 million in funds that previously were unavailable eral National Mortgage Association, the G ov ernment National Mortgage Association, and the Federal Home Loan Mortgage Corporation, although much lower now than a year or two ago, have also provided significant (albeit indi rect) support to the housing market. the liquidity requirement o f member S&L’s from for mortgages. In addition, the Bank Board an nounced that it would permit S&L’s to make con The future course o f homebuilding nation wide will depend in part upon the capital mar ket’s response to the President’s new economic policy. T o date, the banks and the S&L’s both ventional loans with only a 5-percent downpay ment, considerably below the going norm o f 2030 percent. The Home Loan Mortgage Corpora tion meanwhile raised the price it will pay for Federally-backed mortgage loans it purchases from thrift institutions, and announced that it would purchase $300 million o f FHA and V A mortgage loans and an additional $700 million o f conventional mortgage loans over a six-month have gone along with the Administration’s re period. quest to hold the line on interest rates. The con tinued availability o f mortgage money will de purchase $2 billion in FHA and V A mortgages pend, however, on the capital requirements o f governments, businesses, and consumers, each program designed essentially to subsidize interest New economic policy reacting in its own way to the various provisions o f the President’s program. Treasury borrowing requirements will be very heavy in coming months, because o f the con tinued record gap between Federal receipts and expenditures. Corporate financing requirements may be somewhat lighter than heretofore, since 168 OF In addition to these steps G N M A moved to for resale to F N M A and other investors, in a rates on Federally-backed non-subsidized mort gages. G N M A — in effect the Treasury— will then absorb the difference between its buying and selling prices. W ith this resale procedure, G N M A avoids having to borrow in the market to raise the necessary funds to make its pur chases, but the ultimate investor must then go most large firms have now improved their liquid- to the market to raise the funds with which it ity condition through their record borrowings o f will acquire these mortgages. In fact, FN M A September 1971 MONTHLY REVIEW recently announced a $1-billion debenture opera Housing ac tivity strengthens tion, the in face of population slowdown largest in its history, to help finance its own current operations. Thrift institutions meanwhile have begun to C h a n g e (T h o u sa n d s) moderate their lending pace, or at least their rate o f new commitments. Western S&L’s actually reduced their loan commitments in June and July, after doubling their totals to a record $1.4 billion between December and May. Their action may reflect a feeling o f caution about the future availability o f mortgage funds, but it probably also indicates a growing concern over a potential oversupply o f housing in some Western com munities. Shaky demand? Underlying demand, and not the state o f the 1961 1964 1967 1970 credit markets, indeed represents the biggest question mark in the Western housing situation. The question essentially is— how long can a Indeed, effective demand could be expected to be relatively low because o f the W est’s serious record housing pace be sustained, given a popu unemployment problem, caused largely by the lation growth which is only about half the structural problems o f the aerospace industry. amount that proved incapable o f sustaining the (In July, the Twelfth District’s jobless rate, 7.5 housing boom o f the early 1960’s? In the 1961- percent, was substantially above the national 63 period, one new housing unit was built for average o f 5.8 percent.) Net declines in employ ment have actually occurred over the past year in such key states as California, Washington, Oregon, and Hawaii, and unemployment rates have exceeded the national average in six o f the nine District states. Yet, surprisingly, homebuilding activity has been most exuberant in some o f those areas with the highest jobless rates— San Diego, Anaheim, Los Angeles, the San Francisco Bay Area, Portland and Salt Lake every 2.5 people added to the Western popula tion, but in 1970 the ratio was one unit for every 1.4 new people, and in 1971 to date, the ratio has been just about one to one. (T he ratio would be even more striking if mobile homes were counted.) That means one new dwelling unit for every man, woman, and child added to the regional population— and very few children buy homes. Other factors beside basic population growth o f course must enter the calculation o f housing demand. Substantial demolitions and other re City. Recent trends in vacancy rates provide amply evidence o f a potential oversupply o f housing. movals from the housing stock, high rates o f household formation because o f the population’s In Seattle, the apartment vacancy rate exceeded present age distribution, and a catching-up with land, Phoenix, and several California markets, the demand which could not be met during the rates o f 6 percent or more have been reported 1969-70 recently. (This development prompted the San Francisco Home Loan Bank to issue a number o f tight-money period— all have con tributed to the record level o f construction. Even after allowing for those factors, however, the recent rate o f home building may be in excess o f what the regional market can absorb. 13 percent at one point this year, and in Port market "alerts” to member S & L ’s.) T o be sure, vacancy rates, mortgage delinquencies, and fore closure rates are still below the peak levels 169 FEDERAL RESERVE BANK OF SAN F R A N C ISC O reached at the end o f the 1963 boom, but the Policymakers might also be tempted to sup recent trend in these measures has been disturb port the market by easing financial conditions ingly reminiscent o f that earlier period. further, through reduced downpayments for borrowers, reduced liquidity requirements for Government help? What can policymakers do to stabilize the lenders, and expanded secondary-market pur chases by such agencies as G N M A , FN M A , and market in the face o f this oversupply situation ? FHLMC. It should be remembered, however, One way would be to expand effective demand, that the generally easy conditions which pre vailed in the Western mortgage market during and the President’s new economic policy is de signed to do just that. The expansionary features o f that program should eventually increase the real income o f Western (and other) consumers, and thereby expand the household resources that could be allocated to new housing. The antiinflationary features o f the program should help stem the soaring prices o f land, labor, and ma terials— increases which have priced a large pro portion o f the potential buying public out o f the 1964 and 1965— well after the last housing boom had weakened— exacerbated the original problem o f overbuilding, so that vacancy rates, loan foreclosures, and delinquencies in some Western localities soared to levels two, three, or four times the national average. In the light o f the historical record, the nation’s housing auth orities may decide that easy financing is not the only solution to the region’s housing problems. Besides, in view o f the expected level o f effec market. In the area o f costs, much will depend on the success o f the Administration’s "Operation Breakthrough” in achieving the production o f low-cost housing. (T he first housing module produced under "Breakthrough” rolled off the as sembly line in late M ay.) The original intent o f the program was to accommodate buyers in the $15,000-and-under price range— a market pres ently dominated by mobile homes, which account for about 90 percent o f all the units sold under $15,000. H U D Secretary Romney has claimed tive demand and the already reduced rate o f population growth, everyone connected with the industry might do well to reassess the much- "Break publicized housing goal o f an average o f 2.6 million new units annually during the decade o f the 1970’s. In addition, there might be some justification for re-examining the whole question o f housing finance— deciding, for example, just which groups should qualify either for direct or indirect subsidies, and what type o f asset-liability structure for thrift institutions would generate the most effective pattern o f resource allocation. But while pondering these longer-range ques through” type will provide a "substantial por tions, Western builders and mortgage lenders that industrialized housing of the tion” o f the nation’s new housing by 1975, al would do well to keep developments in local though production o f housing markets under close scrutiny in coming industrialized housing units will probably not exceed 15,000 units in 1971. 170 months. Verle ]ohnston
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