If the Treasury Department puts $11.4 billion of rebates into the pockets of taxpayers next April or May, as President Carter's economic stimulus package envisions, the money supply will increase sharply.
This sudden growth will make it difficult for the Federal Reserve Board to formulate monetary policy, as economists discovered several years ago.
Many of the $50 rebates will be deposited in checking accounts before they are either spent or converted into savings by recipients. The money supply, which economists believe has an important impact on overall economic performance, is the sum of checking accounts and currency in circulation.
Such an increase might cause the Federal Reserve Board to take a more restrictive posture in molding the nation's monetary policy if the board has trouble determining how much of the money growth is due to the rebate and how much might be due to other, inflationary factors.
The Fed is expecting an increase in the money supply this spring if Congress approves the tax rebate provisions in President Carter's program to stimulate the economy. The central bank long has claimed that it is not in the business of trying to negate congressional actions, so the Fed would not be likely to move to counter the expansionary effects of the tax rebates even if it feared their inflationary consequences.
But the agency has been tricked by data before into believing that money supply growth was due to more than tax rebates, and then has taken steps to restrict the money supply.
In May 1975, when $8 billion or so in tax rebates was paid to consumers as part of an anti-recession package, the money supply spurted. The Fed expected that. But when the money supply grew both faster and longer than the Fed analysis projected, the central bank began to act to increase short-term interest rates in order to restrict money growth and restrain inflation.
Fed chairman Arthur F. Burns was accused of working at cross-purposes with Congress by many legislators - that is, restricting money growth and therefore cancelling out the economic stimulus Congress had provided in the tax rebate.
Burns testified many times that the central bank was not in the business of trying to negate congressional and administration actions. Instead, he said in testimony before the House Banking Committee in October 1975 that the increase in the money supply in May and June of that year was "considerably larger than we had anticipated and threatened to raise the longer-term monetary growth rates to unacceptably high levels."
Many economists feel that the Fed's sudden switch from a loose to a tight monetary policy in mid-1975 precipitated some of the long pause in economic growth which occurred during much of 1976.
Sen. William Proxmire (D-Wis.), chairman of the Senate Banking Committee, said he hoped the Fed learned a lesson from its handling of the money supply spurt in 1975, that it will take steps to accomodate the borrowing necessary for the Treasury to pay the rebate and that the central bank will not put on the monetary clamps if the money supply grows faster than it expects.
Robert Weintraub, staff director of the House Banking Committee Subcommittee on Domestic Monetary Policy, said the high level of Treasury borrowing that will be necessary in April could put pressure on credit markets, especially because the agency has said that it plans to borrow most of the $11 billion it needs to pay the rebates in the second quarter and does not plan to raise it in small quantities over a period of time.
Weintraub pointed out that interest rates began to rise in 1975 while rebates were being paid out, and that the Fed initially took steps to hold down the interest rate increases. That exacerbated the growth in the money supply, which the Fed clamped down on later in the summer.
Edward P. Snyder, a top Treasury debt analyst, said that while the Treasury is acting conservatively and carrying a high cash balance - the agency expects to keep about $12 billion in the till - and will have to borrow heavily during April and May, the markets will be able to absorb the borrowings without heavy pressure developing to raise interest rates.
Treasury Secretary W. Michael Blumenthal told the House Budget Committee Thursday that while non-federal demand for funds has been rising since late 1975 and the government expects credit markets to handle a record level of funding this year, the supply of funds "appears ample."
Snyder noted that most of the rebate checks will go into deposits at commercial banks. Because of increased deposits, the banks then will be in a "position to buy our securities." He also said that when a tax package is passed by Congress - the Carter administration has not yet sent its formal legislative proposals to the legislature - the agency might "very well do some borrowing" early to get ready for the rebate payouts, which the administration hopes to mail to 206 million individuals in mid-April.
Regardless of whether Treasury borrowings cause dislocations in the credit markets, some economists at the Federal Reserve acknowledge that the monetary implications of tax rebates are not very well understood. As in 1975, the Fed probably will set a monetary growth range during the rebate period which it views as compatible with the long-range growth trend the board and Congress agree on.
That target is growth between 4.5 and 6.5 per cent from the third quarter of 1976 to the third quarter of 1977, although the central bank may change the target during its regular quarterly appearance before Congress this week.
If other parts of the economy are picking up while the rebates are being paid out, the agency might be less comfortable with high growth rates in the money supply than if other factors remain constant. Economists such as Carnegie-Mellon University Prof. Allan H. Meltzer fear that the Fed could make the same mistakes in judgment it made in 1975.
At least one government economist was more sanguine. "There's one thing to keep in mind about the Fed," he said. "It's always right the second time.