Fed Ends Eased Money Policy : Interest Hike Indicated by Volcker Testimony

Federal Reserve Chairman Paul A. Volcker, outlining monetary goals for the year, disclosed Wednesday that the central bank has ended the relaxed money policy that had allowed interest rates to fall since last September.

But the Fed sees no need to push up interest rates yet, Volcker added, saying only that it will behave “a bit more cautiously” than recently in permitting cash to flow into the banking system.

In reaction to Volcker’s testimony, analysts suggested that interest rates are likely to climb somewhat in the next few months because Wall Street expects that the Fed eventually must try to slow the recent rapid growth in the money supply.

David M. Jones, a longtime Federal Reserve specialist at the New York investment firm of Aubrey G. Lanston & Co., warned: “The next time the Fed moves to change policy, it is more likely to be in the direction of restraint rather than easing.” He said he expects that prospect to help spur an increase in the bank prime rate from its current 10.5% to 11.5% by the end of June.

In an appearance before the Senate Banking Committee to give his semiannual report to Congress, Volcker was optimistic about the prospects for solid economic growth this year and the likelihood of lower unemployment with little, if any, increase in inflation.

He suggested that civilian unemployment could fall as low as 6.7% by the end of the year, compared to its current 7.4%, and that inflation should remain between 3.5% and 4% in 1984, nearly the same as last year’s 3.5%.

Warning on Foreign Capital

But he warned again that the U.S. economy is growing too dependent on foreign capital, which has made it relatively easy for the government to finance its huge budget deficits but only at the cost of pushing up the value of the dollar substantially and harming farmers, exporters and manufacturing firms, which are finding it increasingly difficult to compete against cheap foreign goods.

“We cannot logically welcome the capital inflow from abroad in one breath and complain about the trade deficit in the next,” Volcker said. “In a real sense,” he added, the United States is “living on borrowed money and borrowed time.”

Irwin Kellner, chief economist at Manufacturers Hanover Bank in New York, said of Volcker’s testimony: “The message is that the Fed is not going to tighten the screws. But Volcker is not going to ease up any more either, because he believes we can’t be complacent about the future.”

Money Supply Target

The Fed expects to meet a demand for money, Volcker said, that would be consistent with economic growth, adjusted for inflation, of about 3.5% to 4% this year. Each year, the Fed sets targets for the money supply that aim at keeping the economy growing at a healthy pace without adding fuel to inflation.

The Fed’s 1985 target for M-1, which includes cash and checking accounts, was set between 4% and 7%. By contrast, the target for last year was 4% to 8%, and actual money growth was 5.2%.

The Fed boosted the upper limit of its targets for two broader money supply measures by half a percentage point from last summer’s tentative goals, but both Volcker and independent analysts said that the change reflected no policy shift. The target for M-2, which consists of M-1 plus savings accounts and most money market accounts, was set at 6% to 9%, and the target for M-3, which adds large time deposits to M-2, was put at 6% to 9.5%.

“There’s no big surprise in these decisions,” said Allen Sinai, chief economist at Shearson Lehman Bros., a major New York brokerage firm. “If anything, they show that the Fed will not bend even with a high dollar and that Volcker is not caving in to demands that he allow greater monetary growth.”

Rising Interest Rates

As a result, Sinai predicted that both short-term and long-term interest rates should begin rising somewhat within a month or so. On the other hand, Kellner suggested that even though short-term rates should rise because they are more directly influenced by Fed actions, long-term rates could decline this year by as much as a full percentage point to less than 12%.

Volcker was subjected to remarkably gentle questioning by senators on the banking panel, with Democrats making a point of urging the Fed chairman to remain at his post until his full term expires in August, 1987.

Several senators complained that the current distress among farmers was a result of the strong U.S. dollar and they urged Volcker to work just as hard at helping protect farmers as the Fed did at keeping deeply indebted Latin American countries from slipping into bankruptcy. Volcker acknowledged: “You’ve got a real crisis on the Farm Belt.” But he added: “I don’t see any outcome that doesn’t involve losses of some fringes of farmers” who are so deeply in debt that there is little hope of avoiding bankruptcy.

In establishing its monetary targets for the year, the Fed agreed to meet the Reagan Administration half way by accepting a technical recommendation that will allow greater flexibility in the money supply early in the year.