The Federal Reserve has not changed the settings of its monetary policy dials since last December and is not expected to do so this week when its policymaking group meets, according to Federal Reserve officials.
With the economic recovery looking stronger every day, and with most measures of the money supply within or above their target ranges, there is little immediate reason for the central bank to actively try to reduce interest rates at the moment.
Similarly, there is little pressure to tighten policy, either. Officials at the Fed expect inflation to remain low this year even with a healthy recovery, and the explosive growth of the money supply in the first three months of 1983 has slowed.
The Fed has the luxury of not having to make any policy shifts right now partly because the big increase in U.S. Treasury borrowing in recent months has not, as many analysts feared, produced a surge in interest rates. Rates have not moved upward because business borrowing has gone down and consumer demand has risen only slowly as the Treasury has jumped into the market with both feet.
Commercial and industrial loans at commercial banks were no higher in April than they were last October, while the amount of commercial paper outstanding -- an alternative source of short-term business credit -- plummeted at a 42.5 percent annual rate between November and February, the latest month for which figures are available.
Corporations have been borrowing less from banks and through commercial paper for several reasons. Their profits and cash flow are rising with the economic recovery, the stock market surge has allowed them to bring out new stock issues, and lower long-term interest rates have encouraged them to pay down their short-term credits with the proceeds from new issues of long-term bonds.
Meanwhile, banks and thrift institutions are flush with funds again as a result of the extraordinary shift of money into newly available accounts, including the money market deposit accounts, or MMDAs, which have balances of about $350 billion. With so many deposits and weak loan demand, commercial banks chose to increase their holdings of Treasury securities by $30 billion between December and April.
In these circumstances, several members of the Fed's policymaking group -- the Federal Open Market Committee, or FOMC -- including Fed Vice Chairman Preston Martin and Governor Nancy Teeters, believe long-term interest rates will "drift down" as the year progresses, even if short-term rates stay close to their current levels.
"There is a strong possibility of lower long-term rates," says Martin, who sees no need to try to push rates downward. "I feel we are about right in our accommodative posture here."
Last year Teeters, a liberal Democrat appointed by President Carter, felt the central bank could afford to push down rates more rapidly without rekindling inflation. Teeters is still deeply disturbed about the high level of unemployment, but for now she is no longer dissenting. "I'm reluctant to try to force rates down," she says.
Teeters is not urging that course partly because she also believes the recovery this year will turn out to be stronger than previously forecast, though with more modest growth following next year. "We are going to have a boomy quarter or two," she says. "But the recovery will still be slower than previous post-war ones.It looks and feels like 1961."
Finally, Teeters is not all that sure that money growth has slowed down significantly, a possibility certainly underscored by a $7 billion increase in M1 in the week ended May 11, one of the largest weekly increases on record.
She puts little faith in the April figures that showed a small decline from the March level of M1 -- a showing that cheered financial markets, led to drops in some market interest rates, and had analysts saying the Fed would soon reduce its 8 1/2 percent discount rate. That interest rate, which the central bank charges on loans it makes to financial institutions, was last changed in December.
Those hopes were dashed over the last two weeks, however, as M1 -- the money supply measure that includes currency in circulation, checkable deposits at financial institutions and travelers checks -- jumped upward again.
Teeters says seasonal adjustment problems are so severe for the month of April, when final income tax payments are due and many refunds are paid, that "the seasonally adjusted money supply number is a non-number. The more we play with it, the more we screw up the months on either side of it. April doesn't tell me a thing."
Seasonal adjustments are supposed to smooth mouth-to-mouth changes that occur at the same time each year. Lowering one month's blip upward, as the season factors did in April, may also boost the figures for March and May.
Another reason for caution in changing any of the policy dials now is that Federal Reserve officials aren't sure how depositors will use that $350 billion that has flowed into the MMDAs in only about five months. Both the MMDAs, which are a major part of the monetary aggregate M2, and the even newer super NOW accounts that are part of M1, pay market rates of interest. Such interest sensitivity may well affect the relationship of these monetary aggregates to the economy, and for the moment, Fed officials are wary about putting too much emphasis on them.
A wide range of economic forecasters go along with the notion that long-term interest rates will drift downward in coming months. Some also expect similar declines in short-term rates.
Few if any forecasters expect declines of much more than about half a percentage point, however.
"Rates may rise during the summer as inventory restocking begins," sayd Donald Ratajczak of the Georgia State Economic Forecasting Project, "but downward movements of rates now seem likely into 1984."
In a forecast sent recently to clients of Townsend-Greenspan & Co., economist Alan Greenspan described his firm's view of moentary policy and interest rates this way:
"The Federal Reserve presumably wishes to create an environment that is conducive to economic recovery without contributing to a significant acceleration in inflation as the recovery progresses. While the implementation of this policy on a day-to-day basis will vary, we do not look for any qualitative change in policy.
"Under these assumptions, interest rates should continue to drift lower, but long rates are not likely to decline to levels fully consistent with an underlying inflation rate of 5 percent to 6 percent."
The Townsend-Greenspan report emphasizes there are some substantial risks to their interest rate forecast. Those risks include some combination of a failure to reduce the prospective $200 billion-a-year federal budget deficits, a potential reacceleration of money growth, and a recovery that, even briefly, could be so rapid as to increase credit demand sharply.
At some point in the recovery, of course, private credit demand will begin to move upward strongly. If federal borrowing needs do not diminish when that happens or sooner, the Fed will face its familiar dilemma: monetize a greater portion of the debt or let interest rates rise.
Martin Feldstein, chairman of the Council of Economic Advisers, noting the lack of progress on reducing prospective budget deficits after 1985 when the recovery is supposed to be much farther along, said: "If interest rates hang up here, or go higher because of more people coming in to borrow, the pressure on the Fed from Congress to hold down rates will be enormous."
Fed Vice Chairman Martin says that the "megadeficts" are already hindering the recovery to some extent and that they could bring much closer that point at which the Fed must choose whether to let interest rates rise again. "As a practical matter," he told a Washington audience last week, "megadeficits create the potential, as the recovery strengthens, for demands from institutional portfolio managers for continued high interest rates -- high rates that would impede the prospects for renaissance in jobs, in business investment and in housing and the mortgage markets."
Meanwhile, there is no sign of any increased rate of saving flowing from the major business and personal income tax cuts as promised by the Reagan administration, savings needed to finance higher borrowing by both public and private sectors.
Saving as a percentage of disposable personal income has dropped back to less than 6 percent, about its average for the 1977-80 period before the tax cuts. Most forecasters indicate that rate will not rise this year or next, either.
And through all of this, the central bank will also have to keep an eye on the international financial situation -- in particular, whether Mexico, Brazil and other developing countries unable to meet their debt payments could stand another round of rising interest rates.
In short, problems still lie ahead for the Federal Reserve. At some point, the central bank will have to choose whether to continue to accommodate rising financing needs or to let rates begin to rise again.
But not this week.