Facing conflicting economic forces, the Federal Reserve Board has apparently opted for a steady-as-you-go policy of supplying money to the economy. Fed Chairman Paul A. Volcker told the House Banking Committee on Wednesday that ``there has been no occasion for significant change'' in how much the Fed wants to increase the nation's money supply.
The Fed's decision ``means that short-term interest rates will probably be fairly stable,'' says Cynthia Latta, senior economist at Data Resources Inc. Short-term rates, such as those for 91-day Treasury bills, will fall only if the economy weakens or when Congress sharply cuts federal spending, she says.
Longer-term rates, such as those on 30-year Treasury bonds, could fall another half a percentage point, she says, but largely because of market forces and not Fed action.
The conflicting forces the Fed faces in setting policy include a sharply falling dollar, which can trigger domestic inflation by making imported goods more expensive. That inflationary danger is offset somewhat by falling oil prices.
In making his semiannual report to Congress on monetary policy, Mr. Volcker emphasized the inflationary danger of a drop in the dollar's value on foreign-exchange markets. In addition to making imports more expensive, the danger also comes because higher-priced foreign goods in effect give US producers room to raise their prices and still remain competitive.
Those inflationary dangers offset the help a lower dollar provides to US manufacturers and farmers who are trying to sell goods overseas.
``Economic history is replete with examples of countries'' that failed to use a lower currency value to improve their competitive position, Volcker said. ``Too often they lapsed into a debilitating and self-defeating cycle'' of higher inflation, higher interest rates, and impaired growth, he said. But in general Volcker offered an upbeat assessment of the prospects for the US economy. The current economic expansion ``is not about to die from old age or sheer exhaustion,'' he said. The central bank expects the economy to grow from 3 to 3.5 percent, after adjustment for inflation, between the fourth quarter of 1985 and the final quarter of 1986. The Reagan administration is calling for 4 percent growth, and Volcker acknowledged that several Fed officials also expected growth around 4 percent.
The Fed is a bit more optimistic than the administration on the inflation outlook. The Fed expects the implicit price deflator, an inflation measure tied to the gross national product, to climb 3 to 4 percent this year. The administration expects prices to rise 3.8 percent.
The recent sharp drop in oil prices is a key reason for Volcker's relative optimism about the economic outlook in general and inflation in particular. If oil prices remain near current levels, ``that development will also be a powerful force offsetting, and in the short run probably more than offsetting, the direct and indirect effects of the lower international value of the dollar'' on inflation, Volcker said.
He added that lower oil prices ``should work in the direction of offsetting'' the negative effects on the economy of cuts mandated by the Gramm-Rudman balanced budget law. When viewing the economy as a whole, lower oil prices allow people and businesses to spend more on goods and services other than fuel at the same time that government is reducing its spending.
The Fed said it was setting a target range for growth in the basic measure of the money supply, known as M-1, at 3 to 8 percent for the coming year. M-1 includes currency in circulation, and the value of checking and NOW accounts. The 3 to 8 percent level is the same range as adopted in July for the remainder of 1985, but is slightly broader than the tentative 1986 range set last summer.