Interest rates are much too high. They threaten a national economic crisis, especially in the auto, housing and thrift industries. Quite apart from the recent well-publicized complaints of European leaders that high U.S. interest rates are creating problems for them, the objective evidence is that a monetarist policy being pursued by the Federal Reserve Board has pushed interest rates higher than they ought to be -- and higher than the Fed itself expected them to be.
Even President Reagan's economic advisers, according to one of them, are "puzzled" and "confused" about the persistence of high interest rates although they propose to stick with present policy, a decision based "more on confusion than conviction." This is the view of William Niskanen, one of the three members of the Council of Economic Advisers.
One gets the feeling that Federal Reserve policymakers are compulsively flirting with economic disaster because they are afraid to shifts gears, believing that as bad as things are now, they woudl be even worse if policy were prematurely eased.
In part, the puzzlement cited by Nizkanen arises because interest rate have continued to soar even though inflation has come down dramatically. The Consumer Price Index is running at an annual rate of 8.2 percent, compared with 13.3 percent two years ago. When measured against a 14 1/2 percent Treasury bill rate, the "real" interest rate is more than 6 percent, well above the conventional level of 2 to 3 percent.
Even if one decides to measure inflation not by the CPI but by a higher, assumed underlying inflation rate of 9 percent or so, the "real" interest rate is at an historic peak. It's a complete reversal of the pattern two years ago when "real" interst rates were negative because a 10 percent yield was running behind the 13.3 percent inflation rate.
The consequences of a policy that keeps interest rates this high are dramatic. Domestic auto sales have collapsed to an annual rate of about 5 million, a 20-year low. Meanwhile, the savings and loan industry has been pushed to the edge of a disaster that could force the government into a bailout costing as much as $50 billion, according to economist Alan Greenspan.
Niskanen says that at a recent informal session among six government economist, including some from the Fed, "there were eight different explanations (for the peak level of real interest rates) -- and we didn't have a good one."
It doesn't seem all that mysterious: In a telephone interview, Salomon Bros. Money expert Henry Kaufman said the record real interest-rate level "reflects the heavy burden being placed on monetary policy. In the next 12 months, we'll have a major tax cut, increased defense spending and bigger federal deficits. In that environment, What can you expect from interest rates?" Kaufman predicts than within a year, unless the government curbs the big military build-up, the prime rates will top the 21 1/2 percent level set last year.
Kaufman's basic theme isn't challenged at the Fedl when officials speak off the record. A well-posted source uses these plain words: "we face a real dilemma: The financial markets don't believe Reagan will be able to cut the federal deficit. If they [the Reagan administration] were to cut their proposed defense spending increase in half, you'd see an immediate reduction in interest rates.
"But if we were to change monetary policy now by pumping more reserves into the market, we woud lose all our credibility, and long-term rates would rise at least 2 or 3 point. It's one hell of a problem because autos, housing, and the S&Ls are in trouble. But so long as Reagan puts all of the burden on us, we've got no choice."
In effect, the Federal Reserve has consciously made a decision that the economy overall is reilient enough to take its austere policy even though the interest-sensitive sectors such as housing and the thrifts are in serious trouble."In a way," says a Fed source, "as we continue this policy -- although I hasten to say that's not why we are doing it -- we're putting prsesure on the Reagan administration. We're forcing them to face up to the significance of the big budget deficit."
But how long can this lethal game go on? The economy appears to be intering a general downturn or recession. Richard Pratt, head of the Federal Home Loan Bank, says that fully one-third of the nation's 4,700 S&Ls "are not viable" under today's condition of high interest rates.
Greenspan reports that because there is a limit to the number of strong institutions that can absorb weak ones, many S&Ls will have to be liquidated rather than merged out of existence. Insurance will protect depositors (up to $100,00), but the government may have to put up so much cash or credit that it could "seriously threaten the success of the president's anti-inflation program," Greenspan concludes.
Thus, the wisdom of blindly following a high-interest-rate policy needs to be reexamined. The Reagan administration is beginning to worry enough about the problem to be predicting that interest rates will be coming down. But you don't get that kind of soothing assurance from the Fed. In the end, it may take a corporate bankruptcy or an international financial crisis to force a change in policy, and in the underlying monetarist dogma.