Federal Reserve Chairman Paul A. Volcker yesterday said that he believes the current pause in the economic expansion likely is temporary and that the Fed will supply enough money and credit to keep the economy growing "in an orderly way."
Volcker, in his first speech since well before the election, told a New York audience, "A sharp slowing in growth for a time during an expansion period is in fact historically common, typically related to temporary imbalances in inventories following a period of rapid accumulation and temporary fluctuations in consumption. Something of that sort seems to be at work this fall.
"Continuing growth in income and employment and relatively strong investment plans are reassuring signs for the future," the Fed chairman said. "The decided decline in interest rates as the growth rate has slowed should help support both housing and investment, and the related easing of pressures on bank reserve positions by the Federal Reserve will help keep money and credit growing."
Most short-term market interest rates have dropped more than 2 full percentage points since the first of September. After the Fed last week cut its discount rate -- the rate it charges on loans it makes to financial institutions -- from 9 percent to 8 1/2 percent, market rates fell again.
Because lower rates affect economic activity only with a lag, there are as yet few signs of any pickup. Many forecasters now expect that the gross national product will rise no faster this quarter than the 1.9 percent annual rate of the third quarter, and that the first quarter of 1985 will be slow as well. GNP, adjusted for inflation, rose at a 10.1 percent rate in the first quarter of this year and a 7.1 percent rate in the second quarter.
The Fed did report yesterday that in the week ended Nov. 19, the most closely watched measure of the money supply, M1, rose by $6.7 billion.
A number of other members of the Fed's policy-making group, the Federal Open Market Committee, share Volcker's view that the economic slowdown will prove to be temporary. Nevertheless, with both growth of the money supply and the economy's performance falling short of their expectations, the policy makers have decided to move aggressively to get both moving again.
"The Federal Reserve, through its monetary policies, has the responsibility for assuring adequate growth in money and liquidity in the economy to support orderly growth in demand over time, in line with our potential. We intend to meet that responsibility," declared Volcker in his speech, a copy of the text of which was released here.
"Moreover," he continued, "with the dollar so strong internationally, and with inflationary trends more favorable, I believe we have more flexibility in the conduct of policy than for some time, without raising alarms about a new inflationary surge."
But the chairman went on to warn, as he has repeatedly in the past, that large federal budget deficits could throw the economy off track. The policy flexibility must be "exercised with great care and prudence," he cautioned, because "the creation of money cannot remedy the underlying imbalance in our domestic capital markets related to the enormous federal deficits."
Volcker blamed the deficits, in part, for the enormous increase in imports of foreign goods this year and a trade deficit that has reached a new high of a $130 billion annual rate this summer.
"We as a country have been consuming significantly more than we have been producing," he noted. "The GNP -- a measure of production -- has risen by about 12 percent in real terms over the past two years. Domestic spending has risen appreciably faster, by more than 15 percent.
"In essence, a lot of demand generated in this country has flowed abroad, generating production and income in other countries. We didn't feel it much, in overall terms, while our own production was expanding so rapidly," Volcker said. "But it made a very noticeable impact last quarter, when domestic demand continued to expand at the relatively rapid rate of more than 5 1/2 percent, while GNP growth slipped to a rate of only about 2 percent."
The emphasis in trying to reduce the budget deficits should be on spending cuts but with steps taken to increase revenue to the extent it is needed, he said.
In a separate New York speech earlier in the day, Volcker expressed optimism on the international debt situation. "More than two years after Mexico had to declare a temporary standstill on its debt repayments, we can take some satisfaction from the fact that the crisis facing major developing countries and the system has been contained and kept manageable," he said.
But Volcker singled out Argentina as a continuing problem. "Points of vulnerability remain and, to some extent, problems can remain contagious," he said. "Argentina, for instance, only now is at a critical point in negotiating with its creditors for a sizable amount of needed new money and debt rollovers."
Volcker said that steady growth in the industrial nations is necessary for the long-term resolution of the debt problems in developing nations. "The most important need for the industrialized world is to maintain orderly economic expansion, with the important byproduct of a favorable external environment for developing countries seeking to expand exports," he said, adding that it is time for Europe to realize its "potential for above-average growth rates" to make up for the slowdown in the United States.