The Federal Reserve could be forced to choose between an economic slowdown and accelerating inflation in 1986, according to testimony yesterday by Beryl Sprinkel, chairman of the Council of Economic Advisers.
Sprinkel defended the official Reagan administration forecast that economic growth will accelerate rapidly for the rest of the year and will continue at a 4 percent rate in 1986 along with low inflation.
But the CEA chairman also told a Joint Economic Committee hearing that "monetary policy remains a source of uncertainty." Money growth at more than a 13 percent rate so far this year already poses a "serious risk to inflation control," he said, while "a sudden squeeze on money" would carry with it the danger of a "severe slowdown" in 1986.
Sprinkel, as he usually does, sought to avoid any direct assessment of the current conduct of monetary policy, but Rep. Lee Hamilton (D-Ind.) pressed him to do so. Even so, the CEA chairman stopped short of advising the Fed on what path to pursue, saying, "The Federal Reserve is an independent agency. They determine their policy and we must accept it."
In his prepared testimony, Sprinkel urged the Fed "to take caution to pursue a risk-minimizing policy path," particularly since the usual relationships between money growth and the economy have been disturbed this year by financial deregulation and other factors.
Prior to joining the Reagan administration as undersecretary for monetary policy at the Treasury Department in 1981, Sprinkel was an economist for Harris Trust Co. in Chicago and a member of a group of monetarist economists called the Shadow Open Market Committee. Sprinkel is still listed as a member of the SOMC but on leave.
Earlier this week, at its semi-annual meeting in New York, the Shadow Committee assessed monetary policy in much the same terms as did Sprinkel yesterday, although more explicitly. The committee warned that if money growth is not cut, inflation would accelerate sharply beginning next year. The group said the Federal Reserve should reduce money growth even at the cost of the mild recession such a step might produce.
At the JEC hearing, two private economists who also testified were less optimistic than Sprinkel about the outlook for 1986. Lawrence Chimerine, chairman of Chase Econometrics, said recent statistics that suggest a substantial improvement in economic growth "overstate the strength of the economy. At best, only a modest pickup in economic growth is now taking place."
And Alan Greenspan of Townsend-Greenspan & Co. said a projection of continued expansion through 1986 was "inappropriate at this stage," given continued problems in the economy.
Chimerine analyzed the current situation this way: "Underlying factors suggest that, while a recession is not likely between now and the end of 1986, sustained, very strong growth is equally unlikely. These include continued relatively high real interest rates, the still highly overvalued U.S. dollar, slow growth in household income and an extremely low savings rate, weak profits, and high and rising excess capacity in the industrial sector and most segments of construction."
On the plus side, Chimerine said, are "declining oil prices and generally low inflation, the absence of a substantial inventory overhang, rising military expenditures and increasing cash flow resulting from rising depreciation allowances."
The net impact of this combination of positive and negative forces over the coming year "will be slow growth on average," Chimerine predicted. Between now and the end of 1986, the gross national product, adjusted for inflation, will go up in the 2 1/2 percent range, he said.
Both he and Greenspan said that there could be some quarters of faster growth but that it would likely not be sustained. Greenspan's latest forecast calls for a recession beginning before the end of 1986.
A third private economist at the hearing, David Bostian of Bostian Research Associates, agreed with Sprinkel's more optimistic outlook, saying that real GNP may rise at a 6 percent rate in the fourth quarter and continue strong during 1986.