Federal Reserve policy makers will meet today to decide whether the abrupt slowing in economic and money supply growth requires an active easing of monetary policy.
Money supply growth has been very weak and well below the Fed's short-term targets since July. Economic growth has slowed to the point that an increasing number of forecasters, while not predicting a recession, do not rule one out.
Federal Reserve officials are concerned about the slowdown in the expansion, particularly because there are no signs of any acceleration in inflation. In addition, Treasury Secretary Donald T. Regan and other Reagan administration officials recently began strongly urging the Fed to adopt an easier money policy.
Given those facts, many financial analysts predict that the policy-making group, the Federal Open Market Committee, will act to provide more reserves to the banking system and encourage interest rates, which have dropped sharply in the last two months, at least to stay down or perhaps continue to fall.
For instance, economist Henry Kaufman of Salomon Brothers predicted that the FOMC "will formulate a strategy that will validate the current interest rate structure" and move the federal funds rate -- the interest that financial institutions charge when they lend reserves to each other -- down "into the 9 1/4 percent to 9 1/2 percent area." The funds rate has been declining but generally has been closer to 10 percent than to 9 1/2 percent.
Frederick S. Breimyer, chief economist of the State Street Bank and Trust Co. in Boston, said he believes the economic slowdown is serious enough that the Fed will respond both by easing pressure on bank reserves and by cutting the 9 percent discount rate -- the interest that institutions pay when they borrow reserves directly from the central bank.
Some of the Fed-watchers expecting an easing were encouraged yesterday when Fed Vice Chairman Preston Martin told a group of foreign investors that the central bank's policy "is steady as you go, with an awareness that a somewhat accommodative stance is appropriate as the expansion period becomes a bit more mature." In that way, he said, the Fed has tried to help the economy achieve a "soft landing," that is, smooth transition from the very rapid growth of the first half of this year to a more sustainable pace.
Martin also endorsed a monetary policy approach that places greater emphasis on growth of the money supply at times when there is considerable uncertainty about the immediate course of the economy, as at present. This "rule of thumb suggests that this is a good time to emphasize monetary aggregates in the formulation of policy," Martin said.
With the money supply growing so slowly in the last four months, following that rule of thumb would suggest an easier monetary policy. But the drop in interest rates that already has occurred might be seen as enough of a shift to cause money growth to speed up again and therefore persuade the FOMC to adopt a wait-and-see attitude, some analysts cautioned.
Short-term interest rates have fluctuated much more widely since last spring than the minor shifts in Fed policy that have occurred normally would have produced by themselves. Those shifts included a modest tightening of the money supply in March and a small easing in September.
Rates rose substantially in the spring and early summer as financial markets responded to a period of very rapid economic growth and rising concerns about the safety of the banking system in the wake of the crisis at Continental Illinois National Bank. As the pace of economic growth and concern about the banks have receded, rates have dropped once more to levels last seen in March.
At the same time, the demand for credit, including federal government borrowing, has continued to go up more rapidly than the Fed had expected earlier this year.
Some analysts who were expecting an easier Fed stance to come out of today's meeting said that such a decision, in fact, already may have been taken. They cite as evidence the unexpected injection of additional reserves into the banking system on Monday when the Fed temporarily purchased government securities, a step that adds to the banking system's cash balances. Short-term interest rates fell substantially after the Fed's action.
However, it appeared more likely that the reserves were added for technical reasons related to yesterday's planned closing of the New York Federal Reserve Bank and more bond trading activity for Election Day. The New York Fed carries out all market interventions for the entire Federal Reserve system. With it closed, and with the end today of a two-week reserve maintenance period, officials at the Fed's Open Market Desk apparently felt they had to act on Monday or else leave themselves with the need to make a very large intervention today at the end of the reserve maintenance period. The only other alternative presumably would have been a wide "miss" in providing the intended level of reserves to the banks.
The policy record of the FOMC's meeting Aug. 21, the latest publicly available, indicated that the policy makers were taking into account a wide range of economic indicators in setting monetary policy. In the weeks between that meeting and the next one on Oct. 5, the FOMC said that no adjustment in reserve pressures would be "made automatically in response to the behavior of the monetary aggregates, but would be undertaken only in the context of appraisals of the strength of economic activity and inflationary pressures, and evaluations of conditions in domestic and international financial and banking markets and the rate of credit growth."