Declining interest rates, market rally put grinson faces of investor; Fed drops discount rate but not tight money

Edward G. Boehne, president of the Federal Reserve Bank of Philadelphia, had a ''conference call.'' Frank E. Morris, president of the Fed branch in Boston, kept leaving the chairman's seat at his bank's conference here Friday on ''The Future of the Thrift Industry'' to make phone calls. Willis J. Winn, president of the Fed branch in Cleveland, also was called from the conference to the telephone.

What was all the excitement about?

None would say. But it became clear what after the stock market closed later that day. The nation's central bank had decided to drop its discount rate by one percentage point to 13 percent. It was the first drop in a year in the discount rate -- the interest the Fed charges commercial banks when these banks borrow money from the Fed to meet reserve obligations.

The action indicates the Fed now feels secure in encouraging a decline in interest rates without it being misinterpreted as a sign of weakness in the battle against inflation.

The Boston Fed's Mr. Morris said he had ''never seen the 'committee' in a more determined mood.''

(The ''committee'' is the Fed's Shadow Open Market Committee, which set's monetary policy. It consists of the seven governors of the Fed and five of 12 regional Fed bank presidents.)

''There is a feeling that this is really a particularly critical time,'' he said in an interview. ''If we give the market any indication we are not willing to take the flack to hold to a strict monetary course, all the progress we have made would go straight down the drain. Inflationary expectations would be worse than before.''

In an attempt to make certain the discount rate action was not misinterpreted by the money markets, the Fed stated that it was ''taken against the background of recent declines in short-term interest rates and the reduced level of adjustment borrowing at the discount window. The action is consistent with a pattern of continued restraint on growth money and credit.''

In other words, the Fed would stick to its targets for the growth of the money supply.

Short-term interest rates have declined some 4 percent since June. The Fed, by lowering the discount rate, was following down market events. It also was signaling that it would be pleased if rates fell further.

The Fed may have been encouraged to do so by the statement Thursday (Oct. 29) by Henry Kaufman, an influential economist with Salomon Brothers, a Wall Street brokerage house, that the federal funds rate, the critical rate in the money market, would decline by two percentage points as the Fed sought to spur money supply growth. He also said that the prime rate, the rate commercial banks charge their most creditworthy customers, would fall to 16 percent before year end from its current 17.5 to 18 percent.

The Boston Fed's Morris acknowledged, ''The policy is to improve the rate of growth in M-1B (one key measure of the money supply that includes transaction-type bank accounts and cash in circulation), which has been pretty flat for some months.''

The Fed's problem is that M-1B has been growing below its target and a broader measure of money, M-2, has been growing slighty above target. Thus it is difficult for the Fed to decide whether it should or should not pump more money into the banking system.

This led one economist here to tell a joke about two economists out rabbit hunting. One shoots and misses the rabbit by two feet to its left. The other misses it by two feet to the right. The economists embrace, one saying, ''We got it on average.''

Fed bank presidents here feel that they, too, have been hitting the right monetary target ''on average.''

Said Morris: ''I don't think there is a single monetary rabbit we ought to be shooting at. Any one monetary aggregate can be disturbed by particular events of the period we are in.'' He meant that changes in the banking system can distort a specific monetary measure at a certain time and thus central bankers should examine all of them in determining policy.

This is relevant to a dispute last month between the Reagan administration and the Fed. Treasury officials publicly expressed their concern that the undershooting of M-1B would produce more of a recession than desirable. This could hurt Republican prospects in the 1982 midterm congressional elections.

Morris admitted that the economy was ''moving into a recession.'' But he expects it to be a mild one. Business, he noted, has kept its inventories under tight control. So as demand drops, there should be less of an inventory swing than usual to deepen the recession. Moreover, the automobile and housing industries are already in a slump and thus cannot drop much further.

However, Morris believes it important that President Reagan give the Fed its support as it gets more and more criticism because of mounting unemployment and bankruptcies brought on by the recession. ''I think we have it now,'' he said. ''I hope we will have it . . . I don't think we have any real conflict with this administration.''

In any case, he maintains the Fed is winning its battle with inflation. ''We will go into the winter months with some pretty nice looking numbers in the consumer price index,'' he predicts.

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