Ending the Suspense

In rare tandem, the Federal Government's fiscal and monetary policies are currently meshing smoothly together. Early this year President Nixon and his aides decided on a deficit-be-hanged burst of Government spending aimed at stimulating the lagging economy. Testifying before the Joint Economic Committee last week, Federal Reserve Board Chairman Arthur Burns pledged that his independent group would do its part. He confirmed what financial statistics had been strongly suggesting: late last year the board changed policy and is again pushing hard to expand the nation's money supply.

The switch ended what monetarist economists had found a cliffhanging suspense story. Early in 1971 the Federal Reserve pumped money into the economy at a stunning pace, but around midyear it almost turned off the spigot; the money supply in the last half of last year grew only very slowly. Monetarists consider the money supply the most important influence on the economy, and they feared that a continuation of the summer-fall Federal Reserve tightness would cripple any chance for a strong advance in 1972. In their view, the board's shift came in the nick of time--or perhaps not quite. Some expect the lag effect of the wide 1971 swings in money-supply growth to cause irregular wobbles in the economy this year.

The 1971 experience, however, demonstrates some of the difficulties of applying monetarist theory to actual Federal Reserve operations. To begin with, there is not even a single definition of what constitutes "money supply." The most commonly used measure is currency plus checking deposits, but Burns last week complained with some justice about excessive concentration on that standard by "singleminded observers." Then, although the board has several methods of creating new money and stuffing it into the U.S. banking system, it cannot force that money out into the nation's spending stream.

Last year consumers chose to save an exceptionally high proportion of their incomes, and corporations opted to rebuild depleted cash balances. That was one reason why the first-half expansion of the money supply failed to produce the vigorous growth in the economy in late 1971 that some monetarists had expected. The Federal Reserve governors eventually concluded that they were pushing out money faster than the economy needed--especially in view of a gargantuan flight of dollars abroad--and decided to hold down the money supply again.

Rates Down. Prospects that renewed expansion now will really spur the economy are somewhat better. The expansion is being supported by fiscal policy, and Burns last week voiced a belief that businessmen and consumers are getting into a spending mood once more. The likely effect on interest rates is more problematic. Some are continuing to fall; Bank of America, the nation's largest bank, last week cut rates by about 1% on home-improvement and some personal loans.

But economists almost unanimously agree that short-term interest rates, like those on Treasury bills, are bound to rise from current abnormally low levels. The course of long-term interest rates, like those on corporate bonds, probably depends more on inflationary expectations than on money supply. If moneymen can be persuaded that inflation is being held in check, corporate bond rates are likely to hold around their present 7.45% or may even drop a bit. If inflation seems likely to resume, the rates will rise because lenders will demand a higher return to keep abreast of increasing prices.

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