One more squeeze on inflation
Again the Federal Reserve Board -- "like the Dutch boy with his finger in the dike," said a Fed official -- plays a lonely role in the struggle to control inflation.Skip to next paragraph
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The difference is that the Dutch boy's action was not controversial, whereas the Fed's policy is.
Repercussions include a steep plunge in stock and bond prices, soaring interest rates, and a stronger dollar overseas.
Inherent in the turmoil appears to be a conviction that the Fed cannot control the supply of money and that inflation is not going to abate soon.
Banks, forced to pay higher interest to borrow the money they lend, jack up their own rates to borrowers. The prime rate now stands at 19 percent, not far below its 1980 record high of 21.5 percent.
Investors, chasing after the best return for their money, desert stocks and bonds in favour of money market funds and certificates, where interest above 15 percent prevails.
Money managers overseas scoop up high interest rates by investing in the United States. This bolsters the strength of the dollar in relation to foreign currencies.
High interest rates spell bad news for two key US industries -- housing and autos -- already severely depressed by the inability of many Americans to finance their purchases.
Like ripples from a stone cast into a pool, the US economy will show these other effects:
* A strong dollar makes US exports more expensive for other nations to buy and makes imports into the United States cheaper.
* The federal budget deficit may widen, because interest on the national debt -- now nine cents of every tax dollar -- becomes more expensive. The US Treasury, like banks and other borrowers, has to pay prevailing interest rates to borrow money.
* President Reagan's ambitious plans to revitalize the economy may falter, if high interest rates discourage businessmen from making new investments.
TRiggering the lates round of turbulence in financial markets was an explosive $4.2 billion growth in M-1B, a key measurement of the nation's money supply.
The amount of money circulating in the economy, in other words, is running above the growth targets that both the Federal Reserve and the White House consider prudent
Because too much money breeds inflation, the Fed now tries to drain money from the system by hiking interest rates, specifically the rate at which the nation's central bank lends funds to commercial banks.
This discount rate was hiked from 13 to 14 percent by the Federal Reserve, plus a 4 percent surcharge on large and frequent borrowers from the central bank.
Other rates, meanwhile -- the federal funds rate (what banks pay each other for overnight loans) and the prime rate (offered by banks to their best corporate customers) --climbed.
By raising the discount rate and its surchage, the Fed discourages banks from trying to get "cheap" money through the Federal Reserve's so-called discount window.
A large bank that borrows two weeks in a row from the Fed, for example, or four times in a 13-week period, would have to pay 18 percent to get its money -- 14 percent, plus the 4 percent penalty.
When banks borrow less, they cut back also on lending, because businessmen think twice about signing up for high interest commitments.
This has the effect of slowing the growth of the nation's money supply. Hopefully, inflationary pressures ease.
Beryl Sprinke. US Treasury undersecretary for monetary affairs and a tight money advocate, praised the Fed's action. "We're pleased to see that the Federal Reserve means business controlling the money supply," he said.
Some critics, however, charge that the Federal Reserve means business controlling the money supply," he said.
Some critics, however, charge that the Federal Reserve Board canot, or does not, control the money supply, as witness last week's $4.2 billion spurt in M-1 B.
Fed chairman Paul A. Volcker and his six fellow governor insist that changes in US banking laws make it hard to control the money supply week by week.
Billions of dollars are moving in new directions -- into NOW, or interest-bearing, checking accounts and into a proliferation of money market funds.
"What part of these money market funds," said a Federal Reserve Board governor, "are demand deposits [i.e., like a checking account], in which cases they should belong to M-1B?
"Or what part act like time deposits, in which case they should be included in M-2?"
Meanwhile, two conclusions stand out:
* The main burden of fighting inflation falls on the Fed, because any antiinflationary impact from President Reagan's economic program lies months down the road.
* Mr. Volcker is painfully aware that the Fed's effort to drain steam from the economy involves "social costs."
Millions of Americans cannot afford to buy homes, new cars, or make other major investments, and some lose their jobs when interest rates climb sky-high.