"White House officials applaud the Federal Reserve for what it is doing. But do they understand the cost?" That question, from a high-ranking Federal Reserve Board source, strikes to the heart of current tension between the White House and the Fed's gleaming marble palace a few blocks way.
"Some sectors of the economy," said this Fed official, "really are hurting --housing, autos, small business generally, thrift institutions, municipalities."
Business bankruptcies are up -- "I'm surprised they're not higher," said the central bank source -- more than 2,000 auto dealerships have closed their doors; 500,000 automobile and related-industry workers are jobless; housing is in the doldrums.
Collapse of a savings and loan association in Chicago (insured savers were promptly paid by a US government agency) symbolizes the plight of many thrift institutions.
A typical S&L earns 6 to 9 percent on many mortgages it holds and pays 15 percent interest on certificates of deposit to attract fresh savings.
For these affected industries, high interest rates are the culprit, which are bid up in the scramble for credit by people wanting money. Not the least of these borrowers is the federal government, which this year finances a deficit in the $60 billion range.
Too much money in circulation feeds inflation. So the Fed hikes interest rates and by other means limits the amount of credit banks can offer. As interest rates soar, the squeeze on vulnerable businesses and on countless families tightens. Some bankers believe the bellwether prime rate, which banks charge their best corporate customers, may climb above last year's record 21.5 percent before the process ends.
White House officials do not like high interest per se. "We are a low-interest administration," says Murray Weidenbaum, chairman of the Council of Economic Advisers (CEA). The White House wants interest rates to shrink, but not until high inflation stops crackling through the economy. The consumer price index (CPI) for April showed encouraging moderation, rising at an annual rate of 5.1 percent.
But the so-called implicit price deflator -- a broader measurement than the market basket CPI -- showed inflation climbing at a 10 percent annual pace during the first quarter of 1981. A major contributor is a steady 10 percent rise in wages, fueling the nation's underlying inflation rate.
"Wages climbing that fast," says Federal Reserve Board Chairman Paul A. Volcker, "are inconsistent with controlling inflation."
President Reagan rules out any government intervention --even "jawboning" -- in the wage negotiating process. This leaves the problem to the marketplace. There, wage moderation so far has shown up only in distressed industries, where workers prefer a pay cut to no job at all.
For several reasons, the strong pulse of inflation troubles the White House:
* High inflation boosts government outlays, partly because social security and other cash transfer programs are indexed to the CPI. For example, this July social security benefits will rise 11.2 percent, boosting government costs by $ 15.4 billion over the next year.
* Inflation makes it harder for Mr. Reagan to sell his tax-cut plan.
* Higher government spending due to inflation postpones achievement of a balanced budget, Reagan's announced goal for fiscal 1984.
* Inflationary expectations impel many people to buy now, pay later, on the theory that goods and services will cost more down the road.
Such spending prompts much of the vast US economy to boom, in stark contrast to industries especially vulnerable to high interest rates. Overall, the economy grew at a brisk 8.4 percent pace in the first three months of this year.
"The economy is remarkably resilient," says Frederick H. Schultz, vice-chairman of the Fed. "Many people adjust to high interest rates and are creative and innovative in the way they use their money."
The result is strong consumer and business loan demand, which fuels continued growth of the money supply. The Fed then tightens the screws more because neither Congress nor the White House for months to come will have effective anti-inflation policies in place.
Under these circumstances, the White House welcomes whatever the Fed can do to depress inflation. But administration attitudes and policies are complex, containing elements that trouble Volcker and his Fed crew.
Strict monetarists in the Reagan camp believe that excessive money growth is the root cause of inflation and criticize the Fed for failing to prevent erratic swings in the weekly money supply figures.Recent money-supply spurts have triggered dramatic response in the financial markets, depressing stocks and bonds and boosting interest rates.
Federal Reserve experts point out that changes in US banking laws -- notably the establishment of interest-bearing checking accounts and a proliferation of money-market funds -- make it hard to track the movement of money over short periods of time. It is more sensible, according to Fed officials, to monitor the supply of money within the context of longer-range targets established for the year as a whole. Those targets -- consistent with Volcker's determination to fight inflation -- are set on average 0.5 percent lower than the 1980 goals.
Fed officials, although annoyed, try to shrug off criticism from some Reagan monetarists. But they cannot shrug off a deeper concern that the President's massive income tax cuts might trigger a wave of inflationary buying among consumers.
