Federal Reserve Board Chairman Paul A. Volcker hinted yesterday that the central bank soon may have to take steps to slow the recent rapid growth of the money supply, a move that could mean rising interest rates. His statement triggered a sharp drop in both the stock and bond markets.
The Dow Jones average of 30 industrials, which had set five consecutive daily records, fell 21.96 points to close at 1,117.55.
Volcker also told the House Budget Committee that if oil prices decline to $25 a barrel or less, Congress should consider imposing a temporary tax on oil to reduce the budget deficit and to moderate the economic impact of such a large price swing, which likely would be reversed within a year or two.
The Fed chairman acknowledged in an exchange with Rep. Connie Mack III (R-Fla.) that the money supply--including M1, the measure that covers currency in circulation and checking deposits at financial institutions--has been growing very rapidly for several months. "Those numbers have been rising . . . more rapidly than is consistent with containment of inflation over time," Volcker said.
"Can you get M1 back within the target range without a shock to the economy," Mack asked.
"I believe so," Volcker replied, "but it has been rising somewhat more rapidly than I would have expected."
To financial analysts who follow the Federal Reserve closely, Volcker seemed to be expressing some doubt that money growth in fact could be slowed without an increase in interest rates that might be large enough to affect the economic recovery now under way, at least to some degree.
Rising interest rates so early in the recovery, when civilian unemployment is 10.4 percent, could pose serious political problems for Volcker and the Fed. During several of his recent appearances before congressional committees, many members, both Democrats and Republicans, have pressed him to take steps to achieve lower interest rates, particularly for mortgages and consumer loans.
Senate Budget Committee Chairman Pete V. Domenici (R-N.M.) said at a meeting with Washington Post reporters and editors after one such session with Volcker that he supports Volcker's reappointment to the chairmanship of the Fed when his current term expires in August. But if Volcker were to allow interest rates to rise this spring or summer without clear evidence of a resurgence of inflation, then he would withdraw that support, Domenici said.
Officially, the Fed is using several broader measures of the money supply as a policy guide rather than M1, which had been its principal guide during most of the last three years. But the Fed's 1983 targets for growth in those broader aggregates, Volcker said last month, would be consistent with a 4 percent to 8 percent expansion of M1 between the fourth quarter of 1982 and the fourth quarter of this year.
Some analysts expect the average level of M1 to be up about 3 percent in the first quarter alone. Thus, a sharp slowdown in its growth would be required to keep it within the 4 percent to 8 percent range for the year as a whole.
Volcker's comments reinforced other indications that the Fed does not intend to cut its 8 1/2 percent discount rate--the interest it charges on loans to financial institutions. Earlier, there had been a widespread expectation in the markets that the rate would be lowered at least to 8 percent.
In the last few days, some financial analysts have said they thought the Fed has begun to tighten credit conditions slightly and that some key short-term interest rates have gone up about one-quarter of a percentage point as a result.
This particular reading of the tea leaves in the bottom of the Fed's cup is not unanimous. At the end of last week, for instance, economist Henry Kaufman of Salomon Bros., whose interest-rate predictions are closely followed on Wall Street, said that "the Federal Reserve has indirectly indicated that it is not concerned about the present growth" of the money supply and that "official pronouncements seem to favor lower money market rates."
Volcker raised the possibility of new oil taxes in the context of the need to reduce large prospective budget deficits, which he said could be a factor in keeping interest rates unusually high relative to inflation.
"The prospect for declining oil prices helps inflation in the near term. It would also act, analogously with a tax cut, to increase domestic purchasing power and involve a direct loss of windfall profits tax revenues, further complicating" the budget problem, Volcker said.
"In the circumstances--and taking account of the effects on domestic energy prices and conservation--a deep decline in oil prices would suggest early reexamination of the case for energy taxes," he continued. "One possibility would be to bring forward" the $5-per-barrel tax President Reagan has proposed be enacted on a stand-by basis for 1986, he said.
Volcker would not be pinned down on just how large a tax he would recommend, saying that would depend on how far oil prices fall. "I wouldn't do anything if it were only a modest decline," he said. If oil prices fall from the current levels of more than $30 to $25 or less, then "the case becomes quite strong" for such a tax, Volcker declared.