Top Federal Reserve officials meet today to chart a monetary policy course for the next few months amidst unusual uncertainty about the course of the economy for the remainder of 1985.
A number of analysts expect the Commerce Department to announce today a downward revision in the first quarter's already-anemic 1.3 percent growth rate for the gross national product. Some believe the revision in the inflation-adjusted rate could be large enough to make it a negative number, the first since the end of 1982.
Information available so far about April, including yesterday's report on personal income and outlays, suggests that while the economy is growing this quarter, it is not springing back from a poor winter performance.
A scattered few forecasters expect the economy to slip directly into a recession. However, most are predicting that real GNP will grow at a 2 percent to 3 1/2 percent rate for the rest of the year -- and probably slip into a recession in 1986.
The Federal Reserve Board set the stage for today's meeting of its larger policy-making group, the Federal Open Market Committee (FOMC), by announcing on Friday that, effective yesterday, it was cutting its discount rate from 8 percent to 7 1/2 percent. In response to the announcement, both short- and long-term interest rates fell and the stock market yesterday reached a record high.
The question for the FOMC is what further steps, if any, are needed to put the economy back on a healthier growth path without generating added inflation. Some analysts expect the committee to increase pressure on the availability of bank reserves sufficiently to keep the key federal funds rate -- the rate charged when banks lend reserves to each other -- at about the 7 3/4 percent range, where it traded yesterday, rather than have it fall close to the new level of the discount rate.
Federal Reserve Chairman Paul A. Volcker, speaking briefly with reporters after a speech yesterday, said the purpose of the discount rate cut was to "assist in the process of orderly growth and move toward price stability."
Added Volcker, "It would be nice to have a little budget action" dedicated to the same goals. He reiterated earlier statements that Congress should reduce the prospective 1986 federal budget deficit by "upwards of $50 billion" to relieve pressure on credit markets from federal borrowing.
Later in the day, Vice Chairman Preston Martin said the risks of a "growth recession" have increased since he first raised the prospect a few months ago. In a growth recession, real output does not fall but goes up so slowly that unemployment and idle production capacity increase.
The Fed's most serious policy problem may be that it cannot supply money and credit for only part of the economy. The strong value of the U.S. dollar on foreign exchange markets -- which is partly a consequence of the large federal budget deficits -- has greatly damaged American manufacturers at a time when other parts of the economy, such as housing construction and most services, are doing quite well.
Federal Reserve officials were worried about the split personality the economy has developed, and some others problems as well, as they approached today's meeting.
"It's still a fundamentally sound economic situation, but there are some areas of real weakness," said one FOMC member. "Things are not good in manufacturing because of imports, yet employment rises steadily" in other parts of the economy.
"We have never had an experience like this, with prolonged fiscal stimulus and the persistent draining away of demand for domestic production through a trade deficit," continued the official, who added, "I am a little discouraged" by gloomy reports from corporate chief executives who attended the recent Business Council meeting.
Under current circumstances, it is particularly difficult to judge how much weight to give to the various measures of the money supply used by the Fed as intermediate targets in setting policy, the FOMC member said.
The most closely watched measure of the money supply, M1, remains above the official target range set for it by the central bank -- at least when that range is depicted graphically as a section of a cone. (See shaded area in chart.)
However, an alternative version, suggested by Volcker in congressional testimony, utilizes a set of parallel lines rather than diverging lines to show the target range. (Dashed lines on chart.)
M1 is now within those dashed lines, and as the FOMC member noted, would eventually get within the traditional target area if the recent growth rate for M1 continues. Between November and February, M1 ran at an 11.3 percent annual rate. Since then, M1, which includes currency in circulation and checking deposits at financial institutions, has grown at a more modest 5.9 percent rate.
Such a pace eventually would get M1 back within the 4 percent to 7 percent range set by the Fed for its increase between the fourth quarter of 1984 and the fourth quarter of this year.
As another indication of the peculiarity of the current situation, two broader measures of money, M2 and M3, for some time have been growing more slowly than has M1. Last year, for instance, both grew more rapidly than M1, and their targets for this year are somewhat higher, 6 percent to 8 1/2 percent for M2, and 6 percent to 9 percent for M3. Both are well within their target ranges now.
M2 includes M1, savings and small time deposits, most money market mutual fund shares, and other items. M3 includes M2 and primarily large time deposits.
Fed officials are concerned that once again the normal links between money growth and economic growth are behaving in unusual fashion. Thus, the members of the FOMC -- who include the presidents of the 12 Federal Reserve banks as well as the seven Fed governors, but with only five of the presidents voting at any one time -- are placing more reliance on direct information about the economy than on their intermediate money growth targets, in the opinion of most analysts.