The soaring prime: Does it presage a new recession?
Whether the widely expected recession turns out to be shaped like a "W," in the jargon of the economist's trade, will be of little interest to the millions of American families directly affected.Skip to next paragraph
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What matters to them is that the huge United States economy -- which had struggled fitfully out of last summer's downturn --bled by sky-high interest rates.
The likely result, for some months to come, will be higher unemployment and deep trouble for particular industries, notably housing and autos.
Why, then, does the Federal Reserve Board continue to ratchet up interest rates? Are the governors of the Fed --tive to the plight of ordinary people?
On the contrary, they insist. Listen to Paul A. Volcker, chairman of the Fed: "Over the long term," he says, "inflation is geared to excessive monetary growth."
As the supply of money -- cash, checking and savings accounts, plus other categories -- proliferates beyond what the Federal Reserve Board considers prudent, inflation results.
"Restraint on the money supply," Mr. Volcker says, "is essential. But at what cost to other economic objectives? That is the hard question."
In other words, he and his fellow governors are fully aware of the misery caused by soaring interest rates, when companies cannot afford to borrow and have to lay off workers, when young families cannot assume a mortgage or replace the old car.
"We cannot reduce inflation," concludes Mr. Volcker, "without reducing excessive money supply growth, even if this appears to be painful in the short run."
It used to be that recessions wrung some inflation out of the economy, permitting a fresh start at stimulating jobs and production. Partly, this was because workers accepted wage cuts during bad times.
But times have changed. Countless wage contracts, as well as government transfer payments, are linked to the consumer price index. Now, even during economic downturns, wages creep up and so does inflation.
Since the early 1960s, according to experts, the nation's basic inflation rate has climbed from 1 percent to nearly 10 percent today, with some White house officials expecting a higher figure soon.
Failure to pay for the Vietnam war through higher taxes, experts agree, notched the US inflation rate up from 1 to 4 percent. OPEC's quadrupling of oil prices in 1974-75, coupled with poor crops globally, pushed the rate up to 7 percent. Last year oil prices more than doubled again, bringing the underlying inflation pace to 9 percent.
Wage boosts this year averaging nearly 10 percent, say White House economists Charles L. Schultze and Alfred E. Kahn, add to inflationary pressures.
Against this background, the Fed feels it has no choice but to wield the one anti-inflationary tool is has -- controls on the growth of money.
But what about the cost? Rising prices force millions of Americans to spend more of their income on food, fuel, and other necessities, leaving less for discretionary buying.
This hurts retail stores generally, and particularly those selling "big ticket" items, like appliances and furniture. High interest rates add to the problem.
Beginning Jan. 1, 1981, a bigger slice will be taken from payroll checks for social security taxes, while many families -- when they reckon up their 1980 income taxes -- will find they have been pushed by inflation into higher brackets.
Decontrol of domestic oil prices, scheduled to end Sept. 30, 1981, will boost gasoline and home heating oil costs by about a penny a gallon each month, exclusive of what price hikes the Organization of Petroleum Exporting Countries (OPEC) may decree.
None of these items is large in itself, but they add up to a progressive shrinkage of consumer purchasing power -- the engine that powers the US economy.
A stagnant housing market and sluggish auto sales ripple out to affect thousands of supplier firms adversely.Chrysler in particular, which had hoped to survive on the wings of its new compact "K" cars and a $1.5 billion government loan guarantee more quickly than expected.
All this is why President-elect Ronald Reagan and his advisers describe inflation as the No. 1 domestic priority for the new administration to tackle. Nothing the president-elect has proposed, however, impels chairman Volcker and the Fed to unbrake the nation's money supply and let interest rates slide down.