Treasury Secretary Donald T. Regan predicted yesterday that interest rates will fall through the end of this year if federal spending is reduced and said that the Federal Reserve does not need to ease monetary policy to ensure an economic recovery.
"I think that interest rates will come down as it is perceived that these budget deficits are down and will stay down," Regan said in an interview.
He disputed the forecast of some analysts that interest rates will turn up again later this year when the expected recovery boosts business loan demand again at the same time the Treasury's own borrowing needs are rising sharply.
Rates will fall "not sharply, not plummeting in a straight line, but coming down over the period between now and the end of the year," Regan said. The Treasury secretary does not anticipate a significant rise in business loan demand as a result of the recovery. To the contrary, he said, rising sales will improve companies' cash positions in the third and fourth quarters, enabling them to cut back on their short-term bank borrowings.
Regan said the administration expects the economy to grow at an annual rate of between 4 and 4 1/2 percent in the second half of the year, a pace he termed "pretty modest," adding, "It possibly could be larger than that, but we are not counting on it."
This resumption of growth should reduce the unemployment rate, currently 9.4 percent, to "the high 8s over the next four or five months," he continued.
At the same time, the recovery should not mean renewed inflation, the secretary said, although he acknowledged that the recession has been a major factor in slowing price increases.
"What we are looking for is probably continued low inflation, although higher than currently. I don't think it is logical to assume that we could keep up this 1.8 percent rate we have had since the first of the year. We're thinking more in terms of an inflation rate this year of 5, 5 1/2, 6 percent--through there," he said.
Regan said part of the improvement is attributable to lower oil prices and smaller increases in food prices resulting from "abundant crops." But, he added bluntly, "The other main reason, of course: Inflation is down is due to the recession.
"Let's not kid ourselves," he declared. "The fact that we've had high unemployment has resulted in a lessening of wage demands. This, in turn, has brought inflation down, and that has fed on itself . . . There have been a lot of givebacks by labor, and this has also helped the inflationary picture, although it may not have helped the individual laborer's paycheck."
Nevertheless, the progress on inflation should be long-lasting, the Treasury secretary argued. "To the extent that we don't reflate our economy, that is, that we don't accommodate with very loose money, that we don't have unusual demands by labor, and that we are able to increase productivity as we should coming out of a recession . . . we can keep inflation down," he said.
"I think that the rapid increase in wages until recently was due to the fact that management felt it could pass these through in the form of price increases," Regan said. "They were able to get away with it in the '70s and into the '80s. But now we are in a disinflation period, which I think we will be going through for several years. You have a different type of marketplace now that management has to deal with in a disinflationary period."
Lawrence Kudlow, chief economist at the Office of Management and Budget, yesterday also urged the Federal Reserve not to ease its monetary policy as some congressmen have suggested, and predicted a reasonably strong recovery in the second half of this year coupled with declining interest rates.
Meanwhile, Federal Reserve Board Chairman Paul A. Volcker rebuffed Rep. Henry Reuss (D-Wis.), one of those pushing hardest for an easing of monetary policy. He said in a letter released yesterday that, although the Federal Reserve will take congressional views on money policy into consideration, he believes that Congress should not attempt to direct the Fed's detailed operation of money policy.
Speaking at a Brookings Institution conference on the budget, Kudlow said that the recession probably had been unavoidable and was needed to give a "washing out" of inflationary behavior in the economy. He added that today's lower inflation will help to spur recovery by increasing consumer purchasing power. Lower inflation was the most important economic event in the last 15 or 16 months, he said.
Acknowledging that he was more optimistic than many forecasters, Kudlow said "economic recovery is on the way," and he predicted a small positive growth rate for the second quarter