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Industrial powers acted to ease down the dollar; now for interest rates?

By Richard A. Nenneman / January 21, 1986



ARE interest rates still too high? And is this level of rates damping the rate of growth of the major national economies around the world? The finance ministers of the five major industrial powers -- the United States, Britain, France, West Germany, and Japan -- were meeting in London over this past weekend. This is the same group of players who met in late September and began a coordinated action to force down the value of the US dollar. There was considerable skepticism at the time as to whether a stated change in attitude toward the dollar could actually be followed through with sufficient action, given the billions of dollars freely sloshing around in the world's banks. At that time, however, the dollar had already been in a gentle decline for several months. The determination to bring it down further apparently impressed enough of the markets that the plan has had considerable success.

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At the same time, the September plan envisaged concerted action by each of the countries represented to bring about faster growth in their own economies. In Europe, unemployment stands at record levels for the postwar period. And even in the US, while unemployment at 6.9 percent is the lowest it has been so far in the 1980s, it stands at a level that was considered socially intolerable just a decade or two ago.

The purpose, or one purpose, of last weekend's London meeting was to see if these same nations could manage to push down interest rates. Lower rates, other things being equal, would increase economic growth.

Last week the December index of industrial production was released, showing an increase for the month of 0.7 percent. Moreover, the previous month was revised upward to 0.6 percent (from 0.4 percent). Given the mix of sectors that moved up, most economic observers remain cautious and still see economic growth for this year in the 3 to 4 percent area. For the fourth year of recovery that is not bad, of course. But if interest rates were substantially lower, there seems little doubt that growth would be somewhat higher.

A move to force rates down could boomerang, if investors thought of it as merely a prelude to another round of inflation. With commodity prices as low as they are, however, and with oil prices coming down substantially and so much industrial capacity unused, there seems ample room to ``encourage'' economic expansion without reigniting inflation. In fact, significant expansion would ease some other problems on the horizon, such as the willingness and ability of third-world nations to service their debts.

If inflation is not going to return, interest rates are clearly too high. A middle-aged person today can easily remember buying a house 20 years ago and paying 5-1/2 or 6 percent interest. Today the question is still whether rates are going to break the 10 percent barrier again, dipping back into single-digit territory.

But there is also a total demand for credit today that did not exist 20 years ago. This brings us to Gramm-Rudman deficit-reduction plan, which resurfaced last week as Washington began to wrestle with the requirements of that new law. If it is not hastily repealed, or if tax increases are not quickly passed (an unlikely event), there will be significant cuts in parts of the budget by March 1. The deficit for the present fiscal year has been revised upward to $220 billion (before the cuts). These continuing astronomical deficits are wreaking havoc with global financial flows, and are undoubtedly a major factor in how far the world interest rate level will be able to descend.