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Research Papers in Economics

. * Economic Activity Accelerates
4
Tt.gainst a background of very stimulative fiscal and
monetary actions, economic activity accelerated in the
third quarter. Although an inventory adjustment gave
the appearance of an economic pause in the first half,
underlying demand for goods and services has re-
mained strong throughout 1967. Both consumer and
Government expenditures helped maintain final sales
at higher-than-average rates of increase during the
first half of 1967. The growth of total demand, how-
ever, hesitated as business firms sharply reduced out-
lays for inventories.
Thepace of the economy in the immediate future will
be affected by military developments, the possibility
of a tax increase, the final effects of the restoration of
the investment tax credit, and work stoppages in the
course oflabor-management negotiation. In view of the
Federal budget situation and the expansive trends in
bank credit and money, the prospect of excessive total
demand is a major concern.
Several important measures of economic activity ac-
celerated during the summer. Employment rose at an
8 per cent annual rate from May to August, more than
offsetting declines earlier in the year. Personal income
advanced at a 9 per cent annual rate from May to
July, compared with a 5 per cent rate earlier this year.
Retail sales increased sharply from May to August,
bringing the February to August annual rate of growth
to 12.5 per cent. Sales of durable goods accounted for
much of the recent gains. Industrial production in-
creased from June to July for the first time in seven
months, and preliminary data indicate another gain
from July to August. All of these figures indicate a
revival in total economic activity from the earlier
moderate pace.
The economy continued to move forward in early
1967, but at a somewhat slower pace than in the suc-
ceeding two years. Total spending increased at a 3,4
per cent annual rate from the fourth quarter last year
to the second quarter this year, down from the 8.4 per
cent rate from 1964 to 1966. In contrast, spending by
ultimate users of goods and services actually rose at a
faster rate in early 1967 than in the preceding two
years. Final sales rose at an 8.5 per cent annual rate of
increase in the first half of 1967, above the 7.9 per
cent average rate from 1964 to 1966. From 1960 to
1964 final sales grew at an average of 5.8 per cent a
year. In real terms (i.e., adjusted for price changes),
the rise was at a 6.4 per cent rate in the first half of
1967, also slightly above the average rate for the pre-
ceding two years. The slowing in the growth of total
outlays, despitethe rise infinal sales,resulted from busi-
nesses decreasing inventories or reducing the rate of
increase.
Ro
a5C
Gao
75C
70C
450
600
550
500
450 -~ ~959 1960 1961 1962 963 1964 1965 1966 1967
$I ) Dp&~fl~,,,f
P, ~~ ,
9
b ,p • 41 ~,
,,,.—e,thp~f S
S 25
Page 2Ratio Scot. Prices Rote Scale
59 100 957-59--IOO
4’
115
1.0
100
General price levels have risen markedly in recent
months but as of July, did not reflect the pressure of
total demand so much as the food supply situation.
Consumer prices rose at a 4 per cent annual rate from
April to July, well above the 2 per cent rate from
August to April. For all items except food, consumer
prices rose at a 3.1 per cent annual rate from April to
July, compared with a 3.3 per cent rate from August
to April. From 1958 to 1966 consumer prices rose at an
average 1.5 per cent rate. Wholesale prices rose at a
marked 5 per cent rate from April to July, after de-
clining from August 1966 to April of this year. Thisup-
turn in prices was principally due to a sharp increase
in prices of farm products and processed foods which
declined in late 1966 and early 1967. Prices of finished
industrial goods rose at a 1.7 per cent rate from April
to June compared with a 1.3 per cent annual rate from
October to April.
Despite signs of accelerating rates of economic
activity, some evidences of the earlier slowdown re-
mained in the early summer. Manufacturing, which
accounts for about 30 per cent of total output, has
been one of the weakest sectors, Industrial production
declined during the first six months of this year before
recoveringhalf the declineduring July and August. The
decrease in industrial production during the first half
of the year amounted to less than 2.5 per cent and may
havebeen adversely affected by strikes.
The rate of industrial capacity utilization slipped to
an average of 85 per cent in the second quarter, down
from the 91 per cent a year earlier. It has remained
near 85 per cent since the second quarter. This operat-
ing rate, however, compares with an 83.7 per cent
average from 1962 through 1964. Although the unem-
ployment rate rose slightly in the second quarter, it
Industrial Production
Rr,o 5cc-c
50 .‘~ . ‘15759 •3D
14U
~:E~
‘An
•
~
160
3
ISO
140
130
4 4+
:~/
100
1959 1960 1961 196 1963 1964 1965 19 6 967
4, ,~ce, e,,eire, SI,,, It—ep’’ ed,et,d1I, er ,,ted~t,,th,,
“poe,, 4 Iopo,t,,thotts.o,,’ooy,tb ,o,Io,Iht,
“p
01 14, p
4
,11.
