Fed pressured to cut interest rate
The economic weakness that helped cause the stock market's tumble early this week is very much on the minds of Federal Reserve Board officials now meeting here. The board's Federal Open Market Committee is conducting its midyear review of monetary policy amid growing signs that the United States economy is not going to snap back as strongly in the second half of 1986 as many forecasters had expected.
The economy's tepid pace, seen recently in a spate of statistics, leads some analysts to expect the Fed to cut its discount rate, which now stands at 6.5 percent. That is the rate the Fed charges financial institutions for money they borrrow. A lower discount rate would eventually push down the interest rates that businesses and consumers pay, thus tending to speed up economic growth.
With congressional elections coming in the fall, there is mounting political pressure on the Fed to act to stimulate the economy. Last week both the White House and Senate majority leader Robert Dole (R) of Kansas called for lower rates.
In a letter to Fed chairman Paul A. Volcker, Senator Dole argued that lower interest rates are ``essential to our efforts to control spending, revive America's performance in world trade, and maintain public support for anti-inflation policies.''
But the Fed is faced with conflicting signs from the economy, so a discount-rate cut is not automatic. While the odds ``slightly favor'' one more easing of the rate, the Fed ``is going to move very cautiously,'' says David Jones, senior vice-president of Aubrey G. Lanston & Co., a government securities dealer.
A factor favoring a rate cut is that the slow growth of the economy and lower oil prices reduce the danger that lower interest rates could lead to an overheated economy and renewed inflation.
A new survey by the National Association of Purchasing Management reports that the economy ``dropped sharply'' in June. Oil prices fell this week to near $11 a barrel on reports that the Organization of Petroleum Exporting Countries was boosting production.
Signs of economic weakness were one reason the Dow Jones industrial average plunged a record 61.87 points Monday. The decline continued Tuesday with the Dow at 1812.71, down 26.29 points, at 3 p.m..
But other factors argue against a looser credit policy. The money-supply measure known as M-1 -- cash plus deposits in checking accounts -- is growing much faster than the 3 to 8 percent the Fed had planned. In the past, rapid money growth has translated into overheated economic growth and rapid inflation. The links between the money supply and economic growth, however, seem weaker recently because of changes in banking regulations and the apparent dawn of a low-inflation era.
The task for Fed policymakers is further complicated by the fact that if the Fed moves to lower US interest rates and other nations do not follow suit, the value of the dollar would tend to drop in financial markets. That, in turn, could lead to renewed US inflation, as the price of foreign goods would rise in dollar terms.
Also, if dollar investments brought a lower return, foreign investors might be reluctant to buy the large amount of bonds the US Treasury must sell to finance the federal budget deficit.
The Supreme Court's decision Monday invalidating a key portion of the Gramm-Rudman balanced-budget law is already expected to make it harder for Congress and the administration to meet the fiscal 1987 deficit target of $144 billion. And a combination of weak economic growth, low inflation, and unrealistic budget figures leads some experts to predict a 1987 deficit of $165 billion to $175 billion.
Federal Reserve and White House officials have been leaning on Japanese and West German officials to cut their discount rates, but to no avail. There is speculation that the Bank of Japan may act to stimulate the nation's lagging economy now that Prime Minister Yasuhiro Nakasone's party has won a major election victory. But German central bank officials remain adamant.
Another complication for the Fed is the lack of assurance that the domestic economy would benefit from stepped-up consumer demand caused by lower interest rates. ``The problems of oil and agriculture will not be significantly altered by lower interest rates or more rapid money and credit growth,'' notes Paul W. Boltz, vice-president of T. Rowe Price Associates Inc.
So far the dollar's decline in value has not led to a major improvement in the US trade deficit. Thus, Fed moves to lower interest rates could lead to higher demand for foreign goods and an even higher trade deficit.