Chairman of the Federal Reserve Board Paul Volker yesterday warned of "financial market pressures" implicit in the administration's economic forecast for this year, which could signal higher interest rates than the White House has forecast.
At the same time, the nation's 10th-largest bank, Security Pacific National Bank in Los Angeles, pushed up its prime lending rate by one-half percentage point to 17 1/2 percent, in a sign that the recent decline in interest rates could be over. Security Pacific and some other major banks had cut their prime to 17 percent only three days earlier. Meanwhile Citibank, the nation's largest, raised its broker loan rate from 15 percent to 15 1/2 percent yesterday. Most analysts had been expecting rates to go on sliding for several months.
In yesterday's budget hearings, Volcker agreed that the tight-money policy espoused by the administration and the Fed can be reconciled with the administration's forecast for prices and output in the economy only if money turns over much more rapidly than usual. High interest rates are usually associated with such a rise in the velocity of circulation, or the speed with which a single dollar is turned over.
The Fed Chariman also warned that defense spending could be higher than Reagan has forecast. He urged the Budget Committee to make sure the technical as well as economic assupmptions behind its spending estimates were realistic. The Congressional Budget Office has challenged Reagan's numbers as too low, citing both technical and economic reasons.
Higher defense spending because of a faster "spend-out" rate could add $5 billion to spending in fiscal 1982, the CBO said this week. The CBO believes that technical factors will add $12.8 billion to Reagan's budget numbers for 1982, with a worse economy adding a further $13.5 billion.
The Fed Chairman also cast doubt on the administration's argument that a sharp rise in saving as a result of Reagan's economic program could be used to finance a bigger budget deficit. "I would also be cautious, in assessing budgetary prospects and personal savings should be looked to as a means of financing a deficit," he told the committee.
Volcker said he did not know whether the administration or the CBO budget figures were right but that typically administrations underestimate spending. Budget Committee members should make sure that they use the best technical estimates for spending, he said.
Over-optimism on the technical side was more dangerous to budget control than overly optimistic economic assumptions, Volker said. Many economists believe that growth will be lower and inflation and interest rates higher than the administration forecasts.
This would tend to swell the budget numbers for next year. But Volcker pointed out that an increase in spending for this reason could be reversed when the economy improves, whereas an increase because of larger takeup of benefits or faster military budget would be locked into the budget process.
There could be "a rather rocky road" ahead this year for the economy, Volcker said, as Congress and the administration attempt to turn it around and reduce the growth in federal spending. But "we'd better get moving" onto a path of bringing down inflation and spending, he told the committee.
He stressed again the importance of reducing spending as "the keystone in the arch of any new approach to economic policy" and said, in answer to a question, that he would err on the side of cutting more rather than less spending. "All risks lie on the side of cutting expenditures too little," Volcker said.
Volcker was noticeably less optimistic than many administration spokesmen that inflation can be brought down without some short-run pain. He said price increases could not slow down until wage settlements were reduced. "If strong pressures from wage settlements, energy prices or other factors persist or accelerate, strains in financial markets will be greater than otherwise, and real activity is likely to remain constrained," he said.
Reagan's economic program assumes that inflation can be cut at the same time real growth is rising. This has very rarely happened, and many economists doubt that it can happen now.