4
•,+
7
p,.I,’,,..
was below 4 per cent in July and August and well
below the 5.5 per cent average rate from 1962 through
1964.
Some perspective on recent and potential develop-
ments is gained by analyzing various components of
total demand. The first of these components consists of
those categories of total spending which have grown at
relatively stable rates. These stable components in-
clude consumer expenditures on nondurable goods
and services, and expenditures of state and local
governments.
A second component comprises those categories of
total demand which have grown at widely varying
rates, generally fluctuating in a cyclical pattern. These
fluctuating components include consumer expenditures
on durable goods, private fixed investment (residential
and nonresidential structures, and producers’ durable
equipment), changes in business inventories, and net
exports of goods and services.
Finally, Federal Government expenditures on goods
and services are a separate category of total demand
since they are, in part, subject to policy control. Usual-
ly they tend either to grow steadily or to move count-
ercyclically. However, large items such as defense
expenditures, which occur in spurts in response to
external conditions, may causetotal Government spend-
ing to move procyclically
The stable components of total demand have main-
tained a steady aggregate rate of growth over the last
five years. These components grew at an average an-
nual rate of 7 per cent from the first quarter of 1963
~~1tj ISO
Page 3to the second quarter of 1967
On the other hand, the fluctuating components of
total demand grew at a very high 11 per cent annual
rate from 1963 to 1965, inclusive. Following this rapid
expansion they have declined at a 4 per cent rate since
the end of 1965. These outlays typically rise rapidly
in periods of economic expansion and decline in
periods of contraction. The recent pause in the econ-
omyhad some characteristics of an old-fashioned“busi-
ness cycle trough.” Downward adjustments of pre-
viously high levels of investment by consumers and
businessmen acted as a brake on the economy in the
classical manner. The sum of changes in the dollar
values of the stable and fluctuating components was
negative in the first quarter of 1967 and changed little
in the second quarter.
The rapid rate of increase of Federal Government
expenditures on goods and services helped to maintain
total demand in early 1967. These expenditures showed
little net change during 1963 and 1964, but, bolstered
by the Vietnam situation and expanded welfare pro-
grams, Government outlays increased at a 12 per cent
rate during 1965, and have risen at a 19 per cent rate
since then. The continuing buildup in the Federal
Government sector during early 1967 offset a decline
in the private sector, leaving total spending about un-
changed.
Given the likelihood of continued growth in the
stable components, the key to acceleration in total
demand is either a turnabout in the fluctuating com-
ponents or an increasing rise in Federal expenditures.
Either of these, and especially a combination of the
two, could absorb any slack presently in the economy
and might quickly set the stage for greater upward
pressure on prices
Analysis of the fluctuating components seems to
indicate that an upturn may have begun sometime in
the second quarter of 1967. Consumer purchases of
durables rose at a 16 per cent rate from the first to the
second quarter after declining in the two previous
quarters. The rise reflected chiefly a sharp increase in
automobile sales. Retail trade data for July and early
August indicate further expansion in sales of con-
sumers’ durable goods. Consumers used the first quar-
ter to restore their liquidity by reducing the growth of
instalment debts and by adding to their savings bal-
ances. Credit for the purchase of automobiles and
other consumer durable goods rose at only a 3.6 per
cent annual rate from November to June after growing
10 per cent in the preceding year. These credit devel-
opments, together with the continued rise in personal
Components of Total Demand
RatioScale Rat,oScale
B titans afoeliars Good dyl ICE IA,’ II, Stile,, ofDollar
BOO —~-—-----— , ‘ ~‘7 d
1
~_—_
fluctstttnt I
100 // ~- ~c 100
10 10
1949 +951 195 195$ +957 1959 1961 1963 4965 967
• U D,ptoIo,to,,*
TO,,,Ol ,, hold 4so~oo pod, “‘‘‘.01 040,4
pod’.’otllo,dlool~,oo, 1111,,, 0 o,loIod,
ems ,d’fo odoobleod ,,. ‘ottd,h’I,o,, ~del
,pe’l,l~,o ,d
0,4 ., .,p,,p, 0 tOo o 10’4,0 41,1, dbI4tb N ,o,,I4o
*1 4,0,, C ot II
Odd 40 I 11.4 2,,d 0,,,,
incomes, have now given consumers the means to in-
crease their buying.
