White House tilts with the Fed over keeping the money flowing
The Federal Reserve System is coming under strong pressure to keep a relatively loose monetary policy in this election year. Treasury Secretary Donald T. Regan gave the Fed a small shove last week when, at a congressional hearing, he expressed some concern about the central bank's April 6 boost in the discount rate, the interest it charges on loans to commercial banks. Sometimes a discount-rate boost signals a tighter money policy , which could slow or stop the economy.
''I think the economy can stand it, but I'm concerned,'' he told the press afterward.
Last month, both the Republican and Democratic members of the Joint Economic Committee of Congress urged the Fed to supply money to the economy in the upper range of its official targets.
And earlier, the Reagan administration made a significant shift in its money-policy recommendation to the Fed. The change could, if the economy slowed, open the door to asking for faster money growth.
In testimony to the Senate Banking Committee, Beryl W. Sprinkel, undersecretary of the Treasury for monetary affairs, suggested that the midpoint of the Fed's target range for the basic money supply, known as M-1, should be the goal, ''unless convincing evidence emerges that institutional or other changes have altered the relation between money growth and economic activity.'' Since the Fed's target for M-1 is 4 to 8 percent, this meant the Treasury was calling for the Fed to aim for 6 percent money growth this year.
But several days later, Secretary Regan refused to specify any suggested target number. He would say only that the Fed must supply enough money to the economy to meet its own 4 to 4.5 percent projection for real economic growth.
Politically, this change means that even if the Federal Reserve supplies new money at a 6 percent annual rate, should the economy start to slump below a 4 to 4.5 percent growth rate, the Reagan administration could freely call on the Fed to ease monetary policy to meet the central bank's own economic growth target.
As Paul Craig Roberts, a former Treasury economist with continued ties at the White House and the Treasury, put it, the administration's shift in monetary position means it will not have endorsed a policy that is possibly too tight.
''(Fed chairman Paul A.) Volcker can't go collapse the economy and say he met his target,'' Mr. Roberts said.
So far, the fears of too tight a Fed policy appear ungrounded, perhaps even foolish. The annualized rate of growth for M-1 in the 13 weeks up to March 14 was an extremely high 11.4 percent.
Nonetheless, the Reagan administration is highly suspicious of Mr. Volcker after the deep 1981-82 recession. For that slump it blames too tight Fed monetary policy in the last half of 1980 and early 1981.
Volcker and other Fed officials were themselves surprised by the depth of the last recession.
The administration, Roberts commented, ''has been sandbagged enough by Volcker.'' There is a concern that the Fed might ''gamble'' with too tight a monetary policy in the hope of preventing a resurgence of inflation.
Economically, the concern over the adequacy of the Fed's monetary target for M-1, which consists of currency plus checking accounts, arises from an unknown - what the velocity of money will be this year after a period of bank deregulation. Velocity consists of the number of times money is turned over during the year.
During the recent recession, velocity grew much slower than expected, resulting in a deep drop in output. The Fed assumes velocity will return to its growth rate during the 1960s and '70s of about 3.5 percent. So does Martin S. Feldstein, chairman of President Reagan's Council of Economic Advisers.
Treasury officials and the Republicans on the Joint Economic Committee, however, are not so sure.
''Money growth in the upper half of the range of 6 to 8 percent . . . would be appropriate if trend velocity (the ratio of nominal gross national product (GNP) to the money stock) remains lower than the postwar trend,'' the Republican part of the committee report states. ''It is likely that velocity growth, in fact, will remain on a lower track. The sooner the Federal Reserve anticipates and reacts to this outcome, the smaller will be the risk of an unanticipated economic slowdown.''
The issues sound arcane, but if the Fed is right, the economy will grow at a healthy rate and the Republicans will benefit in the coming election. If the Treasury and the committee Republicans are correct, the economy would slip into stagnation, possibly combined with more inflation, and President Reagan would suffer at the polls.
Fed officials are aware of this dispute and the election risks involved. But they are dubious of their ability to ''fine tune'' the economy. Moreover, they regard M-1 as ''on probation,'' as one central banker put it. In other words, there is some question as to whether the close relationship between M-1 and GNP that has prevailed in the past continues. In determining monetary policy, Fed officials are also looking at more comprehensive measures of money, such as M-2 or M-3, which include various types of savings.
''The difficult task before the Federal Reserve is to offset the contractionary effects of slower money growth during the second half of 1983, while avoiding any tendency toward an extended and inflationary expansion,'' writes economist Robert R. Davis in the Joint Economic Committee report. At the same time, that report cautions that ''the nation is unlikely to escape some inflationary consequence of excessive money growth between the summers of 1982 and 1983.''
In other words, Mr. Davis expects higher inflation this year. A chart accompanying Mr. Sprinkel's testimony indicates that he, too, would not be surprised by more inflation as a result of earlier fast money growth.
Mr. Roberts, a supply-side economist, is less concerned about an increase in the inflation rate. He believes that with tax reforms and other changes introduced by the Reagan administration, there are enough incentives in the system now for the economy to grow faster with less inflation. In other words, more of the new money supplied by the Fed will be used for real growth in the output of goods and services and less merely for price increases.