In past circumstances, Reagan aides concede, billions of extra dollars in taxpayers' hands might have set off inflationary buying. Now, they say, Americans will learn that -- as a result of the Reagan package -- government spending will be down, tax savings will accrue to families year by year, and "inflationary expectations" will diminish. Because inflation manifestly will be coming down, no longer will people feel impelled to buy recklessly -- thanks to Reagan policies and the Fed's tight money course.
Most economists, says Joseph A. Pechman of the Brookings Institution, find a flaw in this reasoning. "In the absence of some policy to restrain wages and prices directly," Dr. Pechman says, "a long period of economic slack will be needed to change inflationary expectations."
Much depends on whether or not the giant US economy behaves as the architects of the Reagan package believe it will. Reagan's 1982 budget anticipates that inflation, interest rates, and unemployment all will be lower than most economists expect, and that real economic growth will be faster.
"If real growth," writes Dr. Pechman, "is one percentage point less than the [Reagan] forecast and inflation is one percentage point higher, the [budget] deficit would increase by $14 billion."
This would propel the US Treasury more deeply into capital markets in search of money. Interest rates would climb unless the Fed relaxed and let the money supply grow. Volcker says he will not do that. Neither does he want to be caught in the middle, with accusing fingers pointing at the Federal Reserve as the cause of high interest rates that hurt so many people. so Volcker, buttressed by former Fed chairman Arthur F. Burns, seeks to holdup on personal income tax cuts until the angry glow of US inflation has begun to fade. KEY INDICATORS Real growth, GNP 1st Qtr. 4th Qtr. Past year Percent, annual rate 8.4 3.8 11.0 'Discomfort' index Latest Month ago Year ago Inflation & unemployment 12.4 14.8 18.0 Dow-Jones 30 industrials 971.72 1007.02 842.92 New York Stock Exch. Composite index 76.26 77.41 62.19 Unemployment Percent 7.3 7.3 7.0 Civilian employment Millions, seasonally adj. 99.0 98.4 97.2 Auto production Units 649,794 619,409 576,125 Average weekly wages In 1967 dollars $94.60 $94.20 $95.90 Housing starts Millions of units 1.284 1.214 1.040 Productivity 1st Qtr 81 4th Qtr 80 Last year %change, annual rate 3.6 -0.4 0.0 Savings rate Percent of salary 4.7 5.1 4.9 Net farm income 1st Qtr 81 4th Qtr 80 1st Qtr 80 Billions, 1967 dollars 6.7 (pre.) 8.5 10.7 Corporate profits Billions, after taxes $168.3 $164.3 $184.9 New plant & equipment 2nd Qtr 81 1st Qtr 80 2nd Qtr 80 Invest., non-farm, bills. $317.3 (e) $310.1 (e) $284.3 US crude oil inventories Latest Month ago Year ago 335 Million/barrels avg. 408 394 386 US crude oil production Millions/barrels/day 8.6 8.6 8.7 US oil imports Millions/barrels/day 5.5 5.8 6.6 PRICES Consumer price index Latest Month ago Year ago % change, annual rate 5.1% 7.5% 11.0% Gasoline Per gallon, unleaded $1.417 $1.382 $1.264 Home heating oil Per gallon $1.29 $1.26 $1.01 Wheat Per bushel $4.41 $4.52 1/2 $3.95 1/2 Gold London close, oz. $472.00 $501.00 $501.00 Silver New York close, oz. $10.92 $11.58 $11.60 Existing homes Latest Prev. month Year ago Avg. US sales price $64,500 $64,100 $59,500 INTEREST RATES Prime rate This week Month ago Year ago Percent 20.50 18.50 18.00 Home mortgages Percent, US avg. 13.88 13.76 13.09 New car loans Avg. %, 5 Boston banks 15.16 15.61 14.77 AAA corporate bonds Percent yield 14.20 13.93 11.01 Treasury-bill rates 90-day, percent yield 16.750 13.553 7.675 Money market funds 7-day 30-day 12-month Percent, avg. yield 15.79 14.97 12.31 Sources for table Tables and graphs above are based on data from the American Petroleum Institute, Board of Trade of the City of Chicago, Comex Inc., Donoghue's Money Fund Report of Holliston, Mass., Federal Home Loan Bank Board, Federal Reserve Board, Massachusetts Commissioner of Banks, Moody's Investor Service, Motor Vehicle Manufacturers Association, National Association of Realtors, New York Stock Exchange, US Census Bureau, US Commerce Department Bureau of Economic Analysis, US Labor Department Bureau of Labor Statistics, US Department of Treasury.