INTEREST RATES remain mercilessly high, in violation of all precedents. The rates have twitched down a little this week, but not nearly as far as they should have done if they were following the patterns of previous recessions. This departure jeopardizes not only the Reagan administration's economic plans but, far more important, the businesses and jobs of a great many Americans. Why is it happening?
It reflects, for one thing, the strains inflicted by a declining inflation rate in a country where a lot of people had grown accustomed to high and continuing inflation. Inflation rewards the borrowers, particularly under the American tax system with its deductions for interest payments. A lot of businesses and, in fact, the economy as a whole had developed styles of operating that used a lot of credit. The Federal Reserve Board is now cutting down the availability of credit, and one result of a tight supply is wild bidding by companies whose existence depends on it. You might note that the true cost of interest depends on the borrower's tax position. For a profitable corporation with income tax liabilities to offset its interest burden, borrowing at the current prime rate of 16.5 percent still means an actual cost, after taxes and after inflation, of approximately zero.
But the larger reason for high interest is simply that people remember what happened the last time, and the time before that. The administration argues that a large deficit ought not to drive up rates and choke off the economy's recovery because it didn't happen after the 1970 recession, or the 1975 recession. That's quite true. A lot of people in the financial markets lost huge amounts of money by underestimating the inflation generated in each of those recoveries. The present rates are public notice that they don't intend to make that mistake a third time.
After each of those previous sessions, interest rates dipped smartly. Then inflation surged, leaving investors with bonds and mortages at interest well below the inflation rate--which meant that, in real terms, the lender was paying the borrower. After the first of those cycles, in the early 1970s, people generally attributed the whole experience to a concatenation of events--oil crisis, grain shortage, Watergate--that, reasonably enough, seemed unique. But after another inflationary recovery and another oil crisis in the late 1970s, the lenders got much more cautious.
Unfortunately, Mr. Reagan's projections of enormous budget deficits for years into the future exacerbate all of the lenders' doubts and fears. If the Federal Reserve's monetary restraint remains tight, interest will stay high and there may well be no recovery at all from the recession. If restraint does not remain tight, inflation will take off again--producing interest rates higher than ever. There appears to be no middle course. That's why an increasing number of people in Congress rightly conclude that Mr. Reagan's present budget is not consistent with lower interest rates.