Federal Reserve Chairman Paul A. Volcker told Congress yesterday that lower interest rates and an easier monetary policy are not likely to produce faster, healthy growth for the American economy because of the nation's huge and rising trade deficit.
Volcker, testifying before the Senate Banking Committee, said a significant reduction in the trade deficit is the key to improving American economic prospects. That reduction would require faster economic growth in other industrial nations, such as Japan and West Germany, that buy American exports, but Volcker said there are few signs such growth is on the way.
Nevertheless, several Banking Committee members urged the Fed chairman to cut the central bank's discount rate again in an attempt to bolster U.S. economic growth, which sagged in the second quarter to a 1.1 percent annual rate after adjustment for inflation.
Volcker turned aside the requests for cuts in the discount rate -- the interest rate the central bank charges on loans to financial institutions -- which has been reduced in three half-point steps this year to a level of 6 percent.
Volcker did not rule out such cuts under some circumstances, but he stressed the limitations on the power of monetary policy to affect the economy now. Additional stimulus to consumption, without similar steps by other nations, likely would make the U.S. trade deficit worse and do nothing to deal with the basic economic problems facing this country, he argued.
"We cannot . . . build a lasting foundation for sustained growth and stability on massive international disequilibrium -- huge and rising trade deficits in the United States and counterpart surpluses abroad," he declared.
At the same time, Volcker downplayed the importance of the report Tuesday by the Commerce Department that real gross national product increased at only a 1.1. percent rate in the last quarter. It was not "a terribly surprising number," he said, and was in part the result of some "temporary" factors, such as a cutback in the pace at which businesses added to their inventories.
In its semi-annual report on monetary policy sent to Congress last week, the Federal Reserve said it expects the economy to expand at a 3 to 3 1/2 percent rate in the second half of the year. Questioned about forecasts from some private economists that growth for the rest of the year will be no better than the 2.5 percent rate of the first half -- or that possibly there would be no growth at all -- Volcker explained that the Fed projections assume that there will be some improvement in the trade deficit.
"This all comes back to the basic point I am trying to make this morning," he said. "These questions about the outlook, very legitimate questions about the outlook, are really inextricably tied up with the question of the trade outlook."
In turn, understanding the trade situation requires knowing what is happening in the rest of the world, he continued. "To make an intelligent forecast for the United States now, you have to have some sense of what the prospects are in the rest of the world. That's a new kind of world for us to be living in, but we are living in it."
Volcker noted that the U.S. economy grew about three-fourths of a percentage point faster during 1985 and the first quarter of 1986 than did Europe and Japan. Moreover, domestic demand for goods and services went up at about a 3 3/4 percent rate in the United States but only at a 2 1/2 percent rate in the other nations.
That meant growth elsewhere was being fueled by increased exports, particularly to the United States. "The plain implication is that our overall GNP growth rate was reduced by continuing deterioration in our trade . . . balance," he said.
But while competition from imports has hurt the goods-producing parts of the American economy, other parts of it are doing well, Volcker said.
"So much of the malaise, if I may use that word, in the industrial side of the economy is related to the trade position," he said. "I don't think you are going to see a dramatic change in that side of the economy without some prospect and actuality of improvement on trade."
And bringing about that improvement lies beyond what monetary policy can produce, the Fed chairman declared.
"I don't want you to have the impression that there is some answer to all these problems by reducing the discount rate or easing policy. . . . Our domestic demand, which is what presumably you affect most directly by monetary policy and discount rate changes, has been quite strong already. That is not the weak area in the economy. Consumption has been doing quite well. Housing is having one of its largest years on record.
"You can presumably pump up that part of the economy for a little while longer and a little more strongly," Volcker continued. " But that does not deal with the underlying imbalance, which sooner or later you have to deal with.