THE BOND MARKETS and the interest rates constitute a continuous public opinion pool on the future of the economy. To the indignation of the Reagan administration, interest rates have been moving sharply up this spring. The market's behavior seems, to the White House, perverse and unfair. The president is making strong progress with his budget, and the recent figures on inflation have been declining. Why aren't interest rates responding to the good news?
The beginning of the answer is that a lot of people have lost serious amounts of money over the past several years by understanding the momentum of inflation. They do not intend to repeat the mistake. The administration had hoped that a showing of serious intention by Mr. Reagan would be rewarded immediately by a change in the markets' view of the future. That, so far, has not happened.
The administration and the Federal Reserve are not committed to unprecedentedly close restraint of the money supply. But the economy has been growing more strongly than most people expected, and this growth, pressing against a sharply constrained money supply, is also pushing interest rates up. Because the administration isn't getting the psychological and anticipatory effects that it had counted on, the tension between real growth and tight money is proving more serious than it had forecast.
According to the conventional view, high interest rates discourage people from borrowing and that, in turn, holds down sales and investment. But there's an interesting debate under way, among the bankers and brokers, over this view and whether it has any relationship to the way that the economy is actually working. Last December, for example, interest rates soared to a shocking peak -- but the economy, over the winter, grew fastest than ever. It may now have fallen into a pause, but even that's not clear. Whatever the relationship between interest rates and the rest of the economy, it's nothing familiar, near or simple. People have become accustomed to high rates with astonishing speed. People have seen that the deduction of interest payments on their income tax returns pushes the cost of loans down to levels that are, for many of them, very tolerable. At the same time a lot of borrowing and lending is going on outside the conventional banking system, and the Federal Reserve can no longer be sure that its monetary targets are really as restrictive as they were designed to be.
Financial practices are now changing rapidly, in response to high inflation and high interest rates. No one can accurately foresee the directions that this evolution will take, but it clearly has large implications for Mr. Reagan's economic strategy. It means that high interest no longer works reliably as a brake on inflation, and the danger of inflation is correspondingly greater that it seemed as recently as a year ago. The president is going to have to choose between his commitment to a series of large tax cuts and his commitment to lower inflation. Getting the inflation rate down is now far more urgent.