Federal Reserve Board Chairman Paul A. Volcker said the massive amounts of debt being contracted by government, business and households are not "compatible over time with economic and financial stability."

In a letter to Sen. William Proxmire (D-Wis.) released yesterday, Volcker said he is concerned that heavy borrowing -- especially short-term and variable-rate debts -- may "have increased the vulnerability of some firms and individuals" either to recession or an increase in interest rates.

He said the Federal Reserve is "especially concerned with the risks accepted by financial institutions in the process of creating new debt. If we are not careful, mistakes made by some can spread financial stress to many others through ever more complex financial interrelationships."

The head of the nation's central bank said the persistence of large federal deficits "worsens our long-run prospects for economic growth, ensures that a substantial portion of our future income will have to be sent abroad to finance indebtedness to foreigners and perpetuates the difficulties of our industries that compete in world markets."

Volcker conceded that so far the "the mounting debt burdens have not in any clear way proven an obstacle to the overall expansion of the economy." But he said the speed of debt growth is a concern.

According to an analysis accompanying Volcker's letter to Proxmire, the "rapid growth of debt in the last few years reflects in large part the exceptional size of federal government, rather than private, borrowing."

On an "aggregate" basis, the study said, business debt has not grown unmanageably. But "an extraordinary pace of mergers, leveraged buyouts and share repurchases has retired enormous amounts of corporate equity." As a result, the ratio of business debt to equity has risen markedly since the end of 1983.

In the last few years, businesses have relied increasingly on short-term debts rather than long-term loans with fixed interest payments. During a business turndown, debts must continue to be paid, and during a period of rising rates the cost of paying debts will rise.

During periods of adversity, businesses can reduce or even cease dividends to conserve cash. But replacing equity with debt limits their ability to do so. As a result, the analysis concluded, many businesses are more vulnerable than they were a few years ago.

The study also found that consumer debt, after a long period of stability, has "moved to new highs." In September, consumer debt increased by a record $10.6 billion, and the ratio of consumer debt to disposable income reached a record high of 19.2 percent.

The Fed analysts said that household financial assets also have grown along with their debts, but much of the growth has been in assets that consumers cannot quickly or easily convert to cash during a period of financial stress -- such as individual retirement accounts.