Top Reagan administration officials, dismissing appeals from U.S. allies for higher interest rates to buoy the sinking dollar, have instead voiced concern to the Federal Reserve that monetary policy may be so tight already that it risks a recession, according to administration and Fed sources.
The administration warnings have been private and mild compared with some past clashes between the White House and the central bank. But the development reflects the nervousness that senior Reagan advisers feel about the prospect of rising interest rates and a softening economy in the coming election year.
The administration's position also underscores its unwillingness to see the Fed raise interest rates to boost the dollar, even though the dollar has been sliding to record lows against major currencies such as the Japanese yen and West German mark. Some policymakers in allied governments have been both privately and publicly urging the United States to boost interest rates to support the dollar, whose decline has made their nations' products more expensive in world markets.
Administration sources stressed that the White House and Treasury want to avoid a free-fall of the dollar, which could panic financial markets and eventually lead to a recession. They also said that the Treasury has become more willing in recent days to intervene in foreign-exchange markets to slow the dollar's descent by buying dollars and selling foreign currencies. But such intervention generally works only temporarily, and the administration stance suggests that the United States will be reluctant to go along with demands by some trading partners for more substantive currency-stabilization moves.
Fed policymakers have shown no inclination in the last two months to raise interest rates just to defend the dollar, although they say there might be occasions when they would be forced to do so. Fed sources said policymakers at the central bank reject the notion that monetary policy is too tight, and the sources reiterated that the Fed hasn't moved recently to squeeze credit.
The administration official most upset about current Fed policy is said to be Beryl W. Sprinkel, chairman of the Council of Economic Advisers. Sprinkel and some other aides who share his views have evidently persuaded more powerful officials, notably Treasury Secretary James A. Baker III and White House chief of staff Howard H. Baker Jr., that there are grounds for worry. According to Fed sources, the two Bakers have raised concerns with the central bank about the arguments advanced by Sprinkel.
Sprinkel, according to one source, has complained that the Fed is risking an economic downturn by draining all of the cash it poured into the banking system in the wake of the Oct. 19 stock market plunge.
At the root of the debate lie some disparate opinions about how to determine when Fed policy is "tight" or "loose."
Sprinkel, a monetarist who pays close attention to changes in the money supply, is alarmed by an unexpected decline in the money supply in November. The money measure M1, which includes currency in circulation and checking account deposits, fell at a 6.6 percent annual rate during the month. Sprinkel thus deems monetary policy to be extremely tight.
Many private analysts have reached a different conclusion by looking at a short-term interest rate that the Fed controls, the federal funds rate. This rate, which is the one banks charge when they lend reserves to one another, has dropped below 7 percent in recent days. This has provided some comfort to administration policymakers.
Still, James and Howard Baker are concerned enough about current monetary policy to have discussed Sprinkel's criticisms with Fed officials. Although the two men haven't been converted to monetarism, they may have used Sprinkel's analysis to deliver a subtle warning about the need to avoid tight credit, sources said. "This is a nervous time," said one Fed source. "Nobody knows what's ahead for the economy because of the stock market crash."
This Fed source said that money-supply growth "seems to be adequate," especially when figures for October and November are combined. He also said that the central bank expects money growth to resume at a stronger pace before long.
For several reasons, the Fed is resisting Sprinkel's prescription to inject more reserves into the banking system. First, sources said, the central bank sees no evidence that the economy is contracting along with the money supply; recent government statistics show that the manufacturing sector is more or less booming. Moreover, an overly easy policy could lead to a surge in inflation and a renewed plunge in the dollar. Lower U.S. interest rates tend to depress the dollar by making dollar-denominated investments less attractive.
At the same time, analysts say that the Fed isn't likely to tighten credit much either simply to give the dollar a lift. Draining more reserves from the banking system could weaken the economy at a delicate time. Thus Fed policymakers, who are scheduled to meet Tuesday and Wednesday, are likely to leave policy unchanged or alter it only slightly, analysts said