Nonfarm business inventories showed a nominal in-
crease in the second quarter of 1967, after reaching a
peak $19 billion increase in the fourth quarter of 1966.
In June inventories of both manufacturing and trade
firms declined. The inventory to sales ratio for both
manufacturing and trade was 1.54 in July, down
slightly from May, but still above the 1.48 ratio of a
year ago. Wholesalers and retailers have apparently
been more successful in bringing the inventory-sales
ratio back to more normal levels. Manufacturing in-
ventories of durables, more than of nondurables, seem
to be high relative to sales. However, this may not in-
hibit further production of durables because of the
low levels of auto inventories, defense needs, and the
uncertainty concerning work stoppages in some dur-
Changes in Business Inventories
Billio, ofDollars ~ .4 IyltA,,,ol 0,4,, ,oe ,oll’Ad
4
o s.d Billans ofDollar,
20 20
5 15
10
S S
I- 0
S S
10 40
10 0
+959 1960 1961 1962 +963 1964 1965 1966 +967
See, USUp lOom
Lot, dots plotted 2,0 .,t p l’m’et,r
Page 4able goods industries. Also, expectations of further
price advances in some areas may raise the level of
desired inventories. New factory orders have been
rising relative to shipments, resulting in a somewhat
longer backlog of unfilled orders and thus help to ad-
just inventory levels without cutbacks in production.
Although building of inventories may not become the
strong addition to total demand in the near future that
it was in late 1966, a return to pre-1966 levels would
represent a sizable stimulus.
Investment in producers’ durable equipment in the
second quarter recovered almost to the level of fourth
quarter 1966. Because of the uncertain effect of the
investment tax credit restoration, the decline of cor-
porate profits, and the lower rate of capacity utiliza-
tion, there was a decline in business construction. This
decline was enough to reduce total investment in the
second quarter. Now that inventories are more nearly
in balance, industrial production has shown signs of
increasing, business profits are improving, and fixed
investment by business may be expected to expand.
Residential construction has shown a modest in-
crease during the first half of the year compared with
the low fourth quarter of 1966 but remains well below
the high levels of 1964 and 1965. Despite rising con-
struction costs and some firming of interest rates in
recent months, contract awards and housing starts
point to some future strength in this area. Substantial
amounts of funds have been flowing into savings and
loan associations and mutual savings banks, but these
intermediaries have used a large portion of these funds
to reduce borrowings from the Federal Home Loan
Board and to restore their reduced liquidity. Interest
rates on mortgages have not fallen, apparently because
some institutions which usually invest in mortgages
have been attracted by the high rates offered on
securities issued by businesses and Federal agencies.
Total private investment in the first half of the year
dropped at an 18 per cent annual rate from the second
half of 1966. Examination of the components suggests
that strength began developing in the second quarter
and a turnabout may have occurred, In view of the
previous levels of operation and existing unused ca-
pacity, a moderate rise in the growth rate of total de-
mand would be a healthy move toward more efficient
utilization of resources. A return to the 1966 pace,
however, would be unsustainable and would probably
place excessive demands on the available supply of
resources.
Thefiscaloperations of the Federal Governmenthave
had a stimulative effect on the economy since mid-
ItIt I 3 ‘57.8
~—
Federal Government Expendotures
tdat,anal In one Account, Budget
Sili,on ofDollars 0554 dy blot 5, do,o,l 1,5, Billion of Dollars
54,04044 Ad, 4 d
+60 +60
120 ‘en
GO
1948 50 52 54 56 8 60 62 64 66 +968
555 USOpedeed PC,,,
Psoto~ o,o.,ls 4bs’~sbNe.’peed ••4, dmyoop N sod,
d,lp I o•tlsptt od
L,le,5d,l, pl,tod ,dqo, 0,!
~:~~IeBse
C
1965, primarily because of spending related to the
Vietnam War. This stimulus is expected to continue
over the foreseeable future, although it may be reduc-
ed if the proposed tax surcharge ispassed.
Defense expenditures rose 24 per cent from mid-
1966 to mid-1967, compared with 19 per cent in the
preceding twelve months. From mid-1963 to mid-1965,
defense spending had been virtually unchanged.
The high-employment budget, a measure of the
impact of fiscal actions, showed about an $8 billion
deficit in the year ending mid-1967, compared with a
near balance in the corresponding period a year earlier.
