The Federal Reserve has decided not to attempt to push short-term interest rates down any further as long as the budding economic recovery continues.
The decision, reached last week at a meeting of the Fed's policy-making group, the Federal Open Market Committee (FOMC), likely will mean few if any declines in most interest rates for some time, according to financial analysts.
Fed Chairman Paul A. Volcker yesterday told the Senate Banking Committee that money growth recently "has been on the high side relative to our targets . . . . If we push down short-term rates, we would have faster money growth. We can't have it both ways."
Other Federal Reserve officials confirmed that most FOMC members, including Volcker, are concerned that overly rapid money growth could spark new fears of inflation and lead to higher, rather than lower, interest rates.
As a result, they do not want to try to force market rates lower by reducing the Fed's 8 1/2-percent discount rate--the rate it charges on loans to financial institutions--a technique it used repeatedly last fall.
Volcker, who appeared before the Banking Committee to disclose the Fed's money growth targets for this year, said that the economic recovery could continue even if short-term and long-term rates do not fall, although he added, "The lower interest rates are, the more assured you can feel about it."
A number of committee members challenged that view and urged Volcker to reduce rates. Sen. Donald W. Riegle Jr. (D-Mich.) said numerous businessmen and financial analysts are worried that the recovery will be aborted if interest rates don't come down. And Sen. Jim Sasser (D-Tenn.) said, "I would urge you to push the button to lower short-term interest rates."
"Nobody has given me the button to push to lower short-term interest rates with no other consequences," responded Volcker.
Committee Chairman Jake Garn (R-Utah) questioned Volcker closely on why interest rates remain so high relative to inflation, and whether banks may be "profiteering" by keeping their prime lending rate and consumer loan rates artificially high to boost earnings.
Volcker said that uncertainties associated with prospective large federal budget deficits, the rapid growth of the money supply and the fact that an economic recovery is beginning have all played a role in keeping rates high. In the markets, he said, "there is some feeling of pause, stop, listen and see what's happening."
But Volcker conceded that banks' desire to increase their profits in the face of potentially large losses on some loans probably has also played a role. Consumer loan rates "have been slow to come down in line with market interest rates," and "the spread between the prime rate and other rates has been large," he said.
The new money-growth targets for this year, while numerically different, Volcker said, are "comparable" last year's. Moreover, in 1983 "we should be within them . . . . Money, in its various definitions, should grow less this year than last."
In 1982, money growth exceeded the target for two of the three money-supply measures, but the recession continued throughout the year anyway. This year, the Fed is assuming that a more or less normal relationship between money growth and economic expansion will be reestablished.
If that link, known as the velocity of money, does get back on track, the new targets would allow sufficient increase in money and credit to support a moderately paced recovery, with the gross national product expanding about 4 percent a year if inflation runs in the 4-percent to 5-percent range, in FOMC's view.
Volcker said he is optimistic that inflation will be about 4 percent this year and that, with relatively strong growth in productivity helping to hold down labor-cost increases, the improvement in inflation could continue in 1984. In that case, he added, "I think it would be logical for the money supply to grow less rapidly in 1984 than 1983" and that such a policy "would be perfectly consistent with lower interest rates."
But at every turn, the Fed chairman sought to reassure financial markets that the central bank is still concerned about inflation even as it tries to encourage a recovery.
"There is little or no leeway at this stage for 'mistakes' on the side of inflation," he warned. "Policies designed with the best will in the world to 'stimulate,' but perceived as inflationary, may, unfortunately, produce more inflation than stimulus."
Volcker said the FOMC plans to continue to emphasize growth of the broader monetary aggregates, M2 and M3, as a guide to policy. Until last fall, the Fed had focused largely on M1, a measure of money balances readily available for transactions.
The M1 measure includes currency in circulation, travelers checks and checking deposits at financial institutions. M2 includes these plus small savings and time deposits, money-market mutual-fund shares and other items. M3 also encompasses large time deposits, institutional money-market mutual-fund shares and other items.
The Fed shifted away from M1 in the second half of last year, when it appeared that M1's relationship to the economy had gone particularly awry. But the velocity of M2 also fell sharply in 1982, and the Fed is unsure what will happen this year.
Federal Reserve officials said the FOMC is sufficiently uncertain about what will happen to velocity that it plans to review the targets announced yesterday within three months, rather than waiting until July as usual.
The new target ranges include:
M1: 4 to 8 percent, from the fourth quarter of 1982 to the fourth quarter of 1983, compared with 2 1/2 to 5 1/2 percent last year.
M2: 7 to 10 percent, at an annual rate measured from the average for February and March to the fourth quarter of 1983, compared with 6 to 9 percent last year.
M3: 6 1/2 to 9 percent, from the fourth quarter of 1982 to the fourth quarter of 1983, the same as last year.
The unusual base period for M2 was chosen in an effort to remove much of the distortion of that monetary aggregate, which rose at nearly a 30-percent annual rate in January because of such as the advent of the enormously popular money-market deposit accounts, which in less than two months have grown to more than $230 billion.
Volcker said that up to 20 percent of those deposits represented transfers from other investments, such as large certificates of deposit, that were not already part of M2. As a result, he said, M2's surge last month had no economic significance.
On the other hand, the creation of those accounts so raised the level of M2 that the FOMC decided to use as a base a period when most of the shift of funds will have been completed. At the same time, the FOMC added 1 percentage point to the M2 growth target, to allow for later flows associated with the new accounts.