Fed Official Fears Risks for Economy : Preston Martin Says Nation Is on Verge of a ‘Growth Recession’

The vice chairman of the Federal Reserve Board warned Tuesday that the nation is on the verge of a “growth recession” and that faster money growth and lower interest rates may be needed to counter it.

Preston Martin told a foreign policy conference at the State Department that “a growth recession must be considered a real threat. In fact, the data currently available suggest that the economy is on the edge between healthy, sustainable growth and a growth recession.”

Martin’s statement comes as some financial analysts believe that the Federal Reserve already has eased its policy at least slightly to spur the economy. The Commerce Department reported last week that the nation’s economy grew at only a 1.3% annual rate in the first quarter after adjustment for inflation.

The analysts speculated that the central bank might soon reduce its 8% discount rate, the rate that financial institutions pay when they borrow money directly from the Fed. As it costs less to obtain money to lend, the 10 1/2% prime lending rate at commercial banks also could drop soon, the analysts said.

Unemployment May Rise

The phrase “growth recession” is used to describe a period in which the economy does not actually decline, as it does during a recession, but grows at such a slow rate that unemployment may rise and the use of available production capacity may fall.

“If the Commerce Department is roughly correct in its 1.25% estimate of first-quarter real GNP growth, the economy has advanced at only about a 2.5% rate over the past three quarters,” Martin continued. Such growth is not enough to reduce the unemployment rate, one of the goals of Fed policy, he said.

Both short- and long-term interest rates have dropped in recent weeks. The key federal funds rate--the rate that financial institutions charge when they borrow funds from each other, which may be a good indicator of changes in Federal Reserve policy--is below 8%, down more than half a percentage point in the last month. A decline in the federal funds rate below the discount rate often sets the stage for a cut in the latter.

Some other short-term rates, such as the yield on large certificates of deposit due in 90 days, have fallen about three-fourths of a percentage point to about 8.25%. Large CDs often are issued by financial institutions to obtain lendable funds. At current yields, the spread between that cost of funds and the 10 1/2% prime rate is unusually wide, possibly setting the stage for a drop in the prime interest rate, analysts said.

Economist Paul W. Boltz of T. Rowe Price Associates of Baltimore said the slowdown in economic growth has become so pervasive and lasted so long that it “implies that monetary policy has been too restrictive. . . . With unused capital and labor ample, a more stimulative monetary policy is likely in the weeks ahead.”

The slower economic growth has occurred despite rapid increases in the money supply between November and February and continued moderate money growth since then. Martin said in his speech that, with the link between money growth and the economy behaving in this fashion, the Fed may have to have faster money growth to keep the economy on track. The vice chairman noted that Fed Chairman Paul A. Volcker had mentioned such a possibility in congressional testimony in February.

Many forecasters expect the economy to pick up somewhat this quarter. However, economist Allen Sinai of Shearson Lehman Bros. said that “the U.S. economy is definitely on a slower growth track, in a new phase of the expansion, fading in growth and raising questions about the staying power of the expansion. . . . For the first time in postwar history, a major slowdown is being generated through weakness in trade.”

Because the federal funds rate can bounce around substantially without any change in Fed policy, or even in the central bank’s day-to-day interventions in the credit markets, some analysts cautioned that it is too early to conclude definitely that there has been an easing or that a cut in the discount rate is imminent.