"I think the opportunity for a fall in interest rates is becoming increasingly small," Elliott Platt, economist with Donaldson, Lufkin, and Jenrette, said this week.
Many in the financial markets, Platt included, have been expecting interest rates to fall further this spring and early summer than they have so far. Some still are predicting a slide in rates in the next few weeks. But others are beginning to feel that, if there is a drop, it may be only slight, and that it will be followed swiftly by yet another climb in the cost of borrowing.
A huge increase in Treasury financing in the third quarter of this year, together with any upturn in private-sector credit demand as a result of economic recovery, will stop rates from falling far in coming weeks, the pessimists say. If they are right, there probably will be tremendous pressure on President Reagan to do something to alleviate high interest rates this summer.
Some administration officials, including presidential counsellor Edwin Meese III, have hinted that, if rates do not come down of their own accord this summer, then unspecified "other measures" may be necessary to bring them down.
There are many Reagan officials who will fight strongly against any sizable new spending measures--aimed at offsetting the effects of high rates on particular industries--and even more strongly against any dilution of administration support of the Federal Reserve Board's tight money policy. But with high interest rates the most potent symbol of the failure of Reagan's economic program and a threat to economic recovery, a change in money policy may become more appealing.
This policy is an important cause of today's high interest rates. The Fed's determination to keep as close as possible to its money targets has meant that it has kept a tight control on the supply of bank reserves. This in turn has helped to keep money market rates high this year, despite the evident weakness in the economy.
Moreover, the Federal Reserve's current targets for money growth have been even tighter than intended for technical reasons, according to some analysts. Velocity of the money supply actually slowed earlier this year, thus each dollar of money supply financed less gross national product than might have been expected, making money policy more restrictive.
If the Federal Reserve still were operating under its old, pre-October-1979 technique of controlling the money supply through managing interest rates, it is very unlikely that it would have kept rates so high for so long. It is even less likely that it would have been able to do so without loud opposition from Congress and elsewhere. Then the blame for high rates was laid more easily at its door.
Now that money policy is articulated solely in terms of the various measures of the money supply, interest rates are seen more often as a purely market phenomenon than as an instrument, or even a consequence, of policy.
While the Fed's technical switch in October 1979 has done much to deflect attention from the role of money policy in today's high interest rates, the monetarist argument that easier money simply means more inflation, and ultimately higher interest rates, also has played a part. It is unpopular to argue for more inflation, so politicians are unwilling to argue for "easier" money.
However, rising unemployment and fears that high interest rates may abort the economic recovery this year are beginning to focus congressional attention on money policy. Both budget committees have included a "sense of Congress" that the Federal Reserve should reevaluate its monetary policy if Congress takes significant measures to reduce the budget deficit.
Economists, including some financiers, also wish the Fed would ease. Discussing the central bank's options, analysts William Griggs and Leonard Santow of Shroders write that one option, "which we would favor, would be to become more eclectic, setting policy by emphasizing interest rates, inflation, economic activity, etc., as well as the behavior of the monetary aggregates." But, they add, "There is no evidence that the Fed will move in this direction."
Reagan so far has held out strongly against a change in money policy. "In the past seven or eight recessions since World War II, the normal pattern was to suddenly flood the money market with printed money, paper money to artificially stimulate the economy . . . the only trouble was, within two to three years after each one of those quick fixes, we went into another recession," he has commented.
The president evidently hopes that rates will fall soon without a policy shift.
He could be right. But if rates decline with no easing of money policy, the most likely reason will be because the economy has weakened further, cutting private-sector credit demands. It will not be much comfort to Republicans facing elections this fall if the interest-rate problem is solved at the expense of a still worse recession.