Has the Federal Reserve System blown its anti-inflation battle? Will the basic inflation rate move up to perhaps 8 or 9 percent in a year or two, with the consumer price index possibly in the double-digit area again?
Monetarist economists fear that will happen.
Because of the rapid growth in the nation's money supply since July, one such monetarist lamented: ''We have thrown away most of the progress in inflation we have got.''
Monetarist economists - those who believe that the growth rate of money is crucial to future growth in the economy and the inflation rate two or three years in the future - have had their faith challenged by the recent recession. The downturn was much deeper than they anticipated. Moreover, the recovery started only at the turn of the year, at least six months after most of them predicted.
The monkey wrench in their calculations was the sharp drop in the ''velocity'' of money, that is, the rapidity with which it changes hands as people buy and sell goods and services. The most common definition of velocity is the ratio of gross national product (the nation's output of goods and services in current dollars) to narrowly defined money, or M-1. M-1 is currency in circulation plus checking accounts.
In the postwar period, velocity has grown at a remarkably stable rate of 3 to 4 percent a year, with some modest variation because of the business cycle. The growth would tend to slow down in a recession, and speed up in the early stages of recovery.
Last year, however, velocity plunged by around 6 percent. And it has not bounced back as much as expected.
Arthur Gandolfi, a Citibank economist, says: ''While we are not sure why velocity behaved so poorly in '82, we did expect that once the recovery began it would go back to its usual trend rate of growth, around 3 percent, even if it did not snap back to make up for the lost ground that it suffered in '82.''
The Fed has been creating money at an extremely rapid rate - 15.2 percent from the average of the four weeks ending Sept. 22 of 1982 to the average of the four weeks ending March 23.
But that money has been sticky, not changing hands so fast. Perhaps anxious consumers, disturbed by high unemployment, are wanting to have the insurance of large holdings of cash or other short-term assets. Whatever, the money growth has been enough to bring about the recovery. It has not yet brought about fast growth.
What makes all economists anxious - not just monetarists - is the future of velocity at this stage. What if it returns to the postwar trend? Will that produce such rapid economic growth that inflation will soar again? Should the Fed quickly dampen the growth of money?
In Washington, according to Rep. Bill Alexander (D) of Arkansas, there is a ''raging debate'' over these issues. The Fed itself says money growth must be slowed. The Republicans tend to agree. ''We have to be fairly tight for a while, '' noted Sen. Robert J. Dole (R) of Kansas, chairman of the powerful Finance Committee, during a visit to Boston. The Democrats sound more concerned with the danger of rising interest rates than with getting the growth of the money supply back down into its target range of 4 to 8 percent.
Despite the political furor, most economists are assuming the Fed will rein in money soon. Will it be soon enough to prevent another burst of inflation?
The Federal Reserve Bank of St. Louis, the bastion of monetarism within the Fed system, has cranked up its econometric model to produce some interesting results. Assuming the Fed brings back money growth to a much slower 6 percent, the model shows gross national product (GNP) in current dollars snapping back to a 15 percent annual growth rate in the first half of this year. That compares with a 2.6 percent annual rate for the last quarter of 1982 and an estimated growth rate of 9 or 10 percent in the first quarter of '83.
''We are getting a lot of kick out of past growth in money,'' noted John A. Tatom, a St. Louis Fed economist.
This mathematical model, which assumes that high unemployment and slack industrial capacity do restrain prices, projects that the broadest measure of inflation, the so-called GNP deflator, will accelerate to 5 percent at the end of 1985. The deflator rose 4.4 percent during 1982, pushed down sharply by lower energy costs.
Another model, without the so-called Phillips Curve factor included, shows the deflator rising to 7 percent in 1985. At its worst, the deflator was climbing at a 10.3 percent rate for the five quarters up to the first quarter of '81.
This model run may sound encouraging. But it includes that brave assumption that the Fed can get money growing at just a 6 percent annual rate. If it doesn't, inflation will eventually get worse.
The St. Louis monetarists find that if money grows at a certain percentage - say the 8.6 percent rate of the past year - basic inflation will over some five years climb to approximately that same rate.
Complicating the inflation question are such ''shocks'' as oil price changes. Mr. Tatom figures the shift from oil price increases to price declines may account for some 4 percent of the drop in the deflator since its peak rise in 1980-81. The remaining 2 percent decline is due to slower money growth, he adds.
But can the Fed drop money growth without killing the recovery?
Mr. Tatom reckons that the Fed can get money growth down to 8 percent without prompting a recession. ''But it would be tight,'' he adds. ''You are talking about a slowing in the recovery.''
That, though, implies more inflation unless the Fed can later bring down money growth gradually once more. ''We have lost some ground here,'' this economist says.
In other words, the Fed hasn't yet lost the battle against inflation. But it could do so unless it shows monetary restraint soon.