The high-employment budget, which adjusts the na-
tional income accounts budget for the effect of vary-
ing economic activity on tax receipts and on unemploy-
ment insurance disbursements, had shown an average
Influence of Federal Budget Pol,cy*
Sttmulu or Re tra,,t
- Ooo 1,1,1 tolo,ltooo,te,t
B,lI,o,s of Doll’- e - Silloono of Dollars
20 20
I, IS
+0 10
5 $
V 0
5 5
+0 +0
IS -IS
20 23
1959 1960 1961 1962 +963 196$ 196$ 1966 1967
2’ epd ,105.,.t,,,ltLo•
‘Th.N,~h .,pW, ea od
0
et t• .tpobIo,h d by’l, Ceo, lot
Id,. 14,4 plo odqs 4,
72.5
7,4I’ 44
.1 I
SO
40
Page 5surplus of about $11 billion from 1960 to mid-1965.
The proposed 10 per centsurcharge, when effective,
would reduce the deficit in the high-employment bud-
get by about a $10 billion annual rate. The stimulus
from budget actions would then be dampened, but
assuming probable increases in spending, deficits of
about $5 billion in the high-employment budget might
still be expected in early 1968. This would be less
expansionary than in the first half of 1967, but about
$13 billion more stimulative than in 1963 through 1965.
Corporations have been drawing on the capital mar-
ket at a record rate this year, despite cutbacksin their
investment expenditures. Some of these long-term
funds apparently have replaced bank loans which had
been used to finance last year’s investment surge. Also,
corporate earnings, which declined markedly in the
first half of 1967, have generated fewer internal funds
to satisfy the liquidity and capital formation needs of
corporations. Over thelast two years corporations have
been required to pay taxes on a more current basis.
The strong demands for funds by corporations as well
as municipalities and the Federal Governmenthave re-
sulted in a rise in long-term interest rates despite some
loss of industrial momentum and a climate of rapid
monetary expansion.
Monetary developments have been expansive since
early this year. Total member bank reserves have
grown at an annual rate of 7 per cent during the last
six months, almost double the 4 per cent trend rate
from 1960 to 1968. Reserves available for private de-
mand deposits (reserves other than those needed to
support Government, interbank and time deposits)
have increased at a 9 per cent rate from Febrnary to
August, compared with a 2 per cent trend rate since
1960,
The money stock has risen at a 9 per cent rate over
the past six months after changing little in the previous
half year. By comparison, money grew at a 2.7 per
cent rate from 1960 to 1964 and at a 4.2 per cent rate
from 1964 to 1966.
Money stock plus time deposits in commercial banks
(a broader concept of money) rose at a 13 per cent
rate from February to August. This measure of money
rose at a5per cent rate in the previous six months
and at a 7.5per cent rate in the 1960 to 1966 period.
7
507
I ~j
Money Stock
Ro a Scale Moot 15’ Ame,og. olDaily • o Rob ale
Billiono of0 Ito, p e, o ted Billions ot Dollo
180 180
170 +70
160 160
150 -—-150
1,3’
7,
‘~V5
9
,-,,,-~-
I
“—So
~-
~2T
‘47
II II I Is-sn
959 1 60 1961 +962 +963 1964 1765 3966 967 --
40, ,,o,po,od,00lobhy”s,,O 4 do
mpoo•,too,NdI’p’m’tlm’t p Ito
to tdoteplett doot,Im,ooy
Commercial bank credit has grown at an estimated
13 per cent annual rate since January compared with
growth of about 6 per cent in the preceding year.
Commercial banks have increased their investments in
Government, and state and municipal securities at a
high 24 per cent annual ratesince January after making
little net change in investments last year. Commercial
bank loans have grown at an 8 per cent annual rate in
the first seven months of this year, about half the rate
in the same months of 1966, and more than twice the
2.3 per cent annual rate during the last five months of
1966.
The economy has apparently skirted what might
have become a recession. Mounting inflationary pres-
sures have again become a current problem. Bank re-
serves, bank credit, money and savings accounts have
all been rising rapidly, yet interest rates have increased
in response to a vigorous demand for credit.
The extremely high level of Government spending,
which maintained final demand at a high rate of in-
crease earlier this year, continues to be expansion-
ary. This spending must be financed. The full effects
of the resulting stimulative deficit and the necessary
financing effort may continue to act on the economy
after the private sector is again accelerating. The pro-
posed tax surcharge would help relieve the pressures
on prices and interest rates, but questions remain as to
whether this action alone would be sufficient to pre-
vent inflation and evenhigher interest rates.
Page 6

Economic activity accelerates

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Economic activity accelerates

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