INTEREST RATES are, of course, shockingly high. Or are they? The prime rate that the banks charge their biggest and best customers is now 12 3/4 percent, a record. But that's the nominal rate. The real rate has to be adjusted for inflation -- and inflation is now running about 13 percent.
That's the point that Paul A. Volcker, the chairman of the Federal Reserve Board, was addressing when he spoke of the need to stand fast on interest rates. It sounds cold and heartless, until you consider the arithmetic. If you are one of those biggest and best customers, you are currently borrowing at slightly less than the inflation rate. In that case, the real interest is negative, and the bank is really paying you to borrow. A mortgage rate of 12 percent seems fearfully high. But if the house keeps appreciating at 12 percent for the life of the mortgage, the real interest is zero and the loan is free. After 15 years' experience with progressively higher inflation rates, Americans are now routinely thinking and working in these terms. High interest rates have lost their shock value.
Not only are the nominal rates high but, as Mr. Volcker warned, they may go higher. The Federal Reserve Board is engaged in a gingerly attempt to slow down the expansion of borrowing that is currently contributing, in a big way, to inflation. How high will interest rates go? As high as necessary to get the braking effect that the Fed wants, Mr. Volcker hinted in congressional testimony this week.
That is something more than a mere restatement of orthodoxy. The American economy evidently entered a recession last spring, and unemployment is likely to rise significantly through the fall. In the past, the standard response to a recession has been a tax cut and lower interest rates to stimulate business. But that's inflationary, and over the past decade Americans have made the melancholy discovery that inflation can actually cause unemployment.
The Fed, and most other forecasters, believe that the recession is going to be shallow, and will shortly cure itself without the usual application of artificial respiration. Mr. Volcker was warning Congress that any attempt to shorten or ease it, through loose money or lower taxes, is likely to do more harm than good.
Mr. Volcker is right. If the forecasts prove inaccurate and the recession is deeper than expected, there will be time enough then to reverse policy. Trying to anticipate trouble now will invite much worse trouble later. That's why interest rates have to stay high -- if you think that they are high. If you think that they are low, at least they cannot safely go any lower.