When the Federal Reserve Board voted last Friday to cut its discount rate from 7 percent to 6.5 percent, there was a solitary -- and surprise -- dissenter, governor Emmett J. Rice, who was appointed by President Carter in June 1979.
Rice lined up in opposition to the other four governors present and voting (including Chairman Paul A. Volcker), who concluded that a sluggish economy required lower interest rates to provide some new forward thrust. In a conversation later in his office, Rice said that the board's decision was "ill-advised."
By lowering the discount rate now, as financial markets were begging the Fed to do, the central bank may have embarked on a course it will be forced to reverse later in the year, Rice warned. "And if that happens, it may require a higher level of interest rates than what otherwise might have been the case."
Rice says his main concern at the moment is with the domestic economy. "I have to conclude that since monetary policy takes effect with a lag, reducing the current level of interest rates would (provide) additional stimulus six months out, when the economy should be expanding very nicely," he said.
"We have not yet felt the full impact of the decline in oil prices, the decline of the dollar or the decline in interest rates. All those will probably hit us in the second half of the year, and in my judgment, the economy may well pick up a great deal of steam."
In an economy with puzzling and sometimes contradictory signs, it is not surprising to find more than one plausible course of action. But what caught Fed-watchers off guard was to discover Rice on the opposite side from Volcker. Normally super-cautious, Volcker this time opted for stimulus (in line with the Reagan administration), with Rice assuming the wait-and- see role.
He acknowledged, with a smile, that it was the first time since soon after his appointment in the fall of 1979 that he had voted against Volcker on such an issue. At that time, the board voted 4 to 3 to increase the discount rate -- with Rice in the minority. Rice recalls that most experts said the economy was weakening and some were forecasting a recession, "so I voted against increasing the rate. In retrospect, I was wrong."
This time, Rice thinks that the conventional wisdom about the economy again is wrong. Many observers not only feel that the economy is weak enough to have warranted the announced discount rate reduction, but criticize the Fed for not going far enough. The real worriers would have liked a full one-point drop to 6 percent.
But Rice feels that the economy may be on the verge of moving forward rapidly again. He judges the 3.2 percent growth rate in the first quarter as "not bad," even if much of it can be accounted for by growth in inventories. He scoffs at published guesses that the growth rate might dip to 1 to 1.5 percent in the current three-month period. He predicts that economic growth will be at least 4 percent by the end of the year -- without further stimulus from the Fed.
The growth of the money supply is providing "ample liquidity for the economy," he holds, with the one really weak element in the economy being a sharp drop in business fixed investment. And that, he contends, was concentrated in oil drilling and exploration (the result of the collapse in oil prices) and in computers and office machines.
"The (financial) market was certainly expecting a discount rate cut; there was talk about it all last week. But just because the market expects a decline in interest rates doesn't mean we have to do it," Rice said.
He also places himself "among those who feel that it's not a good idea if the dollar falls too fast," and notes that whenever interest rates fall, it creates new pressures on the exchange rate of the dollar. This was among the reasons that Volcker -- supported by Rice and Fed governor Henry Wallich -- resisted a discount rate change in February.
"If I'm wrong, and I may be, if the economy is really weak, it seems to me that we still have time to lower the discount rate and the leeway to do it. Now we have less leeway to lower rates in case it's necessary to do so," Rice said.
What we have here is a classic case of data sufficiently mixed to make either course of action defensible. Where Rice sees the 3.2 percent GNP rate in the first quarter as evidence of strength, the other governors see it as a sign of weakness. Taking inventories out of the picture, there would actually be a net decline in the rest of the economy, governor Manuel Johnson observes.
It won't take too long to find out whether Rice's gut feeling hat the Fed could afford to wait was right or wrong. He believes the preliminary data on the second quarter -- although likely to be a bit weaker than the first quarter 3.2 percent -- won't show a growth rate any worse than 2.5 percent to 3 percent. If it's less than that, he's prepared to change his mind.