The Fed vs. Jimmy's Aides

Seeing slowdown instead of surge, Bill Miller declines to tighten money

As it enters the fifth year of recovery, the longest in peacetime history, the U.S. economy is throwing off conflicting signals of whether it is speeding up or slowing down. Largely because inflation-pinched consumers are reducing some spending, the output of goods and services grew at a paltry 0.7% annual rate in this year's first quarter, way down from almost 7% in last year's final quarter. Yet a batch of fairly robust statistics indicates that there was a rebound in March, and that is causing a significant split in the Carter Administration over what policy to pursue.

The differences were felt most keenly last week at the monthly meeting of the Federal Reserve Board's Open Market Committee, which determines the pace of money growth and interest rates. The 17 members, seated around a 30-ft. mahogany table in the room where some of the most secret plans of World War II were drawn up, faced an exquisitely difficult choice. They had to decide whether to further tighten credit and raise interest rates, thus taking the risk of tipping the nation into recession, or to maintain rates at their present levels, which might worsen inflation. Their deliberations will be kept secret for a month, but early signs are that the committee, which has been closely divided on the issue in the immediate past, voted not to lift rates at all.

The independent Reserve Board's decision went against the advice of some top Administration advisers, including Treasury Secretary W. Michael Blumenthal, Inflation Adviser Alfred Kahn and Chief Presidential Economist Charles Schultze. Sensing that a surge of inflation is in the making, they take the position that money policy should be tightened to produce a mild slowdown. The alternative, they fear, is too fast economic growth that would lead to even worse inflation--and then a sharp recession later on. Private economists as ideologically diverse as Conservative Alan Greenspan and Liberal Arthur Okun, both members of TIME'S Board of Economists, support the case for tighter money. Says Greenspan: "A recession is unavoidable. The sooner we have it, the better off the economy will be." Adds Okun: "Despite high interest rates, there is no place in this economy where anybody is saying no to a borrower."

Feeding the fears is a flock of boomy indicators. In March unemployment remained relatively low, industrial production rose strongly and housing starts increased. Businessmen also have been building up then" stockpiles, raising the danger that in event of an economic slowdown later this year, they might be caught with big backlogs and forced to cut back severely, causing a deep economic drop.

Disagreeing with the tight-is-right philosophy, Federal Reserve Chairman G. William Miller contends that the strong March statistics represent a temporary rebound from weather-battered January and February, and that because of the lag in monetary policy any further money stringency now would dangerously aggravate a future decline. Many private and Government economists agree with him. As Miller told TIME Washington Economic Correspondent George Taber: "The economy is slowing. The leading indicators are down. I see housing starts down in the first quarter compared with the first quarter of last year. I see a moderation in personal income. I see a moderation in consumer installment debt. I see retail sales moderate to soft. I see no evidence of businessmen suddenly hoarding materials."

Miller believes that economic growth will pick up slightly in the second quarter, to about a 2.5% rate, and then decline to 1% or 1.5% in the second half. He predicts low growth continuing early next year--in all, five to six quarters of sluggishness. He does not anticipate a recession this year or next but concedes that the risk of such a slump early next year is growing. Adds Miller: "On prices, we're going to have bad news pretty much through the first half of the year. It will be the second half before we begin to see the inflation rate begin to turn down. But it will take four, five, six, seven years to wring this inflation out."

Even many Administration insiders recognize that their anti-inflation policy is not working. Admitted a top policymaker: "We cannot go on expecting the wage and price guidelines to hold." Since President Carter has ruled out mandatory controls, the only other policy choice, in the view of White House advisers, is to raise interest rates. Leaks to the press and other pressures on Miller to tighten money became so obvious before the Open Market Committee meeting that Carter sent notes to Blumenthal and Schultze telling them to stop it. The President did not necessarily oppose the Fed's raising interest rates, but he did not want the voters to blame him for it. Said a White House staff member: "There was a feeling that if a Democratic Administration was even tighter than the Federal Reserve Board, something was wrong. Put the monkey on the Fed's back, not ours."

To complicate the Federal Reserve's problem, it is becoming even tougher to make major policy decisions on the basis of money growth figures. Officially, the nation's money supply has not grown since October, and in the past three months, M-l (currency plus checking accounts) actually declined 1.5%. But Fed insiders believe that the actual stock of money that is available to be spent has been expanding by perhaps 6% to 7%. Reason: there is a proliferation of new financial devices that effectively enlarge the money supply but are not measured by the old standards. One of these innovations ran into problems last week. The U.S. Court of Appeals in Washington ruled that automatic transfers of funds from savings to checking accounts violate current banking laws; but the transfers will be allowed at least until Jan. 1, to give Congress time to liberalize the laws. There are many other sources of liquid assets. The increasingly popular money market mutual funds, unlike conventional securities, permit holders to draw out their money immediately and put it to use.

In addition, Americans are using many sources of credit over which the Federal Reserve has little direct control. Sears, Roebuck and other retail chains are pushing instant credit, as are finance companies, credit unions and similar "near banks." Moreover, bank depositors can lay their hands on credit and cash around the clock by sticking plastic cards into street-corner automated teller machines. Says Finn Caspersen, chairman of Beneficial Corp., which charges up to 20% interest on personal loans: "The consumer is borrowing today's dollar to get today's goods and is paying back with tomorrow's inflated dollars. It's a rational choice."

But, as Miller notes, consumer spending, the key propellant in the economic expansion, seems to be waning. Americans are up to their credit cards in debt, with installment and mortgage payments taking 23% of their disposable income, up a full three points since 1975. At the same time, soaring prices for food and energy are eating into paychecks and limiting consumer ability to repay loans and make other purchases.

In this volatile environment, the Federal Reserve chairman argues that the board should take great care before making any marked change. As he told TIME: "We must avoid the unpredictability of monetary policy and moderate the swings of interest rates. Last summer there was criticism that if the Federal Reserve tightened money, we would wreck the economy. Now the clamor is the other way, telling us to do more. We must resist those temptations and have more nerve and sense of responsibility to look at the final good for the nation and not to our popularity from week to week."

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