Federal Reserve Chairman Paul A. Volcker yesterday resisted pleas from several members of Congress that the Fed act quickly to reduce interest rates, warning that such a step could backfire later, cutting off the economic recovery that is just beginning.
Volcker told the Joint Economic Committee that he, too, would like to see rates lower. Then he added, "Maybe you can push them down... But that would be counterproductive if [that] set in motion forces that will abort the recovery or stimulate inflation a few months down the road.... It's sustainability that is the key, in my judgment."
The Fed chairman, like Treasury Secretary Donald T. Regan the day before, said that a recovery, in fact, is beginning. "I'm cautious, but I think now we can see some crocuses blooming," he said.
Sen. Edward M. Kennedy (D-Mass.), Rep. Lee Hamilton (D-Ind.) and other committee members pressed Volcker repeatedly about the high level of interest rates relative to inflation. Kennedy, pointing to a chart, noted that the prime lending rate at commercial banks is 7.8 percent higher than one measure of inflation far higher than at the start of the recoveries that followed the previous four recessions.
In Hamilton's exchange, he thumped the rostrum and declared, "The overriding concern of the Federal Reserve ought to be to get interest rates down."
Sidestepped Volcker, "The overwhelming purpose of policy is to get a sustained recovery."
The Fed's role in securing that goal, the chairman said, "is easy enough to describe but hard to implement: We want to be sure to provide enough money to keep the recovery going but we have to be sure not to overdo it."
Increases in the money supply in recent months have been above the long-term targets set by the Fed and some participants in financial markets have been disturbed that the increases could lead to more inflation later. Volcker said he does not think the money supply increases "have any implication for inflation" but he acknowledged that the Fed must be wary of that concern in the marketplace.
Volcker noted that a few days after the Fed reduced its discount rate -- the rate it charges on loans to financial institutions -- in December, market interest rates were higher rather than lower. With increases in the last week or so, long-term rates are several tenths of a percentage point higher now than they were before the last discount rate cut.
"We are not dictators of interest rates, and we have a hypersensitive audience," Volcker said. That audience in financial markets is worried not just by the recent growth of money but even more so by the size of prospective federal budget deficits.
Volcker, too, is worried by the size of the deficits, though not for this year or next when the economy will still be severely depressed even if a recovery has already begun. "Those cyclically induced deficits are not my main concern -- indeed, they currently help support spendable income and buoy the economy," he said.
But in later years, there should be less economic slack and greater private demand for credit. "Left unattended, the situation would pose a strong potential for a clash between the need to finance the deficit and the rising financial requirements for housing and the business investment that is crucial to a healthy recovery," Volcker said. "If you don't get the deficit out of the way as the economy expands, you will have a collision."
Under questioning about how much those deficits need to be reduced, the Fed chairman endorsed the proposal by President Reagan to reduce them by about $125 billion in fiscal 1986 and by $150 billion the following year. "As orders of magnitude at which to aim, they seem quite appropriate to me," he said.
However, Volcker appeared quite skeptical of the stand-by tax increases proposed by Reagan to raise between $40 billion and $50 billion in those years if the deficit does not drop below an amount equal to 2 1/2 percent of the gross national product.
Asked if it might not be preferable to eliminate indexing the personal income tax now set to begin in 1985, Volcker said, "You are talking to someone who has congenitally not liked indexing, so that is one approach. That would be a practical and possible way of dealing with the problem" of reducing deficits after 1984.