There are already signs of a clash between large federal budget deficits and a growing economy, Federal Reserve Board Chairman Paul Volcker warned yesterday.
Testifying before the Senate banking subcommittee on economic policy, Volcker said the budget clash, which many believe could happen in 1985 if Congress does not increase taxes or cut spending, is likely to come well before then.
"And you have some indications of that in the market now," he said.
Interest rates have risen in recent weeks, and some analysts believe there may be further rises if the economy continues to grow very rapidly. The Fed has moved to tighten credit conditions slightly in response to rapid money growth and to the signs that the economy is picking up strongly from the recession.
Volcker said he did not believe that the momentum of the economy would be upset by "moderate" interest rate increases now and repeated his view that it was better to tighten a little now than to be forced to take more drastic action later.
The Fed chairman's warnings about the dangers of large deficits have, however, become increasingly vigorous. Yesterday he stressed again that "I do believe prospects for lower interest rates and for sustained and balanced recovery would be enormously assisted by more vigorous and earlier action to deal with the budgetary deficits."
Volcker said in answer to a question that there seemed to be "a kind of feeling . . . that this budget problem has a kind of fuse for 1985." But that would only be true if the economic recovery is anemic. If the recovery proceeds on its present strong track, "then I think the fuse is much shorter," Volcker said.
"Rising private credit demands, in reflection of rising private activity, are beginning to clash with the continuing heavy financing needs of the government," Volcker said in his written testimony.
The White House has appeared to put less weight recently on the importance of reducing the budget deficit, with some officials arguing that a strong recovery will help significantly to close the budget gap, sources say. When the Fed's recent credit tightening was first reported, the White House said there should be no need for rate increases to slow the economy. However, officials have since endorsed the Fed policy.
Last week, Volcker told Congress the Fed had shifted its monetary targets so it would not be trying to undo the money bulge of the first six months of this year but rather to slow growth in the year's second half.
Yesterday's hearing was called in response to an instruction in the budget resolution that the congressional banking committees should "report . . . a resolution expressing the sense of Congress as to the coordination of the Federal Reserve's monetary policy with the fiscal policy reflected in this budget resolution."
Volcker suggested to the subcommittee that the Fed give Congress more detailed analysis of the effect of budget decisions on credit markets in its twice yearly report on monetary policy and conditions. This would give still more opportunity to the Fed to comment on the likely impact of the budget deficit.
Volcker, however, rejected proposals that monetary policy should be aimed at specific objectives for prices or for gross national product.
The Fed already supplies its assumptions of how the monetary policy-makers expect the economy to perform, and these should not be "deified" into objectives that may be unattainable or turn out to be inappropriate.
Volcker said the present Fed reports to Congress "seem to me to provide a reasonable basis upon which the Congress can . . . come to a view about whether monetary and fiscal policies are appropriately complementary."
But he said "implications or risks with respect to the availability of credit to the mortgage market, the bond market and other loan markets could be noted more directly in the report itself."