Miller Fears Recession if Fed Tightens Reins
The Federal Reserve Board is in danger of raising interest rates too much and plunging the nation into a recession next year, Budget Director James C. Miller III said Thursday in blunt remarks that could set off a major Reagan Administration dispute with Fed Chairman Paul A. Volcker.
“Our greatest danger is overreaction,” Miller told a breakfast meeting with reporters. The chances are only one in 10 that the nation will suffer an economic downturn next year, Miller said, but “we can surely bring it on” through mistakes in policy.
‘Substantial’ Slump
If the Fed restricts the supply of money excessively and drives interest rates up rapidly, he added, “we could be in a substantial recession a year from now.”
Seven times during an hour of questions and answers, Miller warned against “overreaction” by Volcker and the other Fed policy-makers, who are grappling with a resurgence of inflation. Although prices are rising faster than last year, he stressed, there is no cause for panic.
Most economists expect the cost of living to increase between 4% and 5% this year, far above the minuscule rate of 1.1% during 1986. Last year’s inflation level, the lowest in 23 years, was caused by an extraordinary plunge in oil prices.
Stable Oil Prices
With petroleum prices remaining relatively stable now, the general inflation rate is returning to the level of about 4% that prevailed from 1983 through 1985.
But the fall of the dollar in comparison with other currencies gives another inflationary boost by driving up the prices of imported goods for American consumers. And domestic manufacturers are able to increase their prices as competition eases.
If the Fed fears an acceleration of inflation, it will move to slow the economy through higher interest rates. Higher borrowing costs discourage businesses from making investments and deter consumers from buying homes and cars.
The Fed must feed the economy enough money to keep business healthy but avoid an excess of funds, which could spur inflation.
Influences Economy
The Fed tries to influence the economy through its huge portfolio of government securities. If it sells securities to banks, they have less money to lend their customers. If it buys securities from the banks, they have more funds to stimulate business.
Miller said the Fed could risk a disaster if it squeezes the money supply too hard. “My dad, who was a flight instructor in World War II, said he would always tell people: ‘Don’t overcontrol the stick,’ ” he said, offering this analogy as advice to the Fed.
If the Fed goes too far in limiting the money supply, it could choke off business growth, the budget director said.
“My feeling is (that), if we get in a recession, we are in deep soup,” said Miller, who is expecting a $108-billion budget deficit in fiscal 1988, which begins Oct. 1. The current budget estimate includes $68 billion in tax revenues generated from normal economic growth--revenues that could disappear if a recession wipes out business profits and causes layoffs.
Miller’s strong remarks to the Fed reflect both economic and political concerns. A recession obviously is unwelcome at any time, but a slump could be politically disastrous to the incumbent party during a presidential election year.
In addition, his warning on the economy was matched by equally tough statements about the budget impasse between the President and the Democratic majorities in the House and Senate.
Both sides agree that there should be deficit reductions of about $36 billion, but the Democrats want to get the funds through higher taxes and cuts in defense spending that the President finds unacceptable.
President Won’t ‘Buckle’
“I don’t think the President is going to buckle on a tax increase,” Miller said. “I will do the negotiating, and I don’t see it happening.”
The Democrats have big enough majorities in Congress to adopt their own budget resolution, which is the general spending plan for the government. The specific spending levels for various programs are decided later by congressional appropriations committees. The President can veto bills containing the appropriations proposed by those panels.
“You better look for some vetoes,” Miller said. “There may be a stalemate; the President is going to play pretty hard ball on this.”
The House adopted a budget resolution that would cut defense spending by $9 billion from current levels, a proposal that Miller said is “just ridiculous.”
