Federal Reserve Chairman Paul A. Volcker warned last night that the prospect of huge continuing budget deficits is keeping interest rates high, while their realization could bar a sustained economic recovery.
Volcker said the fiscal 1983 deficit could end up equal to 6 percent of the gross national product, well above the previous 4 percent peak, with between half and two-thirds of the red ink due to the recession.
Lowering the deficits would, "in and of itself . . . have favorable effects on current interest rates and in damping concerns about future increases," he declared.
Volcker stressed that he was not suggesting there is some simple "trade off" between tax and spending policy and monetary policy. But he added, "As things stand, fear of growing deficits clouds the future and contributes to market pressures and inflationary uncertainties, adding to the burdens on monetary policy."
The Fed chairman, speaking to a tax policy seminar sponsored by the American Council for Capital Formation, said that the "heart of the difficulty is that there is, as things stand, no reasonable prospect that we can grow out of the deficit. Even if the economy expands at or beyond most projections, over the next few years and with satisfactory price performance, the deficit is not likely to fall below 4 to 5 percent of GNP over the rest of the decade, assuming no change in current policies. Even those estimates may be a bit low."
Volcker said the reason the deficits will stay so high is that the so-called structural deficit--the portion that would remain even if the economy were operating at high employment levels--"threatens to grow at least as fast as recovery reduces the cyclical component."
Volcker's remarks came as President Reagan is completing work on the fiscal 1984 budget he will send to Congress Jan. 31.
Some economists have claimed recently that projections of such large budget deficits are the result of "pessimistic" economic forecasts, and that a faster economic recovery than that predicted by the Reagan administration would virtually eliminate the imbalance between revenues and spending.
Volcker, however, called such claims "wishful thinking," adding, "Under any reasonable forecast for sustained growth and without further policy adjustment, the deficits will remain historically huge unless we make the unacceptable assumption that we will also revert to an historically high inflation rate."
One reason for such a rapid increase in the structural portion of the deficit, Volcker said, is that "in these circumstances, interest payments on the debt will remain a rapidly growing budget category, even in an environment of reasonably declining interest rates."
Volcker said federal borrowing to finance the deficits would mean higher interest rates than otherwise, reducing investment in housing and business plants and equipment. The higher interest rates could also weaken U.S. exports and encourage more imports, "hardly a happy prospect," he declared.
"The long-run implication is both a weak investment and a weak balance of payment structure, with a lower level of output over time," he said.
Now, however, he continued, the prospect of huge deficits contributes to "an atmosphere of exceptional caution and uncertainty about future planning by business . . . in a way that cannot be precisely measured--lingering concerns about a sharp rebound in interest rates from already relatively high levels, continuing strong pressures on monetary policy, or a reversion to inflationary policies 'forced' by the deficits."
Volcker noted that despite money growth above the Federal Reserve's target ranges, interest rates remain both high by historical standards and well above current inflation rates.
But he cautioned that an easier monetary policy could not offset the impact of the budget deficits and force rates downward.
"In the end, excessive monetary growth would put us back in the same unsatisfactory situation of more deeply ingrained inflation expectations and greater skepticism about the ability of our nation to manage its economic affairs," he said.