Fed Vice Chairman Signals Rates May Not Drop Further

No further cuts in the Federal Reserve’s discount rate are likely in the near future, the vice chairman of the nation’s central bank signaled Wednesday.

Manuel H. Johnson, one of the Fed’s strongest advocates of lower interest rates, said at a seminar held by the American Enterprise Institute that the current economic environment argues against any such steps.

With “some early signs of economic strengthening” and indications from the bond market that inflation may be modestly on the rise, Johnson said, the nation is in a “scenario that would not make you highly aggressive with monetary policy.”

That position marks a turnaround for Johnson, who had been one of the prime movers behind the dramatic cuts in interest rates engineered by the Fed since early this year.

Nonetheless, there was some confusion over Johnson’s speech in the bond market, which gained strength on the basis of a wire service story mistakenly suggesting that he had said the United States should not be deterred from driving down interest rates despite the reluctance of West Germany and Japan to cut their own rates. (The price of existing bonds rises if there is an expectation that new bonds will carry lower interest rates.)

In fact, Fed officials noted, Johnson had merely been pointing out the Fed’s reasons for its previous discount rate cuts rather than discussing future actions.

Since March, the Fed has cut the discount rate in four steps to 5.5% from 7.5% in an effort to help spur economic growth. The discount rate, which the central bank charges financial institutions for borrowings, generally has followed other short-term interest rates, such as three-month Treasury bills, which have declined to about 5.1% recently from about 7% at the beginning of the year.

The Fed’s first discount rate cut this year, in March, was done in conjunction with similar steps by Germany and Japan. But since then, the Fed has moved on its own as the Reagan Adminstration has failed in its recent efforts to encourage Germany and Japan to lower their interest rates as a means of stimulating worldwide demand and thus easing U.S. trade problems.

The head of the German central bank insisted again Wednesday that his country would not reduce interest rates in response to U.S. pressure. “We cannot do things at home which we consider are wrong,” Bundesbank President Karl Otto Poehl told the West German newspaper Die Welt, “just because pressure is applied from abroad.”

Recently, interest rates in long-term markets have begun to creep up, suggesting that investors are becoming worried that future inflation will erode their earnings. The tentative evidence that the economy is on the mend also raises warning flags on Wall Street, because stronger growth would discourage the Fed from further interest rate cuts.

Johnson, in outlining his reasons for being cautious about future interest rate cuts, said: “There are several things going on in the financial sector that at least lead you to pause in monetary policy.”

Among them, however, he excluded the large increase in the money supply over the last year. In the past, the Fed has often tried to limit the increase in the money supply--a course that usually results in higher interest rates--but Johnson said the recent increase merely reflects the growing willingness of business and consumers to hold money in checking accounts instead of other forms of investment.

Besides, he said, money recently has been circulating through the economy more slowly than usual, an aberration that he predicted would continue.

Since the size of the money supply is “not giving good guidance” for determining monetary policy, Johnson added, “the best place to look is market signals.” And the market, he said, is beginning to suggest that the Fed has gone far enough in reducing interest rates.