When the Federal Reserve Board is doing a bad job, as in 1932 or 1982, nobody pays any attention. Today, the Fed is doing a pretty good job, yet monetary policy is suddenly as newsworthy as the weather.
Fed officials are actually expressing opinions and even (horrors!) voting differently from the chairman. A major news magazine headlines “A Rebellion in the Money Palace.” A financial paper worries that “the consequences . . . for worldwide financial markets . . . could be enormous.” If candor and democracy at the Fed is such a bad thing, why have more than one Fed governor?
On Feb. 18, the remark by Treasury Secretary James A. Baker III that “we will not be displeased by a further decline in the dollar,” was quickly followed by Fed Chairman Paul A. Volcker’s testimony that the dollar has fallen far enough.
On Feb. 24, two new Fed governors, Manuel H. Johnson and Wayne D. Angell, joined two earlier appointees of President Reagan to outvote Chairman Volcker and two other Fed governors in favor of a discount rate cut. That move was postponed, however, until Volcker and Baker could persuade central banks in West Germany and Japan to reduce their interest rates first.
Rumors that Volcker would resign did not seem to upset the bullish financial markets, as some expected, though Vice Chairman Preston Martin’s unexpected resignation March 21 briefly knocked the stock market down by 35 points.
A typical press account described Volcker as “a pillar of financial stability,” while we were led to believe that the unruly majority consisted of political hacks and wild-eyed inflationists, determined to trash the dollar.
Even after Martin resigned, a business magazine worried that the Reagan Administration “could replace Martin with someone else bent on easy money.”
Yet the issues and personalities are not quite that simple. Easy money is a matter of degree, and tighter is not always better.
After all, the discount rate still remains higher than at any time between the creation of the Fed in 1914 and the beginning of the era of floating money in 1973.
Why all this fuss over a mere half-point cut in the discount rate? When the Fed pushed short-term interest rates above 14% in early 1982, and again pushed them above 12% in the fall of 1984, there was barely a whisper of doubt.
It is almost as though only low interest rates present any danger. Incredible as it now seems, some former Reagan Administration officials pretended until recently that the Fed had nothing to do with interest rates or exchange rates. Instead, everything supposedly depended on the budget deficit, leaving central banks impotent.
Since Sept. 22, when five major industrial countries began to coordinate their central bank policies, that non-monetary theory of money has been thoroughly embarrassed by reality.
We can all see that the Fed and other central banks can lower interest rates and that interest rates affect exchange rates. The only debate is whether interest rates and/or the dollar are already too low--that is, low enough to risk sending inflation back up.
Volcker figured that U.S. interest rates could safely be lowered only if they were also lowered in Europe and Japan.
That would leave the gap between U.S. and foreign interest rates unchanged, so there would be no reason to switch out of dollars, and exchange rates would stay about the same. Reagan’s appointees--the “Gang of Four,” as they are often called--did not completely disagree but also did not want to make U.S. policy completely dependent on West Germany or Japan.
The missing link in the evolving currency arrangements among major industrial countries is that they cannot yet answer these questions.
There are no rules or guidelines to tell us which countries should raise or lower interest rates under various circumstances. How can we tell if the dollar is really too weak or the yen is merely too strong? It is hard to argue that the dollar is “weak” when both producer prices and consumer prices are falling and commodity prices are as low as they were eight years ago. Prices are also falling in West Germany, France and the Netherlands.
In Japan, wholesale prices have been falling at a 10% pace, even before the oil-price decline. Falling prices are putting a lot of producers out of business, particularly in Japan, where industrial production has fallen for about six months.
If it is appropriate to raise interest rates to stop inflation, it should be obvious what to do when many prices are falling. Countries with falling prices should ease their monetary policy.
The only reason it is not obvious is that we ask monetary policy to do too much--to regulate assorted “money supplies,” to fine-tune quarterly gross national product or to seek trade advantages by manipulating exchange rates. Monetary policy can stabilize prices within a reasonable range, and that’s all we should expect it to do.
The Bank of Japan has been keeping short-term interest rates well above their discount rate and, with falling prices, the result is a brutally high “real” interest rate.
Unlike the United States, Japan has never before deliberately engineered an unnecessary tight-money recession. But Japanese authorities are even more worried that easing would lower the yen (raise the dollar) and thus strengthen the enthusiastic efforts of protectionists in Congress to demolish the international financial system.
The protectionists think countries get rich by paying more for imports and unloading their exports at distress-sale prices. Sell cheap and buy dear.
They should try running a business that way. In any case, U.S. protectionists are the reason that Japan keeps money tight, the strong yen is the reason the United States keeps interest rates higher than necessary, and high worldwide real interest rates are the reason prices are falling in the industries seeking protection. This is not a trade war but trade suicide.
It is not in the United States’ interest to see Japan, Hong Kong and Singapore slip into recession, along with the developing countries who already have stopped buying from us. Instead, we need to help get the rest of the world moving again so they need and can afford our exports. Japan should ease aggressively, even more so than the United States and Europe.
When that happens, as it must, the next stories may be about the “Gang of Five"--all of the Reagan appointees, including Chairman Volcker--being quite happy to cut the discount rate again.