Interest rates are now "extraordinarily high," at least partly because of the federal budget deficit, Federal Reserve Chairman Paul A. Volcker said yesterday.
Volcker also told a House banking subcommittee that the Fed had not changed its monetary stance since it decided in May to tighten credit conditions slightly to counter rapid money growth.
Recent rises in interest rates were a result of "a variety of considerations that converged" to worry financial markets, he said. He went on to list as the factors affecting the market this week's large Treasury financing, "some small indication at the same time of a rise in private credit demands," and a "less accommodative" stance by the Fed in terms of the reserves that it has supplied to the banking system.
The Federal Reserve chairman also said that he was not concerned about the speed of the present economic recovery "in and of itself. The question is whether it is accompanied by other things" that could lead to problems later on.
Rapid money growth in the narrow M1 measures and "some tendency in May and June" for the broader money measures to rise rapidly were factors to worry about, he said, adding that the July money numbers for the broader aggregates were not so bad. "You have to ask yourself whether we're building in some forces here that are going to give us problems . . . of unsustainability" later on, Volcker said as he explained the Fed's May decision.
Money market rates stabilized yesterday and the key federal funds interest rate declined slightly from Tuesday's rate, trading at around 9 5/8 percent for most of the day, Elliott Platt of Donaldson Lufkin and Jenrette said in an interview. It appeared that "dealers were very successful" at selling yesterday's 10-year Treasury note, Platt said, adding that this cheered up the markets.
Volcker said that "if we can assume . . . that we're going to keep inflation under control, then I think these interest rates . . . are extraordinarily high" both in terms of their impact on interest-sensitive sectors of the economy and "in terms of an orderly, sustained advance in overall economic activity over time."
Volcker was testifying on proposals to require the Fed to report targets for gross national product (GNP) as well as the monetary and credit targets that guide monetary policy at present. He strongly rejected the notion of framing monetary policy so as to aim at a particular level of GNP, saying that he thought this would increase the pressure to aim policy at short-term growth targets at the expense of longer term anti-inflation goals. He also said it might tempt Congress to ignore the difficult decisions on the budget that it has to make.
Volcker said that monetary policy alone cannot achieve a smooth, steady and predictable path for the economy, and warned that setting objectives for GNP rather than merely publishing forecasts would be misleading. "I would just implore you to be suspicious of any particular number" that is proposed as a new target for monetary policy, Volcker said.
"When you call it an objective . . . it gives it a kind of being, a kind of holiness perhaps" that is unjustified, he said.
He pointed out that the existing money growth targets had to be adjusted in light of last year's economic experience, when old relationships between the growth of money and the growth of prices and output seemed to break down. "We may be in the midst" of a fundamental change in this relationship, he said.