Federal Reserve Chairman Paul A. Volcker yesterday said that, if inflation turns out to be as low as he thinks it will be over the coming year, then "the basic outlook for interest rates is in a downward direction."
Volcker quickly tempered his optimistic statement to the House Banking, Finance and Urban Affairs Committee by adding, "There's a huge caveat I have to put on that, and that's what happens to the federal budget."
The Fed chairman said that the U.S. Treasury is borrowing about three-quarters of a billion dollars each day to finance budget deficits, and an expectation that that "will continue indefinitely" is one of two major reasons interest rates are so high compared with current rates of inflation. The other primary reason is "more than a residual concern" among investors that high inflation rates may return, he said.
Some financial analysts have expressed concern that the Federal Reserve would have to boost rates in order to slow down the recent rapid growth of the money supply. Volcker said the "most recent evidence in March shows some welcome" indications that growth of some of the monetary aggregates, which has been far above Fed targets, is slowing.
"It would certainly make us uncomfortable if those aggregates continued to rise more rapidly than our targets," he said.
The slower money growth makes it less likely that the Fed will act soon to raise rates, analysts believe. But some of them, such as economist Charles Lieberman of Morgan Stanley & Co., who listened to Volcker's testimony, cautioned that the Fed will need a great deal of luck if it is to avoid higher rates as the recovery proceeds. "They are on a tightrope," he said.
Meanwhile, the Reagan administration released additional details of its revised economic forecast for 1983 and later years, some key portions of which were disclosed by administration officials last month.
Administration economists now expect the gross national product, adjusted for inflation, to grow at a 4.7 percent annual rate between the fourth quarter of 1982 and the fourth quarter of 1983 compared with the 3.1 percent rate forecast in January. Faster growth will mean a faster drop in the unemployment rate, to 9.7 percent in the fourth quarter instead of 10.4 percent. The rate in March was 10.3 percent.
Consumer prices, as measured by the index covering urban wage earners and clerical workers--the so-called CPI-W used to adjust most federal benefit programs for inflation--will rise 2 1/2 percent during 1983 rather than 5 percent as predicted earlier. That index rose 4 1/2 percent during 1982.
Volcker told the committee that he does not think the current level of interest rates threatens the "moderate" economic recovery now under way. However, if long-term interest rates remain as high as they are today relative to inflation, then the nation could lose what he said was an "opportunity for a long, sustained, durable recovery with relative price stability."
Rates on new long-term corporate bonds carrying the best credit rating have been running about 11 3/4 percent for the past several weeks, while long-term Treasury securities have carried yields slightly below 10 3/4 percent. Whether these yields are high in "real" terms depends on the level of inflation an investor expects over the life of the bond, analysts point out.
Volcker thinks that inflation will stay low for some time to come, although he noted that falling energy prices have caused various price indices to overstate the progress against inflation recently. At the same time, however, "Wage increases have moderated to annual rates of 4 percent to 5 percent, providing, together with increases in productivity, a base for further slowing in unit labor costs," he said.
"The simple fact is that we have come a long way in setting the stage for non-inflationary expansion in which unemployment will decline and workers can again enjoy lasting increases in real income," Volcker said. "But the process needs to be nurtured with care and discipline."
The Fed chairman urged Congress to take steps to deal with the large budget deficit that is projected to remain even if the economy returns to high employment levels. He argued that the deficits are a factor both in keeping interest rates unusually high and, in turn, in keeping the value of the dollar high on foreign exchange markets. The latter effect tends to reduce American exports of goods and increase imports, and thus reduce employment in the United States