Volcker on the Spot

By Christopher Byron

Congress and the White House step up pressure on the Federal Reserve

Tough audiences are nothing new in Las Vegas. Even so, when Federal Reserve Chairman Paul A. Volcker stepped to the microphone at the Las Vegas Hilton last week to address a standing-room-only crowd of 3,000 delegates to the National Association of Home Builders, the mood was distinctly chilly. In the past two years, sky-high and gyrating interest rates have pitched the American housing industry into its worst sales slump since 1946. Now a rising chorus of critics in the Administration and Congress has begun blaming Volcker for housing's plight and for the recession that is spreading through the economy.

In reply, Volcker has begun to counterattack with the argument that the Reagan Administration is as much to blame as anyone for the nation's worrisome economic situation. Volcker charges that by letting the deficit run up toward $100 billion, the White House has all but abandoned its fight against inflation. This has left the struggle to be waged singlehanded by the Federal Reserve, and that, Volcker feels, is asking too much of the American central bank. It is those Ozymandian budget deficits that are soaking up private capital, driving up interest rates and draining the economy of productive investment.

Volcker's critics charge that he has turned the economy topsy-turvy through misguided management of the nation's money supply, and that his two-year-old struggle to fight inflation by slowing the growth of money and credit has sent interest rates leaping and lurching wildly. Since October 1979, when the Fed first began concentrating on directly controlling monetary growth while letting interest rates move more freely, the prime rate charged by large commercial banks has slumped to as low as 11% and rocketed to as high as 21.5%, wrecking budgets and spending plans for families and businesses alike. Though hopes for a sustained economic recovery were buoyed last autumn when rates began to fall from their 1981 peaks, the cost of money has now begun to rise again. This has angered the Reagan Administration and threatened to cut off, or reduce, the predicted spring pickup of the economy.

By last week the escalating attacks on Volcker both by the Administration and in Congress had reached their shrillest pitch yet. Said Senate Majority Leader Howard Baker of Tennessee in graphically blunt terms: "It is time for the Fed to give us a little air, to get its foot off the nation's neck and give the economy an opportunity to recover."

Meanwhile, weeks of behind-the-scenes sniping between Volcker and Treasury Secretary Donald Regan burst into the open during separate appearances before a congressional committee. In testimony to the Joint Economic Committee, the towering, cigar-smoking Fed chairman argued that the Administration was following a loose fiscal policy that threatened to push budget deficits into triple-digit figures, and said that interest rates had begun to rise simply in anticipation of the Government's gargantuan borrowing requirement for later this year and in 1983 and 1984.

The next day, Regan told the same committee that the Administration's projected deficits were not the real problem. Instead, he said, the "erratic swings" in the money supply permitted by the Federal Reserve were forcing up rates. Regan maintained that rising rates, in turn, were fueling inflationary expectations on the part of investors and businessmen and, in the process, deepening and prolonging the recession. To bolster the point, Treasury aides produced charts showing a crazily careening pattern of growth and contraction in the U.S. money supply since last autumn.

During the first three months of 1981, the money supply expanded sharply. Then from April to July it contracted equally abruptly. Between midsummer and late October money again began slowly expanding, but beginning in November the monetary base exploded anew, growing at an annual rate of 13.7%. This jump in the growth of money is now perplexing the Federal Reserve as much as it is enraging the Administration. Said Anthony Solomon, president of the New York Federal Reserve Bank: "Frankly, there's no way of knowing precisely what is causing the bulge, but the problem is most likely to be temporary, owing to seasonal factors."

One explanation being bruited about is that people might recently and mysteriously have begun switching their money from savings accounts to various interest-bearing checking accounts, thereby distorting conventional capital flow patterns and skewing the data. If so, not even Volcker seems to know why. He asked of a group of senior citizens meeting in Washington last week: "If any of you have ideas why people are shifting their money into NOW accounts, I'd like to know about them."

The fact that the Federal Reserve cannot explain what is going on with its figures is being given as evidence of Volcker's failure. Says Economist Beryl Sprinkel, the Administration's Under Secretary of the Treasury for Monetary Affairs: "I assume that he is trying as hard as he can. After all, he has got the same goals that we do. But you evaluate a man on goals and performance, and between the two, performance is more important. What we want is stable, moderate growth of money, and the growth has been anything but stable."

Many economists and business people argue that the situation is not quite that simple. In a free economy as large and complex as that of the U.S., it is impossible to fine-tune the control of money. Even the definition of money is open to question, and corporations and individuals are shifting funds around and conducting business in ways that sometimes cannot be fully understood until long after the fact. The best that the Federal Reserve can hope for is to keep the increase in the money supply generally within its guidelines, accepting weekly blips and bumps in the figures as an inevitable result of the system. Says Princeton University Economist David Bradford: "The Fed is doing what has to be done. I am convinced that Volcker is being attacked by people who are unfamiliar with economic truths."

Volcker supporters agree with the Fed chairman that the high interest rate problem ultimately goes back to the Administration and its budget policies. Says Donald Nichols, a professor of economics at the University of Wisconsin: "The Administration's economic program is seriously unbalanced because there is an overreliance on monetary policy to carry the burden of the fight on inflation. Meanwhile, the Government merrily pumps money into the economy with an easy fiscal policy."

Despite the trouble it has had controlling the money supply, the Federal Reserve's policy has significantly helped bring down the level of inflation, which in the final analysis represents the most pernicious threat to the economy. From a peak of close to 19% in the first three months of 1980, the annual rate of consumer price increase has slowed steadily in the past two years. During 1981, prices rose at an annual rate of 8.9%, compared with 12.4% in 1980. During the last three months of 1981, prices were increasing at a moderate 5.3% annual rate. Many economists anticipate still further gains in the months ahead. Says Volcker somewhat sardonically: "If we get blamed for high interest rates, we at least ought to get some credit for the improved inflation statistics."

In fact, Volcker and the Federal Reserve have become scapegoats for Congress's and the Administration's multiplying frustrations with the economy and the failure of supply-side economics to live up to its earlier promises. Says one top Fed official candidly: "Reagan's wish is for the impossible dream of supply-side economics running hand in hand with tight monetarism. That is something that you just cannot have in the real world."

Like American Presidents going back to Thomas Jefferson during his fight with the first U.S. national bank, Ronald Reagan is finding it convenient to use the top U.S. banker as a sort of whipping boy for the public's dismay over an economy that is not working very well. For the time being, that may prove to be good politics. Certainly, if the economy does not begin to correct itself as next November's congressional elections approach, the pressure on Volcker to expand the money supply will increase sharply. In the end, though, the level of inflation and interest rates will be strongly influenced by the size of the federal deficit. That is a problem that will not go away no matter how much politicians harass and harangue the Federal Reserve chairman.

--By Christopher Byron.

Reported by David Beckwith/Washington and Dean Brelis/ New York

With reporting by David Beckwith/Washington, Dean Brelis/New York

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