Federal Reserve Chairman Paul A. Volcker said yesterday that the Fed has tightened credit conditions slightly to increase chances that the economic recovery will be long lasting.
At the same time, Volcker told the House Banking, Housing and Urban Affairs Committee that recent increases in interest rates of a percentage point or more pose no threat to the recovery in the short run. And he eased some financial market participants' concern about how far the Fed might go in its effort to rein the growth of the money supply.
A relieved stock market responded with a great surge of buying as the Dow Jones Industrial Average closed up more than 30 points. It was the biggest gain of the year and the ninth largest ever, recalling the record market increases that accompanied the Fed's decision to ease interest rates a year ago.
The Fed chairman said that there are no current signs of a new round of inflation and that the pace of the recovery so far is no more than average compared to those following other postwar recessions. But some restraining action was needed because of recent accelerating growth of the M1 money supply measure and of total credit demand, he said.
Implicit in Volcker's testimony was the likelihood that this restraining action will continue until the Fed is satisfied that money and credit growth have slowed sufficiently. Financial analysts are uncertain whether this process will involve any further increase in interest rates.
Volcker warned that if federal budget deficits are not reduced, interest rates will begin to rise as a result of a collision between federal government borrowing and increasing private credit demands generated by a healthier economy. "The speed of the current economic advance certainly brings the day of reckoning in financial markets earlier," he said. He did not predict when a collision might occur.
Volcker told the committee that the Federal Reserve had decided to seek M1 growth at an annual rate of 5 percent to 9 percent from the second quarter to the fourth quarter of this year.
Earlier the Fed had set a 4 percent to 8 percent growth range for M1--the measure of money available for transactions, which includes currency in circulation, checking deposits and travelers checks--from the fourth quarter of last year to the fourth quarter of this year.
Moving the base up to the second quarter erases any concern that the Fed might try to reverse the very rapid expansion of M1 in the first half of this year, while at the same time reiterating its intention of slowing M1 growth in coming months. From the fourth quarter to the second quarter, M1 grew at a 13.4 percent annual rate.
Volcker said the Fed would "monitor" M1 closely but not give it full weight as a monetary indicator until more information is available about the measure's current relationship to economic activity.
More emphasis will continue to be given to M2 and M3, two broader measures, he said.
M2 is within its target range, although it, too, has been growing more rapidly recently. It includes all of M1 plus savings and small time deposits, money market deposit accounts, most money market mutual fund shares and other items.
M3, which is just above the upper limit of its range, includes M2 along with large time deposits and other items.
This year's targets for M2 and M3 were left unchanged at 7 percent to 10 percent and 6 1/2 percent to 9 1/2 percent, respectively.
For 1984, the Fed has tentatively lowered the ranges by one-half a percentage point.
"That small reduction appears appropriate and desirable, taking account of the need to sustain real economic growth while containing inflation," Volcker said. "Those targets appear fully consistent, in the light of experience with the economic projections" of the Fed's policymaking group, the Federal Open Market Committee, the Reagan administration and those underlying the congressional budget resolution, he added.
The 12 voting members of the FOMC do not try to come up with a consensus economic forecast, but Volcker reported that the "central tendency" among their respective projections is for real economic growth of between 5 percent and 5 3/4 percent during 1983 and 4 percent to 4 1/2 percent in 1984.
Similarly, the members' forecasts of inflation, as measured by the deflator for the gross national product, group in the range of 4 1/4 percent to 4 3/4 percent for this year and 4 1/4 percent to 5 percent for 1984.
With economic growth of that sort, the civilian unemployment rate, which was 10 percent in June, should drop to about 9 1/2 percent by the fourth quarter of this year and to a range of 8 1/4 percent to 8 3/4 percent by the final quarter of 1984.
Numerous members of the Banking Committee, both Democrats and Republicans, argued that with no sign of rising inflation there was no need to raise interest rates at this time.
As Rep. Stewart B. McKinney (R-Conn.) put it, "Most of us are dreadfully concerned that this resurgent economy may be eclipsed by rising interest rates."
Volcker responded, "Whether viewed from a domestic or international perspective, limited, timely and potentially reversible measures now, when the economy is expanding strongly, are clearly preferable to the risks of permitting a situation to develop that would require much more abrupt and forceful action later to deal with new inflationary pressures and a long-sustained pattern of excessive monetary and credit growth."