President Reagan has now taken a firm and forthright position on interest rates: he wants it both ways. He wants the money supply, with its inflationary implications, held firmly in check-- but, the White House emphasizes, he doesn't want interest rates to go up. As a policy, it's balanced, it's appealing and it responds to public demands. It has only one defect: it won't and can't work.
The federal deficit is now running nearly twice the size of last year's, and there's no decline in sight in the years ahead. The more money the Treasury needs to borrow, the higher it's going to have to bid. The full impact of the rapidly increasing Treasury requirements has not yet hit the credit markets, because the private economy is just coming out of a long recession and business' needs for credit have been abnormally low. But as activity picks up, the competition for credit threatens to send rates up sharply.
In anticipation of that bidding war, the rates have been slowly rising for the past two months. Interest stayed low for two or three years after the trough of the last long recession in 1975, but that won't happen this time. Too many people lost too much money in the late 1970s underestimating the speed with which interest and inflation were going to increase. The professional money managers are going to be exceedingly careful to see that they aren't caught again.
That gives the Federal Reserve Board a bad choice. If it holds the money supply down to its target--as the White House urges--that will sharpen the bidding for credit. If the Federal Reserve decides instead to accommodate the enormous increases in Treasury borrowing that are pouring more money into the banking system, lenders' fears of future inflation will grow. In either case, the response will be rising interest rates.
There is one way out of this trap, and it is illustrated by a wise decision that Mr. Reagan himself made just a year ago. Because his earlier tax cut had been grossly overdone, it opened a prospect of steadily widening deficits as far ahead as the eye could see. Through last spring, as a result, interest rates remained stuck at levels much higher than today's. Then last summer the president agreed to support a tax increase. It didn't do much to reduce the deficit for 1983, but at least it promised that in following years the deficits would not keep getting bigger. With that, interest rates fell steadily for three months. If Mr. Reagan wants to keep them down now as the recovery proceeds, he is going to have to follow his own example of a year ago.
But this year he doesn't want to raise taxes. As long as he holds to that position, interest rates are very likely to keep going up. The commentary from the White House suggests plaintively that it must be the fault of somebody else since, after all, Mr. Reagan isn't doing anything. But that's just the point. Doing nothing, when the water is rising, is the way to get soaked.