The money supply has been misbehaving again.
For the second time in the last four months, the money supply has skyrocketed, for reasons that are not totally clear, and the Federal Reserve is trying to put the clamps back on.
When the central bank tightens up on monetary policy, short-term interest rates rise. Short-term rates climb nearly three-quarters of a percentage point when the Fed put the squeeze on last spring, and they have risen a similar amount over the last several weeks.
In response to rising interest rates, major banks Friday announced that they would boost from 6.75 to 7 per cent the prime rate they charge their best corporate customers for a short-term loan. In recent years, banks have tied their prime rates to so-called market rates - such as the interest paid on Treasury bills and commercial paper - that are determined by demand and supply factors.
While economists differ on how important the growth of money supply is to overall economic behavior - including economic expansion and inflation - in recent years nearly all analysts have agreed that policymakers must be concerned with changes in the money supply. The Federal Reserve Board, the nation's central bank, has been entrusted by Congress to try to influence the rate of growth of money. It does so primarily by buying and selling government securities in the open market to inject or withdraw funds from the banking system.
As the Fed has tightened money policy in recent weeks - primarily by not supply reserves to the system and allowing the so-called federal funds rate to rise - other short-term interest rates have risen as well.
Minutes of the latest Federal Reserve Board open market committee meeting released Friday demonstrated that the nation's money managers were concerned that growth of the money supply is getting out of hand.
At the regular monthly meeting July 19, the 12-member open market committee decided that the money supply should grow within a 3.5 to 7.5 per cent range in July and August. By Aug. 4, according to the minutes, it had become apparent that the money supply had exploded and had grown at an annual rate of about 18.5 per cent in July. As a result, Federal Reserve Board Chairman Arthur F. Burns cabled members of the committee, who agreed with him that monetary policy should be made more stringent to get the growth of the money supply back under control.
Despite the concern at the Fed that the money supply - narrowly defined it is checking accounts and currency in circulation, and more broadly defined includes savings deposits at commercial banks - is growing too fast, opinions about what happened in July vary.
"We're at the Rubicon," according to Robert Weintraub, staff director of the House Subcommittee on Domestic Monetary Policy. "If the Fed doesn't take the bull by the horns and get money growth back within its target, the 1974-75 recession was all in vain. We'll be off on another inflationary toot that will end in recession or accelerating inflation."
But Leon Gould, an economist for Commercial Credit Corp., is less concerned about the apparent July spurt in the money supply. He thinks the big July jump does not indicate that money growth is slipping from the Fed's grasp but attributes the rise to technical seasonal adjustment factors. He says that other economic indicators, such as slowing economic growth, just do not correlate with a sharply expanding money supply.
Gould said that most of the spurt can be attributed to the central bank's inability to seasonally adjust the money supply to account for the early payment of Social Security benefits in July and the impact of the New York blackout that made transfer of checks difficult and exaggerated the size of bank deposits for a day.
The Federal Reserve itself has acknowledged that technical factors complicated the analysis of what has been happening to the money supply. But most members of the board of governors think that the technical factors explain only asmall portion of the July jump, although they have no ready explanation for the sudden jump in the money supply.
Had it failed to react to the July growth, as some econonomists have urged, the Federal Reserve feels it would have lost credibility in its fight to keep money growth within a range that is consistent with keeping the economy grwoing but with reducing prices.
Indeed, Jerry L. Jordan, chief economist for Pittsburgh National Bank, thinks that the Fed has not reacted aggressively enough, that its open market policies have provided the "foundation for excessive money growth," Jordan, like many other monetarist economist, thinks that the growth of the money supply cannot be controlled by focusing on interest rates.
Short-term interest rates, including the federal funds rate, are influenced by demand for funds as well as by the Fed. So if demand for funds is rising, the Federal Reserve, by watching the federal funds rate, may think it is being restrictive when it is not.
The federal funds rate is the interest banks charge each other for overnight loans of excess reserves. The Fed tries to determine what rate is consistent with the money growth it wants to achieve and then runs its open market operations with a view to maintaining its target rate.
Jordan says that "as much as they've raised the fed funds rate" over the last four months, Fed officials have not been as stringent as they thought they were, being. The federal funds rate has risen from around 4.5 per cent last March to 6 per cent today.
Jordan also said that until the central bank raises the discount rate - the interest it charges member banks to borrow from it - the market will not believe the central bank is as serious about holding down money growth as it claims to be. The discount rate is 5.25 per cent and could be raised to 5.75 per cent and still be below other market rates.
federal Reserve Board moves to slow money growth are not always popular. Many congressmen, among others, are more concerned with interest rates than money growth.
When the Fed tightened up last spring, the Fed got a blast from the administration as well as from many congressmen. Administration spokesmen argued that raising interest rates was not a good way to flight inflation.
But the Fed has not received the same criticism this time and is not likely to. Office of Management and Budget Director Bert Lance was the prime archistect of the admistration's critique of the Fed last May. Lance's personal financial matters have been occupying of his time in recent weeks.