Monetary policy is at a critical juncture.
The Federal Reserve Board -- which spent the spring, summer and early fall boosting interest rates to retard excessive money growth -- is faced with a money supply that has suddenly begun to decline.
The question the Fed must resolve soon is whether that decline is a technical, flukey one or whether it is real.
If policy makers guess wrong, they run the risk of plunging the nation into a recession or exacerbating the very inflation they spent all of 1978 fighting.
Even if the decline is reall -- and the consensus of most analysts is that the contraction is temporary and the money supply will again grow sharply -- the Fed will be confronted with the dollar problem. Should it ease up on its program of monetary restraint in the interest of preventing a recession, if that easing could trigger a renewed wave of dollar selling in foreign currency markets.
"It is a puzzlement," congressional economist Robert Weintraub said of the abrupt decline in the amount of currency and checking accounts. "If we have another two or three months of this we're not only going to have a recession, it'll be a wing-dinger."
But, Weintraub concedes, he is no more convinced that money growth has really slowed than he is that the money growth will take off again within the next few months.
The Fed seems convinced that the recent declines in the money supply are temporary, that it must keep shortterm interest rates high. The Feb has not budged one bit from the 10 percent target it set on its key interest rate (the so-called federal funds rate).
Although economists are divided on just how important the money supple is to inflation and economic growth, most now agree that if the money supply grows faster than the real output of goods and services, inflation results and if it grows more alwly, a recession can occur.
The Fed has managing monetary policy for the last year with an eye to slowly winding down the rate of inflation without senbding the economy into a tailspin.
It seemed up until October that the Fed had falied to curb demand for money. Despite near record interest rates the money supply grew rapidly and demand for credit continued apace. But beginning in November, just after the Preident announced a dollar-propping program that included further sharp increases in interest rates, the money supply began to slow its growth, then actually fall.
According to figures prepared by the Federal Reserve Bank of St. Louis, the basic money supply that grew at an annual rate of 8.5 percent in the first 10 months of 1978, fell at an annual rate of 1.7 percent during November and December.
Although Federal Reserve Board chairman G. William Miller recently complained that the press had not taken notice of the Fed's seeming success in slowing money growth, the central bank, by its actions, appears convinced that it has not in fact succeeded in slowing money growth.
The sudden slowdown may be due to "technical factors" such as a run up in the size of Treasury accounts, which the government will reduce in the weeks ahead, giving renewed impetus to money supply gorwth.
Lawrence Kudlow, vice president of Paine Webber, said the brief abatement in money growth appears to be more related to such technical considerations rather than to Federal Reserve Board tightening. He expects money growith to "re-enter the highly inflationary 7.5 to 8.5 percent growth range that has existed during most of the past two years."
But many monetary economists criticize the Federal Reserve for trying to reduce money growth using interest rate targets. The agency tries to figure out what level of federal funds rate (the interest banks charge each other for overnight loans of excess reserves) is compatible with the money growth target it seeks.
Inevitably, these economists say, the Federal Reserve thinks it is tightening monetary policy because interest rates are going up, when in fact demand for credit is boosting interest rates. But at some point, the economists contend, the Fed does get a federal funds rate that not only begins to squeeze demand for credit, but squeezes too much. By the time the agency recognizes it has overtightened, so to speak, the economy is headed into a tailspin.