JUDGING by the reaction to Paul Volcker's remarks on inflation at the International Monetary Conference in Boston last week, there must be days when he wishes he never had to say anything. A Federal Reserve chairman's remarks can, of course, be a useful signal, and there are times when it comes in handy for him to say something. But the interpretation given his remarks that inflation still had to be watched shows how markets hang on every word that could hint at a change in policy.
Later in the week, back in Washington, Mr. Volcker made it clear he was not giving such a signal. But his mention of inflation makes this a good time to mention that the Fed has to be concerned about three factors in making its decisions on monetary policy.
If the board goes too slowly -- that is, if it restricts money growth so that interest rates rise sharply -- it can cause recession. On the other hand, if it lets out the string too loosely, allowing the money supply to grow rapidly and interest rates (at least in the first instance) to decline, it can raise fears about renewed inflation down the line. And while such actions are helpful in pulling an economy out of recession, at other times they can create such fear about renewed inflation that they result in lenders demanding a higher rate of interest on long-term instruments. And that, in turn, curtails at least some economic activity.
Now, in the days of fixed exchange rates, those were the two factors the Fed had to think about most. Since 1973, when the dollar has been floating, it has also had to bear in mind the effect of its actions on the foreign-exchange value of the dollar. During much of this period, the administrations in office virtually took a hands-off attitude on the dollar. During most of President Reagan's tenure the dollar had been rising, to the point of cutting into United States exports.
Since last September, when the Treasury, with the concurrence of the Fed, engineered an agreement among the five major financial powers to lower the value of the dollar, the dollar has lost ground steadily. (For six months before September it had already been falling slowly.) In recent months, with the dollar declining and the Fed probably wanting to keep that decline within limits and in any case not let it be precipitous, there has been some linkage between the decline in interest rates here and in West Germany and Japan. If interest rates decline too fast here, the dollar becomes less attractive and the other leading currencies more attractive.
While it is presumed that a lower dollar will eventually help reduce the US trade deficit, there has been little evidence of that so far. One related item the Fed must keep in mind is that, with the federal budget still running $200 billion in the red this year, it hopes foreigners will still want to buy US bonds.
If you want to get a glimpse of one other technicality that makes the Fed's job even harder, there is some disagreement over how one measures money supply growth. The most-watched figure, M-1, has been growing fast enough to make Fed-watchers think the Fed must be concerned. But Ed Hyman, an economist with Cyrus J. Lawrence, notes in a recent study of the ``M's'' -- the various measures of money supply -- that M-3 may be the most accurate measure of money supply growth and says that M-3 has not been growing too fast.
An educated guess is that the Federal Reserve is least worried today about inflation. But it still has a difficult juggling act, if it is to be generous enough to keep the business expansion going but not so generous as to let interest rates decline to levels that make US bond investments unattractive for foreign holders of US dollars.