Faulting the Fed On Money

The perils of stop-go

In its efforts to keep the economy expanding steadily and avoid inflation, the Federal Reserve Board strives to hold the annual increase in money supply with-in a narrow range--at present, 4% to 6 1/2%. Yet for most of the past year, money growth has been riding a wild roller coaster--dropping all the way down to zero in one month, soaring to an annual rate of almost 20% in another. In the past few months, the money supply has been swelling at such a fevered rate as to cause anxiety even among powerful congressional Democrats, who usually favor an easy-money policy.

The sharpest critic is Wisconsin Democrat Henry S. Reuss, the scholarly chairman of the House Banking Committee. In a letter hand-carried by an aide to Federal Reserve Chairman Arthur Burns two weeks ago, Reuss charges that the board "has lost control of the money supply." Reuss perceives at least two dangers to the economy: 1) "a real threat of nourishing inflation in 1978," 2) a deeper stock market slump, because investors may sell shares out of fear that the board will have to slam on the brakes suddenly.

In the five months from April to August, the basic money supply (cash plus checking accounts) has grown at an annual rate of as little as .7%, but twice it has topped 18%. Despite the stop-go gyrations, the monthly rate has averaged almost 10%. For a while the rise seemed to be moderating in August, but in the last week of that month the money stock ballooned by $3 billion, jolting many analysts. Then in the week ending Sept. 7, money supply took a header, dropping by a dizzying $800 million.

Why the runaway rise and fall? Some money-market analysts suspect that Burns and his colleagues may simply have misjudged the strength of the recovery, and pumped out more than the economy needed or could use. A more technical reason is an increase in money "velocity" --the speed at which money moves from checking account to checking account. Critics fault the Fed for not anticipating that this factor would make money supply grow more quickly than it wished.

Beryl Sprinkel, executive vice president of Harris Trust & Savings Bank in Chicago and a member of TIME's Board of Economists, suggests a third reason: the Fed sets targets for both money-supply growth and interest rates, and it has had great difficulty in choosing goals that are consistent with each other. For example, it may try to keep the "Fed funds" rate --the rate on reserves that banks lend to each other--at around 6%. But it may then find that in order to prevent the rate from rising above that, it has to pump reserves into the banking system, and that increases the money supply more than it intended.

The board is now trying to restrain the growth of money; in consequence, interest rates are rising. Last week it let demand for money push the Fed funds' rate as high as 6 1/4%, instead of pumping cash into banks to stop the rise. Other short-term rates are going up too. Chase Manhattan last week led the way for other major banks in lifting the prime rate charged to their best corporate customers by a quarter of a point, to 7 1/4%, the highest in a bit more than a year. Three-month U.S. Treasury bills, which traded at 5.57% during the first week this month, climbed last week to about 5.8%.

Many analysts think that rates will have to go higher still if the board is to get a firm handle on the money supply. Lawrence Kudlow, vice president of the Wall Street brokerage firm of Paine, Webber, Jackson & Curtis Inc., predicts a prime rate of 7 3/4% by year's end. That prospect is depressing an already listless stock market, as investors find better returns on interest-bearing securities. The Dow Jones industrial average last week dropped close to a 20-month low of 854.12, then finished the week slightly down at 856.81.

Anxieties over money supply and interest could not come at a worse time for Chairman Burns. His term as Fed chief runs out in January. There has been widespread speculation that President Carter would ask Burns to stay on. But one Senate committee staffer who is close to the Fed says he has been told by the White House that Burns will not be reappointed. The Administration is said to be considering at least two possible successors: Robert Roosa, former Under Secretary of the Treasury and now a partner at Brown Bros. Harriman & Co.; and Paul Volcker, also a former Under Secretary of the Treasury and now head of the Federal Reserve Bank of New York. Still Burns is a veteran of Washington's power game and nobody is ready to count him out yet.

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