The Federal Reserve warned yesterday that, to fight inflation, it will allow even less growth in the money supply this year than in 1979. Unless the economy falls into recession, that will mean continued high interest rates.
The new announcement followed the Fed's related decision Friday to lift its discount rate -- the interest rate it charges on loans to member banks. In response to that, several of the nation's largest banks lifted their prime lending rates yesterday back to 15 3/4 percent, the highest ever.
The high interest rates are already having significant effect. The Commerce Department, for example, reported yesterday that housing starts dropped about 6 percent last month, to an annual rate of 1.42 million, the lowest since 1976.
Separately, the department said personal income rose $11.4 billion, or 0.6 percent, last month to an annual rate of $2,035,600,000,000. It was the smallest monthly rise since last May.
Yesterday's Fed announcement was made by Chairman Paul Volcker.
"Let there be no doubt," Volcker told the House Banking Committee, "the Federal Reserve is determined to make every reasonable effort to work toward reducing monetary growth from the levels of recent years, not just in 1980, but in the years ahead."
Volcker said the Fed will seek to reduce growth of one key measure of the money supply, known as M1-B, from about 7 percent in 1979 to 5 1/4 percent this year. Growth of the other measures of money would be cut by comparable amounts.
M1-B, one of several new definitions of money adopted this month by the Fed, includes coins and currency in circulation and all checking deposits at commercial banks, as well as those at thrift institutions such as savings and loan associations and credit unions.
Because some regulatory changes that took effect last year artifically inflated the growth of M1-B, it expanded by 8 percent in 1979, Volcker said, but 7 percent is the "economically correct" figure to use for comparison with the new targets.
As prices rise, more money is required for tansactions throughout the economy. When the economy is expanding, that requires more money, too. Over time, many economists believe, slowing money growth will mean a slower rise in this combination of inflation and real economic activity. If the slowdown occurs mostly in real activity, as some analysts fear, the country would be plunged into a serious recession.
Volcker told the committee, "most members of the Federal Reserve Board have shared the view of the administration and most other economists that an economic downturn will probably develop sometime this year. However, such a result is by no means inevitable and many forecasters appear currently to be raising their sights."
If a recession infact develops, the Fed's new money-growth targets should provide ample credit this year, analysts said.
Or as Volcker explained, "In the short run, we believe those targets are fully consistent with an orderly process of economic adjustment and modest growth, provided the inflation rate subsides as the year wears on.
"We also believe that, should inflationary pressures begin to build more strongly in the context of strengthening demand, those same targets would imply strong financial restraint. In fact, the restraint implied by the new targets would be inconsistent with higher rates of inflation over a significant period of time," Volcker declared.
In other words, either inflation or real output -- which means jobs -- will have to give, because the Fed does not intend to relent. In different ways, that was the message Volcker repeatedly gave the committee.
On related issues, Volcker said:
He is strongly opposed to wage and price controls.
He is equally against credit controls, which were suggested by a member of the committee as an alternative to high interest rates. "What do you want to control at this time?" Volcker asked. Credit controls in the past have been used to require higher down payments for home and consumer durables, such as autos. "I do not think you would want to cut further" on either, he said.
He believes the U.S. stock of gold "should be available for sale when and if that meets our economic objectives" and the Treasury should "maintain flexibility on that."
He is opposed to any tax cut, even to stimulate business investment, unless and until Congress gets better control of federal spending. The result of a cut now "will not be constructive but destructive," he warned, appealing to Congress to "get the budget in the kind of shape that makes that kind of tax cut possible."