The White House pointedly praised the Federal Reserve yesterday for acting quickly to counter an unexpectedly large jump in the money supply even though the Fed's actions and financial market reactions have sent interest rates up sharply.
"We feel like it's an essential step at this time," Deputy White House Press Secretary Larry Speakes declared.
In an address delivered last night in New York City before an audience of business and economic writers, Murray Weidenbaum, chairman of the President's Council of Economic Advisers, added, "We welcome efforts by the Federal Reserve to improve its operating procedures. We support the system's perseverence in restraining excessive money supply growth, notwithstanding any short-term repercussions on interest rates as financial markets adapt to the new policy environment."
As a bulge developed last month in the weekly money supply figures, and it was not quickly reversed, the Fed steadily increased pressure on financial markets by reducing the availability of the reserves that banks must hold against deposits. These reserves consist essentially of vault cash and non-interest-bearing deposits that banks keep with the Fed itself.
Unfortunately for themselves, many participants in financial markets had been expecting interest rates generally to decline more or less steadily at least until midyear, and they had invested their money accordingly. As the Fed's pressure grew, interest rates turned upward with a vengence, with the banks' prime lending rate hitting 19 percent this week. Because prices of bonds and similar financial securities move inversely with interest rates, bond holders suffered large losses.
The Federal Reserve capped its actions Monday by increasing its discount rate -- the interest that the Fed charges when financial institutions borrow directly from it -- by a full percentage point to a record 14 pevent. It also upped the surcharge it imposes on large banks that borrow frequently from 3 percentage points to 4 points.
The unanimous vote by the seven members of the Federal Reserve Board to raise the discount rate masked differences among the board members over how far to go in increasing the rate. Some members wanted an even more vigorous step taken, while others preferred a smaller increase.
But in the end the 7-to-0 vote underscored the Fed's commitment to keep tight control of money supply growth. As Fed Governor J. Charles Partee noted yesterday, "It is a very significant point that the vote was unanimous."
While the administration is fully backing strong Federal Reserve action -- and indeed has been putting considerable pressure of its own on the central bank to encourage it to reduce growth of the money supply -- there is a hope that the future will not see such sharp ups and downs in interest rates which could harm economic growth.
For instance, press secretary Speakes said the White House is "hopeful" that increases in the discount rate will not be necessary in the future once President Reagan's budget and tax cuts are passed and begin to improve the economy.
But many analysts believe it will be quite some time before financial markets will be able to take in their stride those moves that the Fed will have to make continuously to keep money supply growth on target.
"It took a long time for the markets to become convinced that we were in an inflation-prone economy," said Judith Mackey, an economist who follows financial developments for Townsend-Greenspan & Co., a New York consulting firm.
"Now they are going to have to go through a period in which they see that the Fed does react under all situations [and] they will have to see the impact of the Reagan fiscal program," Mackey said. "That does not mean that long-term rates may not be [going] a bit too high right now and will not come back down later this year. But I suspect that those long rates will be sticking past a period in which they see fiscal and monetary policy" in place and working in a non-inflationary direction.
She added that the high level of long-term rates is evidence that the markets expect a fairly healthy economy with continued high inflation in 1982 and beyond.
Whatever expectations, the close focus by the Fed and the markets on money supply growth means that occasionally both are going to be surprised, just as they have been in the last few weeks and days. In the present instance, the economy has been stronger than forecast and that strength has led directly to greater increases in money than expected. "I don't know where it is coming from," said Steven Blitz of Data Resources Inc., another economic consulting firm, "but someone out there is borrowing money. The market thought for a month that the Fed was loosening up . . . but the market misread the Fed's intention."
There could be frequent collisions between the demand for money in the marketplace and the amount the Federal Reserve is willing to supply.