Treasury Secretary Donald T. Regan this week renewed his attack on the Federal Reserve for allowing sharp fluctuations in money growth last year, fluctuations that he said caused interest rates to rise.
"During 1981, there appeared to be a particularly close relationship between variability in monetary growth and short-term rates," Regan told Congress' Joint Economic Committee. "Acceleration in monetary growth was associated with sharp increases in short-term rates, while deceleration in monetary growth was associated with declines in short-term interest rates.
"This is an important lesson. Faster money growth causes interest rates to go up, not down," Regan concluded.
Regan flatly asserts this is a cause-and-effect relationship, but many economists do not share that view. Nor does the evidence of 1981 necessarily support it.
Economists at the St. Louis Federal Reserve Bank, known far and wide for their strict monetarist persuasion, recently looked at last year's changes in money growth, interest rates and the demand for business loans. In a direct contradiction to Regan's assertions, they wrote earlier this month, "Market interest rates are determined by numerous factors that affect the supply of and the demand for credit, including changes in the rate of growth of money. All other things equal, an acceleration in the short-run rate of money growth will cause interest rates to fall, while a deceleration will cause interest rates to rise."
In 1981 interest rates and money growth often did move together, the St. Louis analysts noted, but they went on to probe more deeply. "Data on the rate of growth of M1-B corresponding to peak-to-trough and trough-to-peak movements in the 90-day certificate of deposit rate, however, suggest that changes in the rate of money growth have not been the primary determinant of short-run movements in short-term interest rates during the past year." Movements in the 90-day CD rate instead "appear to have been closely linked to changes in credit demand."
In other words, fluctuations in credit demand, not shifts in money growth over short periods, primarily were responsible for the ups and downs of short-term interest rates, they said.
Furthermore, an increase in the demand for credit also can produce a jump in money growth unless a prescient Fed moves instantly to counter it. Doing so, many economists believe, would lead to more volatility of interest rates, not less.
Regan in his testimony also called for a change in the Federal Reserve's monetary policy this week, asking for money growth this year of between 4 1/2 percent and 5 1/2 percent rather than the 4 percent figure that is the midpoint of the Fed's target range. He specifically rejected moving up the target range, which stretches from 2 1/2 percent to 5 1/2 percent, in favor of shooting for the "upper third" of it.
The new proposal for faster money growth this year is Treasury's alone, Regan later said. Other administration officials said the recommendation had not been discussed in the regular meetings among economists from Treasury, the Council of Economic Advisers and the Office of Management and Budget.
"That's really Don way out in front," said one official, who did not want to be named because he wants no public fight with Regan.
In fact, the idea of seeking money growth this year somewhat faster than the Fed's intended 4 percent probably appeals to a great many economists, both in and out of government. It does to the official quoted above, for instance. But he added, "If I thought you could control money that well, I would say, okay. The trouble is there is no empirical evidence the Fed has that kind of precise control over money."
Regan and his aides obviously believe the Fed could do it if only it would, and that its failure is costly.
"The erratic pattern of money growth that occurred in 1980 and 1981 ... contributed to the onset of the current downturn," he told the JEC. The volatility of money growth "destroys the credibility of long-run monetary controls, adds to uncertainty and risk, and thereby helps keep interest rates high as lenders seek to protect their principal."
Again, Regan makes a leap. It is the volatility of interest rates that creates the greater uncertainty and risk. Short-term changes in money growth rates can be blamed only if they are responsible for the volatility in interest rates. They certainly are not the sole cause and likely not even the primary cause. Moreover, if the Fed is able to meet its money growth targets over the longer term--not weekly or monthly--why does short-term volatility of money growth destroy the Fed's credibility?
"Why in the hell are we attacking the Fed?" the administration official mentioned above asked. "It would be far more productive to admit that we are going to have fluctuations in money growth. We should be belittling the short-term movements and stressing the fact that the Fed's doing pretty well controlling the long-term growth of money."