The nation's financial community has one big question regarding the Federal Reserve System: Will it adhere to its anti-inflationary monetary policy, once the current recession produces high unemployment rates and increasing bankruptcies?
Frank E. Morris, president of the Federal Reserve Bank of Boston, says, "Yes, I think so." Mr. Morris, a member of the Fed's 12-member Federal Open Market Committee, which makes monetary policy, adds: "We all feel we are in a situation where we simply have to stick to our targets, simply because the long-run consequences of failing to deal with the inflation rate in this go-round would by 1985 be socially destructive."
If the Federal Reserve were to move to an unrestrained monetary policy in an effort to get unemployment down as soon as possible, he noted, the rate of inflation would exceed 20 percent by 1985.
After each recent recession, the government's effort to speed the recovery has resulted in inflation moving a notch higher than during the previous expansion and unemployment bottoming at a worse level than during the previous recovery, he added.
"However," he cautioned, "it will be a lot easier for us [at the Fed] if we can develop some sustained political support."
The Federal Reserve System, he said during an interview that was unusually candid for a central banker, has sometimes been described as a fourth branch of government after the presidency, the Congress, and the Supreme Court. "But that is not true," he said. "The Federal Reserve has a certain amount of independence designed into it by Congress. But we don't have the independence of a separate branch of government. Therefore, we cannot follow a position for a long time that is contrary to the view of the majority of the people."
If the Fed tried this, he added, Congress by a simple majority could alter the laws governing the central bank to make it more compliant to congressional desires for an easier monetary policy.
Mr. Morris said: "We can drag our feet and do an unpopular thing for some time. But there is no quick fix to inflation. It will take us at least five years to get it down to a level that people are comfortable with -- say 3 or 4 percent. Five years is a long time."
In the meantime, he predicted, the nation will experience a recession that could be close in severity to that of 1974-75. There will be "a lot of slack" in the economy in both 1980 and 1981, he said. Unemployment could hit 9 percent in the first half of 1981 before gradually moving down to around 7 percent. But inflation, which already shows signs of moderating, could drop to a 7 percent annual rate by the end of 1981.
"If we want to continue to reduce the inflation rate, we have got to follow a slow-growth policy and maintain enough slack in the system that it is difficult for producers to pass on cost increases, including wage hikes," he said.
By 1985, he went on, the United States should have established the economic conditions for a healthy economy. During the last half of the 1980s, the nation could once more enjoy faster real growth and rising living standards without excessive inflation.
"But this program requires something which Americans have not been famous for , and that is patience. We have a national propensity for quick solutions. If we are making some sacrifices, we want quick results. It will be difficult for us to show the kind of patience required for this sort of monetary program.
"If the American people aren't willing to show this patience, then the Federal Reserve will have to give in to the wishes of Congress, reflecting public opinion."
Mr. Morris sees one hope for speeding the transformation to a noninflationary economic environment. If the administration, Congress, and the Federal Reserve demonstrate they are really serious about controlling inflation and staying with a restrained economic program, it will change public expectations for inflation. Businessmen will not be so quick to boost prices. Labor will not demand such high wages. Long-term interest rates will quickly decline. Then the inflation rate will drop faster.
The Fed's strategy has been termed "monetary gradualism." The plan is to reduce the rate of growth of the money supply gradually over the next several years until a noninflationary growth rate has been established. Some academics have advocated that the Fed announce in detail its monetary targets for these years.
Mr. Morris commented: "I am hesitant to set forward the exact course of money growth over the next five years. We don't know enough about the exact relationship between the money supply and the course of the economy. Moreover, a lot could happen in five years. I'm not convinced that is a sensible thing to do."
Nonetheless, he does maintain that "a big majority" of the Federal Open Market Committee is committed to monetary gradualism.
The cost of such an anti-inflationary strategy is high, he admits. But the cost of a "quick fix" severe monetary contraction would be even higher. "It would require such a sizable depression that no one would contemplate that as a sensible course of action. Gradualism is the only responsible course. It has a connotation of ineffectiveness. But I don't think that is true."
One difficulty could be public misunderstanding of the course of interest rates. Mr. Morris explained that the Fed is now following a monetary policy of controlling the growth of money rather than interest rates. So, once the economy starts expanding again next year, the new demand for credit will not be accommodated by a more rapid expansion of the money supply.
"What that means," he said, "is that interest rates will start moving up at a time when the unemployment rate is probably still over 8 percent. That is precisely the point when the Federal Reserve will need some political support if we are going to be able to hang in there."
Mr. Morris said he believes the American people have become concerned enough about inflation to accept some economic sacrifices to battle it. But it remains an open question as to whether the public and Congress have the patience to slog it out over several years.