Fed and the Treasury appear to be in sync on US money policy
Boston — Economist Lawrence Kudlow speaks of an ``entente cordiale'' between the Federal Reserve System and the Reagan administration. And a Treasury economist, in a background interview, appeared to confirm the situation. Referring to the rapid growth in the nation's money in the last couple of months, this economist commented: ``It is adequate for the time being.''
White House officials, perhaps more than in any other administration of the past two decades, have felt free to comment on Federal Reserve monetary policy. After all, Fed chairman Paul A. Volcker and other Fed officials do not hesitate to criticize fiscal policy (the huge budget deficit). Why, President Reagan's economic policymakers contend, should they not offer their ``two bits'' on monetary policy, maybe even influence it a little?
As Treasury secretary, Donald Regan had spoken up over the past couple of years or so whenever the Fed's provision of new money to the economy was, in his view, too generous or too slim. Since the basic money supply has tended to grow rapidly in the first half of each year and then slowly in the second half, Mr. Regan had a number of occasions to criticize. Treasury economists would prefer, as one put it, ``smooth, steady growth in money.''
Those differences between the Fed and the Treasury are partly due to economic ideology and partly institutional.
Beryl Sprinkel, who just left a Treasury job as undersecretary for monetary affairs to become chairman of the President's Council of Economic Advisers, is a strict ``monetarist.'' He believes that steady, modest growth in the money supply would moderate the business cycle and reduce both inflation and interest rates. Another Treasury economist, Manuel Johnson, is something of a supply-sider. He figures the Fed should steady the supply of money. But he also figures that tax and other institutional changes permit a fairly rapid growth in money to accommodate a vigorous growth rate for the economy -- faster than most conservative economists would think possible without stirring up inflation.
The Fed's 12 monetary policymakers are a mixed lot ideologically, ranging from monetarists to economic eclectics. Chairman Volcker has called himself a ``pragmatic monetarist.'' Probably the dominant view is that the Fed should look at a whole range of economic indicators, including the monetary aggregates, and then vary money-supply growth according to the circumstances. They are willing to manage money in an attempt to counter the business cycle.
From an institutional standpoint, the Treasury wants generous economic growth to reduce the budget deficit and help the administration politically. The Fed, as an institution, tends to be more concerned with sound money and thus prefers somewhat slower economic growth.
What this boils down to is that the Treasury now wants the Fed to err, if anything, on the side of ease in monetary policy. The Fed has a target this year of 4 to 7 percent for basic money, known as M-1. The Treasury would like money to grow toward the upper end of that sizable range.
Assuming that the velocity of money -- how fast it turns over -- slows somewhat this year, the Fed is happy to go along, Mr. Volcker indicated to Congress last month.
Certainly the Fed has supplied lots of new money lately. M-1 has grown at an 11 percent annual rate since mid-October, far above the target. Before that, however, money growth was slow for several months. For the past year, M-1 has grown some 6.3 percent.
Mr. Kudlow, former chief economist in the Office of Management and Budget, says the Fed should dampen today's excessive money growth rate to around 4 percent this year.
This, he says, would keep inflation at about 4 percent, permit 4 percent growth, reduce long-term Treasury bond rates to 10 percent, and maintain a strong dollar and weak commodity prices.
If the Fed follows the Treasury's wishes for growth in the upper range of the target -- say around 7 percent -- then inflation will accelerate to 6 or 7 percent, growth won't be any greater, long-term Treasuries will offer 14 percent, and the dollar will depreciate 15 percent, Kudlow predicts.
Moreover, the stock market would tumble and the economy would be poised to fall into a slump toward the end of this year or in 1986, he adds.
Fed officials at the moment appear less concerned about the prospects for inflation than Kudlow is. The Fed has apparently thrown monetary policy into neutral -- not loosening up as it had in recent months, but not braking much, either. But Kudlow, among other money-market-watchers, holds the Fed will at some point have to exercise more monetary restraint.
He speculates that Fed chairman Volcker does not want to alienate the White House or Congress by raising interest rates sharply. The Fed has several regulatory issues before Congress, plus its independence, to worry about, he notes.
Nonetheless, he says, it would be better for the economy if Volcker tightened up now, rather than later.