Volcker to world bankers: US policy not unstable
There's a debate and story wrapped up in the accompanying chart. Paul A. Volcker, the lanky chairman of the Federal Reserve System, showed it around a lunch table earlier this month at a conference of the world's top bankers in Lausanne, Switzerland.
By coincidence, sitting at the same table was Guenther Schleiminger, general manager of the Bank for International Settlements (BIS), a sort of club of central bankers of industrial nations based in Basel, Switzerland.
What makes that bemusing is that about 10 days later, on June 15, the BIS released its annual report -- signed by Mr. Schleiminger -- critical of United States monetary policy. Mr. Volcker's chart is a defense of US monetary policy.
A word of explanation is necessary:
European central and commercial bankers have been greatly disturbed by the high interest rates prevailing in the United States. It has prompted a flow of hot money into the US, seeking the high return available, and pushing down the value of European currencies on the foreign exchange markets. This not only makes imports more costly, thereby increasing inflation rates in Europe; it also has prompted the European central bankers to shove up their own interest rates at a time when they would rather not slow down their economies.
However, the Europeans can't complain that US monetary policy is too tough. Only two or three years ago they were arguing that the United States was not conducting a stern enough economic policy in battling inflation.
So, the Europeans can only lament the high American interest rates and complain about two aspects of US economic policy:
1. It is imbalanced. It is firm in monetary policy, but it does not do enough to reduce government deficits.
2. The monetary policy is too oriented to "monetarism." In other words, it aims at controlling the supply of money to the economy, but ignores interest rates in doing so.
Looking at US monetary policy in his annual report, Mr. Schleiminger noted that the Federal Reserve System switched in October 1979 from a policy of keeping interest rates (the so-called federal funds rate) within a narrow band to controlling the growth of the money stock by regulating the volume of reserves available to the banking system. Now, some 18 months later, he comments: ". . . fluctuations in short-term interest rates have been exceptionally large and frequent during this period, while the growth rate of the monetary aggregates has not been noticeably more stable."
Similar remarks have been made by American economists.
Mr. Volcker's chart says, in effect, that the US has carried out a much stabler monetary policy than some other major industrial nations, including Switzerland and West Germany where some critics reside. The chart shows average money growth (money is defined as currency in circulation plus checkable bank accounts) for one month compared with the same month in the previous year.
One Fed economist admitted that if the comparison was made over only six months, the line showing the variations in US money growth would probably move up and down considerably more. Nonethless, most economists would reckon that short-term money growth variations are of less influence on the business cycle and inflation rates than longer-term money growth patterns.
Mr. Volcker had similar charts, also showing relative US stability, for other so-called "monetary aggregates" such as broad money growth, the monetary base, and narrow money growth seasonally adjusted.
Looking at the fiscal side, other US officials have noted that the US federal deficit is relatively small when related to the nation's total output of goods and services if compared with the deficits of such nations as West Germany, Japan, the United Kingdom, or Canada.
So, here too, the US is no great economic sinner.
To be fair, Mr. Schleiminger was careful to point out that other industrial nations also were overreliant on monetary tightness as vs. fiscal restraint in their battle against inflation. Moreover, his criticism of US monetary policy was aimed more at "monetarism," the economic school that gives primacy to control of money growth in managing the economy.
He writes that ". . . the heavy reliance placed on monetary policy and the experimentation with new monetary control techniques . . . have created problems of their own. . . ."
He indicates that the US aim for more precise achievement of monetary targets over short-term horizons was probably too ambitious. There may also have been "teething troubles" for the more forceful, quantitative monetary approach. "Data imperfections, rapid financial innovations, and often large and unexpected shifts in the demand for money caution against the pursuit of perfection in controlling monetary aggregates," he argued.
Whatever, he went on, the resulting fluctuations in US short-term interest rates prompted great variability in the foreign exchange rate of the dollar against most European currencies (with the exception of the British pound). These flucturopean countries heavily dependent on foreign trade.
Mr. Schleiminger concluded that when combating inflation domestically in a period burdened by the second oil shock and international payments imbalances, "it is all the more necessary that in whatever is done on a national level, sufficient thought should be given to the effects on the rest of the world -- and this in no way applies solely to the United States."
International cooperation, he said, "may be considered as the most effective bulwark against a repetition of the kind of events witnessed in the 1930s, which ultimately resulted in a disintegration of the world economy. The warning signs are written on the wall. The Western world is already paying a high price for having tolerated too high an inflation rate for too long."
But Mr. Schleiminger's alarm isn't likely to change US policy. Though admitting that high interest rates may cause some short-term problems, American policymakers see their new, tough monetary stance as the cure for inflation and economic troubles -- not as its cause.