The Federal Reserve Under Fire

There are only seven members of the Federal Reserve Board, and they are badly outnumbered these days. Liberals and conservatives, Republicans and Democrats, economists of all persuasions and more than a few Administration officials could cheerfully throttle the nation's monetary-policy managers for their performance over the past several months. Some congressional leaders, among them the new chairman of the Senate Banking Committee, Wisconsin Democrat William Proxmire, are so fretful that Federal Reserve policies are driving the economy deeper into recession that they have come to a conclusion: the board and its crustily conservative chairman, Arthur Burns, should be relieved of at least some of their cherished independence.

Effectiveness Doubted. Not many of Burns' critics have yet gone so far as Labor Leader George Meany, who has declared Burns to be "a national disaster." But they do question whether the man and his stubbornly restrictive policies are an asset at a time when the nation is deep in its worst postwar recession and unemployment is above 8% and still rising. The essence of the dispute between Burns and his opponents is whether the Federal Reserve has pushed hard enough to expand the money supply and ease credit so that buying by companies and individuals can begin to restore sales, production and jobs.

Interest rates have been coming down steadily; the prime rate for loans to corporate borrowers was lowered another notch by some big banks last week to 8 1/4%, down from 12% last October. But many economists say that the Fed could have forced interest rates down much more swiftly. Despite Burns' repeated assurances that expansion of credit had been "adequate," economists have been startled to discover from the Federal Reserve's own figures that the money supply has in fact been expanding at an average annual rate of just 3% since June, and that it actually contracted sharply in December and January.

One of the congressional leaders who is most upset by the Federal Reserve's performance is William Proxmire. He has proposed a resolution urging the board to "actively promote" economic recovery by "substantially" increasing growth in the money supply. In hearings before Proxmire's Senate committee last week, Burns protested that the 8%-to-10% growth rate urged by many liberal economists would be "dangerous"; he worries that pumping a flood of money into the economy could cause another upward surge in inflation. Burns also suggested that Congress would be mistaken to try to enact legislation to "limit the flexibility" of the board in determining monetary policy.

Yet Burns himself concedes that there is something amiss in the monetary machinery. He acknowledges that money-supply growth has "fallen short" of even the Central Bank's own goals. In December, for instance, the Federal Reserve set a money-supply growth target of 5% to 7% for the following month; what it actually achieved was a nearly 9% rate of decline.

The danger is that the U.S. economy may have stumbled into a so-called liquidity trap--a situation in which economic activity is so slack that the Federal Reserve is unable to provide stimulus at will. Normally the board controls the money supply indirectly by altering the amount of reserves available to its member banks. The banks are required to count as reserves the cash in their vaults and a certain portion of their demand deposits--mainly checking accounts. They must place the portion of their deposits in non-interest-bearing accounts with the Federal Reserve. The board controls the amount of reserves in the banking system by buying and selling Government securities from bond dealers and thus either adding or withdrawing cash from the market.

The board decides whether it should inject reserves or take them away from banks by watching the highly sensitive federal funds rate. This is the interest rate one bank charges another for the loan, usually overnight, of any money it has in its Federal Reserve account beyond what it needs to meet its own reserve requirements. The fewer the banks' extra reserves the higher will be the federal funds rate. This rate peaked at about 131/2% last July and was still nearly 10% late in October--evidence, according to the board's large group of critics, that the Federal Reserve has moved too timidly. The rate has dropped more swiftly in the past three months and now stands at 6%.

Growth Stifled. But the creation of reserves is only the first step in expanding the money supply. Customers must actively borrow and make deposits if banks are to be able to turn their checking-account deposits into an expansion of credit several times as large. Yet this is not happening. When the economy tilted down steeply late last year, the nation's banks began to turn away would-be borrowers. At the same time, business-loan demand dropped sharply. By then the Federal Reserve was increasing bank reserves rapidly, but it was too late: banks swallowed the added liquidity, and money-supply growth was stifled.

Burns argues that individuals and businesses are not borrowing because they do not want to spend, and not because money is too tight. This, he says, is the explanation for the paradox in the present monetary situation: interest rates are falling even though the money supply is barely increasing. Burns' critics agree--but only partially. Says Arthur Okun of the Brookings Institution, a member of TIME's Board of Economists: "To argue that Fed policy did everything it could is untenable." The critics say that if the Federal Reserve had been more alert to the danger of severe recession last year, interest rates would have come down faster, borrowing and spending would have increased and the downturn might have been softened.

Burns and his board could wriggle off the hook if only the money supply would resume growing. But the figures released by the Federal Reserve late last week were not encouraging: they showed that the money supply growth from mid-January to mid-February was precisely zero.

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