Fed considers move to head off inflation

December 02, 1992|By New York Times News Service

WASHINGTON -- Alan Greenspan, chairman of the Federal Reserve, said in a letter to a key congressman released yesterday that the central bank was considering whether to reduce its targets for money supply growth next year.

Such a move would underscore the Fed's seriousness about combating inflation but would probably also upset politicians who fear that it could hurt economic growth.

For the last two years, the White House and Democrats in Congress alike have battered the Fed over monetary growth that has fallen below its targets, saying this has been a key reason for the weakness of the nation's recovery from recession.

Economists generally agree that slower growth in the money supply helps reduce inflation but also slows economic growth, while faster money supply growth aids economic expansion but can also fuel inflation.

One Fed governor said in an interview that "our view of what the appropriate stance of monetary policy is has not changed one iota."

But in interviews before Mr. Greenspan's letter became public, other Fed officials suggested that reducing monetary targets could actually promote economic growth. By reassuring the financial markets that it will persist in being tough on inflation for the long term, they indicated, the central bank might have more leeway not to raise interest rates to combat inflation in the face of stronger growth.

Still, several economists said the Fed might be more ready to raise interest rates if it adopted a lower monetary growth target. The reasoning is that if the money supply grows faster than expected and thus rises toward the top of the target range, the Fed might feel compelled to raise rates. This discourages lending and helps reduce money supply growth.

"I think the markets would view this as another reason for the Fed not to ease," said David M. Jones, chief economist at Aubrey G. Lanston & Co. "If they lower the target and the economy starts to pick up, it might then feel it has to tighten monetary policy sooner rather than later."

Mr. Greenspan's statement about the possibility of lowering targets came in a letter to Henry B. Gonzalez, the Texas Democrat who is chairman of the House Banking Committee.

Mr. Greenspan sought to explain why money supply growth had fallen below expectations. He also said that growth in economic output had been higher than Fed officials and most economists would have expected, considering how slow the growth in the money supply has been. This, he suggested, was causing the Fed to rethink how much growth in the money supply was needed to obtain a desired rate of growth.

Mr. Greenspan's letter said that any change in money supply targets "would be largely of a technical nature" to take account of the changing relationship between economic growth and growth in M2, the most closely watched gauge of the money supply. He said such a move would not be "indicative of a change" in the Fed's "desired or expected outcomes for the performance of the economy."

Fed officials insisted that such a move would be consistent with their desire to encourage sustained growth while keeping inflation in check.

But some economists suggested that any move to lower monetary growth targets might be intended, in part, to deflect criticism: Lowering the targets would make it easier for the Fed to hit them.

And in his response to Mr. Greenspan's reply to him, Mr. Gonzalez complained that lowering the targets, like the Fed's undershooting of current targets, could "jeopardize the chances for a strong recovery."

Mr. Greenspan noted in his letter that M2 grew at a 1.75 percent annual rate in the first nine months of this year, well below the target of 2.5 to 6.5 percent growth. Fed officials noted, however, that the money supply grew at a 2.5 percent rate in the first 11 months of the year.

Mr. Greenspan said one reason for the slow growth in M2 was that many people were moving money from short-term deposits, which are considered part of M2, into mutual funds, which are not part of M2.

The Fed has lowered monetary growth targets in the past in reaction to lower inflation because when inflation is lower, the money supply need not grow so fast.

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