Fed Ready to Spur Economic Growth : Signals Willingness to Add Stimulus by Hiking Money Supply to Cut Interest Rates
Predicting faster economic growth and lower unemployment for 1987, the Federal Reserve Board said Friday that it is willing to boost the nation’s money supply--a step intended to add stimulus by lowering interest rates for business and consumers.
The Fed thus seems eager to spur the lagging economy and has, at least temporarily, relaxed its fears over a resurgence of inflation, experts believe.
Heating Up the Kettle
The move signals that the Fed will expand the money supply “for as long as it takes to get the heat under the (economic) kettle turned up,” said Jerry L. Jordan, senior vice president and economist at First Interstate Corp. in Los Angeles. “They are willing to make mistakes on the side of too much stimulus, if necessary. They don’t want to tolerate any more weakness in the economy.”
This is a sharp reversal of the policy that was in effect from 1979 through 1984, when inflation was the primary worry, he noted.
“It’s a good time for easier monetary policy,” said William Orzechowski, director of federal budget policy for the U.S. Chamber of Commerce.
The Fed’s report, combined with the July 11 cut in the rate charged for loans to member banks, apparently affirms the Fed’s determination to provide an ample supply of lower-cost loans to businesses and consumers. Its intent is to increase sales of homes and automobiles, which are purchased with borrowed money, and to expand investment by business in new machines and equipment, thus creating new jobs.
The Fed has been striving this year for a money supply growth ranging between 3% and 8%, but it said Friday that faster growth “would be acceptable.” It set no target for 1987, although it said 3% to 8% would be a “likely range.”
The Fed, in its semiannual report to Congress on monetary policy, said: “Overall, prospects for the economy appear to be favorable.”
The nation’s output of goods and services, known as the gross national product, should rise an anemic 2.5% to 3% this year but a more robust 3% to 3.5% in 1987, the report said. A shrinking trade deficit, it said, should be “a critical element in the expected improvement in economic performance.”
With oil prices falling and food prices stable and occasionally declining, there is little fear among Federal Reserve Board members of a return to the double-digit inflation that plagued the nation during the late 1970s and early 1980s. Prices in the overall economy, now rising at a rate of less than 3%, may accelerate to the 3% to 4% range next year, the report said. The retail inflation rate, measuring prices paid by consumers, may run at a slightly faster pace, it said.
More Business Investment
The nation’s languishing economy should accelerate, “although the exact degree and time remain uncertain,” the Fed said. Lower energy prices will mean that consumers can buy other goods; lower interest rates will stimulate consumer spending and help home sales, and business investment for new machines and equipment should improve, the Fed said.
Unemployment, now 7%, may not drop below that level before the end of the year, the Fed said. But an improvement is expected for 1987. By refusing to set a specific target for the expansion of the money supply, the Fed is saying that it “will attempt to drive interest rates to sufficiently low levels to assure continued growth in the economy,” said John O. Wilson, senior vice president and chief economist at the Bank of America in San Francisco.
The basic measure of the money supply, known as M-1, grew at an annual rate of nearly 13% in the first half of the year, well above the 8% upper limit of the Fed’s target range. M-1 consists of cash and checking accounts.
For the growth of two broader measures of the nation’s money supply, the Fed tentatively set new and slightly lower target ranges for next year. But economists said that the revised target ranges reflect technical factors rather than an effort by the Fed to slow the growth of the money supply.
Its tentative targets for the growth of M-2 and M-3 in 1987 are 5.5% to 8.5%, compared with 6% to 9% for 1986. M-2 consists of M-1 plus most personal savings accounts and money market funds, and M-3 consists of M-2 plus large certificates of deposit and money market funds sold to institutions.
Buys, Sells Securities
The Fed determines the size of the money supply by buying and selling government securities. It pumps money into the banking system by buying securities from banks; it removes money when it sells securities.
Lee Ohanian, vice president and economist at Security Pacific National Bank in Los Angeles, said that the Fed’s prime concern clearly has shifted from high inflation to low growth. He said that the Fed, like most economists, has been surprised and disappointed by the failure of falling oil prices and interest rates--cheaper oil and cheaper money--to spur business activity.
The Fed expects trade to provide a major boost for the economy next year. The plunge in the value of the dollar in relation to several major currencies, notably the West German mark and the Japanese yen, makes American products much cheaper and more competitive for foreign customers. At the same time, the change in currency values discourages imports here because they become more expensive for American consumers.
However, driving down the dollar will not boost export sales unless other countries cooperate, stimulating their economies to absorb more American products. And U.S. firms must have “open access to foreign markets, which underscores the critical importance of avoiding protectionist measures here and abroad,” the Fed said.
