There was no good alternative to the dramatic tightening of credit announced by the Federal Reserve Board over the weekend. But to say that is to declare the bankruptcy of the Carter administration's policy for holding down inflation.
Not only is a nasty recession now virtually ensured, but even after the awful medicine is taken, the country will still be suffering from a bad case of chronic inflation.
Until July, the administration's anti-inflation strategy consisted of a mild program for wage-price guidelines, a mild program for restraining credit and a mild program for holding down the federal budget. The switch that sent Paul Volcker, a banker, to the Fed in place of G. William Miller, who went to the Treasury, implied a much rougher stance on credit.
The idea was that the Fed would push up interest rates sharply to build confidence in the determination of the administration to lick inflation. When that confidence developed, inflation would slack off and there could be an easing of credit. Thus, serious recession would be avoided.
By its open-market operations, the Fed under Volcker did in fact push up the prime interest rate -- the rate banks charge their best customers -- from 11.5 percent to 13.5 percent at the end of September. But almost simultaneously a wave of political troubles hit the administration. The Andrew Young affair was followed first by the discovery of Soviet combat troops in Cuba and then by the quasi-entry of Sen. Edward Kennedy into the presidential campaign.
On top of these shots to the president came clear signs of failure to hold the line on inflation. Producer prices for August rose at an annual rate of over 14 percent -- prefiguring a further rise in consumer prices that are already advancing at over 13 percent. General Motors and the Auto Workers signed a three-year contract calling for increases of over 30 percent (over three years). The administration surfaced a refurbished program of wage-price guidelines that lacked both teeth and support from business.
Furthermore, the raising of interest rates did not abate the flow of credit. Bank loans soared. There was easy, expensive money.
Confidence in the administration's capacity to fight inflation, accordingly, plunged. At the end of September there took place a sudden surge in the price of gold and a flight from the dollar. Failure to hold the dollar raised the specter of another hike in oil prices -- and a new surge of inflation. But the Germans and the Japanese and the other big dollar-holders -- notably, Saudi Arabia -- demanded some new sign of willingness to fight inflation as a price for cooperation in propping up the dollar.
The latest set of measures by the Fed is designed to move from expensive easy money to more expensive, scarce money. By increasing reserve requirements for the most active source of loans and by raising the discount rate at which banks borrow from the government, the Fed is not only pushing rates higher. It is making the banks pay for handing out credit wholesale.
The first returns from abroad justify these measures. Gold is down, and the dollar is way up. The prospect for an early increase in oil prices now seems slight. The worst has been averted.
But, of course, there is a price to be paid. A credit squeeze is in the offing, and consumer demand, already faltering, is bound to be reduced. Neither business spending nor government spending can take up the slack. Inevitably, inventories will accumulate, production will be cut back and workers will be laid off. All signs point to a typical postwar recession, apt to bite hard by Christmas and to continue for months thereafter.
No doubt inflation will ease some. Food and fuel costs cannot keep rocketing at recent rates. But even when they do taper off, the basic rate of inflation -- the rate by which business has to raise prices to keep up with labor costs -- will be running at over 8 percent. That is two points higher than at the end of the recession of 1974 -- 1975.
Moreover, the timing of the slowdown on inflation is highly uncertain. The longer inflation holds high, the longer interest rates will have to be held up to sustain the dollar and the worse the recession will eventually bite.
So the praise the White House has heaped on the latest measures by the Fed is a kind of confession. The world is being told that when it comes to fighting inflation, Jimmy Carter depends on the actions and reactions of others. In economic affairs he has become a lame-duck president.