The Federal Reserve Board, determined to end the speculative binge in financial markets that has battered the dollar, sharply boosted interest rates yesterday and adopted sweeping changes in the way it controls the availability of credit.
The steps, taken to combat a soaring inflation rate, will make most loans more costly for borrowers and -- particularly for businesses and home buyers -- harder to obtain.
Specifically, the Fed:
Increased from 11 percent to 12 percent the interest rate it charges on loans it makes to banks.Other short-term rates are sure to rise also. A similar one-percentage-point increase in the Fed's so-called discount rate was the key ingredient in last November's successful dollar rescue package.
Abandoned the practice it has followed for years of trying to control indirectly growth of the money supply and bank lending by setting a key interest rate, known as the federal funds rate. As some economists have been urging for years, the Fed now will concentrate on controlling the level of bank reserves, money that banks must set aside before they can make loans. Because of this change, some short-term interest rates will fluctuate sharply every day.
Slapped a new 8 percent reserve requirement on increases in funds that banks have been getting in forms not subject to direct Federal Reserve control. These funds, which include, among other items, borrowings of dollars in foreign markets and large certificates of deposit maturing in less than a year, have been growing by tens of billions of dollars a year. They are not counted as part of the money supply, yet they can be lent to borrowers like any regular deposit.
Even though the Fed's actions carry the potential for worsening the slowdown in the U.S. economy, the White House quickly endorsed the moves.
Press Secretary Jody Powell said the steps "will help reduce inflationary expectations, contribute to a stronger U.S. dollar abroad and curb unhealthy speculations in commodity markets."
"The administration believes that success in reducing inflationary pressures will lead in due course both to lower rates of price increases and to lower interest rates," Powell said.
Federal Reserve Chairman Paul Volcker said the board acted because expectations of continued high inflation was creating "unsettled" conditions in financial markets around the world, including increased speculation in the United States.
Those conditions last week included a widely fluctuating gold price that shot up to a peak of $444 an ounce before plummeting to $385.50 at Friday's close.
Meanwhile, the dollar's value on foreign exchange markets sagged to near the lows it hit a year ago just before the first rescue package was announced.
All week the markets rose and fell mostly on the basis of rumors, including one that the United States was readying new measures to shore up currency. Absurdly, there were rumors that Volcker had resigned or had died.
But Volcker stressed at a press conference that the Fed's eye is on the domestic economy as well as on foreign markets.
Total bank lending "has been excessive," Volcker declared. The Fed's intention is to slow expansion without shutting it off and causing a so-called credit crunch. "Waht we want to get at is the froth," he said.
Only two weeks ago the seven governors on the board split 4 to 3 whan it decided to raise the discount rate from 10.5 percent to 11 percent, an all-time high. Yesterday's action on the discount rate was unanimous.
"What's changed since then is quite clear, Vocker said. The business data has been good, better than expected. The inflation data has peen bad, more so than expected." And financial markets have become generally unsettled, he added.
Last week the government reported the unemployment rate fell in September to 5.8 percent from August's 6.0 percent. Moreover, employment growth resumed as shown by the usually reliable survey of business establishments.
At the same time, however, a 1.4 percent jump in prices charged by producers of finished goods was reported. That was the largest one-month increase in nearly five years, and it brought into question Carter administration predictions that consumer prices would be rising at less than double-digit rates by the end of the year.
The Federal Open Market Committee, which oversees monetary policy and includes the presidents of five regional Federal Reserve banks as well as the seven governors, unanimously approved the Fed's switch from using the federal funds rate to control the level of bank reserves.
Federal Reserve officials have acknowledged for many years that pegging the interest rate did not usually work the way it was supposed to in regulating growth of the money supply.
The federal funds rate is the rate one bank charges another for the loan of reserves, usually on an overnight basis. Policymakers have regarded it as an indicator of whether there were enouch reserves available to banks to allow them to expand the amount of their loans to the public.
When the level of lending increases, the process adds to the amount of money in the system, thereby expanding the money supply.
But all these links are hardly tight, and the Fed often has not been able to control the money supply nearly as well as it wishes. The group of economists known as monetarists, who generally believe that the pace of economic acitivity depends largly on the amount of money in the system, have complained for years that the Fed should stop trying to keep interest rates stable and should instead zero in on keeping the money supply growing at a constant rate.
That is what the Fed will now try to do.
Bankers may have some trouble until they get used to the different way the Fed will be operating when it intervenes in financial markets. Part of that difficulty may be large daily variations in the federal funds rate, Volcker acknowledged.
The chairman emphasized that the Fed was not changing its targets for growth in the money supply, which is a 3 percent to 6 percent rate in M-1 -- the total of currency in circulation and checking account deposits at commercial banks -- between the fourth quarter of 1978 and the fourth quarter of this year.
But recently the money supply was growing so rapidly that its "trajectory was too high," Volcker said. "These actions will bring the money supply under surer control."
With many economists forecasting a renewed slump after last summer's rebound, the Fed's actions are sure to be criticized by some as being too much too late. Except for the decline in the value of the dollar, the Fed's changes probably would have been much smaller, analysts said.