Federal Reserve Board Chairman Paul A. Volcker, while stopping short of declaring victory over inflation, said yesterday that it appeared that low inflation expectations are finally being built into the economy, paving the way for long-term price stability.
Volcker's remarks, at the annual Washington Post Business Outlook luncheon, were his strongest to date about the prospects for keeping inflation under control.
His comments were credited by Wall Street analysts for a sudden burst in the stock market yesterday, as prices surged on heavy volume after reports of his speech were carried on news wires. The Dow Jones industrial average closed more than 20 points higher for the day.
For more than four years, the Federal Reserve has followed a relatively stringent monetary policy in an effort to prevent the acceleration of inflation to the double-digit levels of the late 1970s. Despite repeated public criticism of his policies by members of the Reagan administration, the Fed until last summer attempted to keep tight control of the money supply to hold inflation down.
However, as economic indicators continued to suggest that inflation would remain below 4 percent for the second year of the recovery and it appeared during the summer that economic growth was faltering, the Fed began an easier monetary policy to avert a recession.
The Fed indicated that the reacceleration of inflation was less of a problem than sustaining economic growth last month when it reduced its discount rate to the lowest level in six years. The discount rate is the rate the Fed charges when it makes loans to banks.
Volcker said yesterday that the economic recovery had been the second-best in postwar history and has been "accompanied by continued progress on the inflation front.
"Inflation is probably running as low now as it did at the bottom of the recession, early stages of the recovery," Volcker said.
Inflation, measured by the implicit price deflator -- a measure of changes in prices and the type of goods produced -- increased at a 3.8 percent rate last year. That was the same as in 1983, the first full year of recovery, but is still considered high by historical standards.
Volcker cautioned that he was not "about to declare victory" over inflation, but "there are some reasons to think that we are beginning at least to build into the economy some trend toward more stability in prices. There is some evidence that expectations are certainly moving in a more moderate way in terms of the inflation outlook, and I think that's important not just as a reflection of what's been happening, but to a degree there is greater confidence in stability that gets reflected in consumer and business behavior in ways that tend to perpetuate the process.
"We went through a long period of time when that psychology was obviously going in other direction, when people were anticipating inflation, more inflation -- anticipating even more than took place -- and that very anticipation helped to bring about the acceleration," Volcker said.
Volcker also said that the U.S. economy could be on the verge of a new era of stability and long-term economic growth. However, he warned that the federal budget and international trade deficits are standing in the way.
"Let me raise the question as to whether these favorable developments for a couple of years after that long cycle of deterioration presages some kind of new era of sustained growth and more stability," Volcker said. "My simple answer is that it could and we have the opportunity to make it a harbinger of continued good performance in the rest of the '80s and into the '90s. But there are an awful lot of 'buts' that must be attached to that statement."
Volcker suggested that those caveats included what fiscal and monetary policies are taken, what happens to inflation and the federal budget and trade deficits.