An unexpectedly large drop in the money supply sent bond prices climbing yesterday and could hasten a decline in the prime rate.
The Federal Reserve announced a $2.9 billion drop in the M-1B measure of the money supply for the week ended June 3. This measure, which includes currency and checking deposits at all thrift institutions, averaged $424.6 billion in the week.
Markets had been predicting a fall of up to $1 billion in M-1B, analysts said. The Fed recently has begun to focus more on "shift-adjusted" M-1B, which takes into account shifts to interest-bearing checking accounts from savings and other accounts. This by $1.5 billion to $418.7 billion.
Yesterday's figures confirm the view that the Fed has controlled an earlier spurt in money growth. In the latest four weeks M-1B averaged a 6.8 percent annual increase over three months earlier. On the same comparison, the narrower money measure, M-1A, showed a 3 1/2 percent rate of decline.
However other figures released yesterday by the New York Fed showed business loan demand continuing strong. Commercial and industrial loans on the books of the nation's large banks rose $1.2 billion in the week ended June 3 compared with a rise of $88 million the previous week.
Meanwhile, a senior administration official told the Joint Economic Committee that multiyear tax cuts will help to ensure that future spending cuts are made.
Many Democrats have said they fear that a commitment to three years of tax cuts will force their hand on future budget cuts. Lawrence Kudlow, chief economist at the Office of Management and Budget, told the JEC yesterday that "in many ways I view [a multiyear tax cut] as a compelling device to keep momentum on the budget."
Kudlow said that President Reagan's economic program, including the tax plan, would have "a chance to make a big dent on inflation."
Meanwhile, Treasury tax officials told reporters that they do not yet know how the changes proposed this week in the administration's tax plan will affect their economic forecasts. The new plan would cut taxes in fiscal 1981 and 1982 by $23.8 billion less than the previous proposal.
Presumably this would reduce growth from the level forecast by the administration. Officials have argued that their tax proposals will boost the economy and encourage a rapid buildup in saving and investment. The Treasury's undersecretary for tax policy, Norman Ture, said yesterday that because the changes have not been fed through the Treasury's model, he does not know what their effect would be.
True and the assistant Treasury secretary for tax policy, John Chapeton, also were asked why the administration enlarged the tax cut for business for the years after 1985. Ture replied that the "budget imperative" for the years up to 1984, when the administration is forecasting a balanced budget, made cutbacks in the original plan necessary but that after 1984, the budget constraint is much less.
Kudlow told the JEC that budget and credit policy is a critical link between fiscal and money policy. If markets believe that the budget is going to be restrained, then interest rates will come down as inflationary expectations are lowered, he said. Kudlow agreed that so far markets have remained skeptical about the Reagan administration's chances of success in bringing down federal spending and credit.
Kudlow stressed the importance of the budget deficit in creating inflation, in contrast to recent comments by Treasury Secretary Donald Regan and by Beryl Sprinkel. Treasury undersecretary for monetary affairs, that budget deficits need not cause inflation.