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Date: Thu, 12 Nov 92 13:00:17 EST
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11/12/92


TITLE FED SEES ROOM TO . . . SPEND?!?

All Of A Sudden, Growth It So Feared Seems OK Kathleen Hays In
New York Will the real Federal Reserve please stand up?

Is the U.S. central bank an inflation-fighting stalwart whose
finger is on the trigger, ready to raise interest rates at the
first sign the Clinton administration intends to push for a
deficit-swelling fiscal stimulus package to boost the economy?
Or does the Fed take its own forecasts of a continued decline in
inflation next year seriously enough that it would be prepared to
hold policy steady while a mix of low interest rates and
stepped-up government spending get the economy growing strongly
again?

This is one of the most frequently asked questions in the post-
election process of trying to sort out what happens as a Demo-
cratic president takes over the White House for the first time in
12 years.  Because Fed Chairman Alan Greenspan has said many
times that an active fiscal policy is not the best way to get the
economy growing - and because it is now clear that Clinton will
likely get the green light from Congress for a fiscal stimulus
package - many have warned that the central bank and the new ad-
ministration may be on a collision course.  Indeed, many analysts
have pointed out that an increase in yields on short-term govern-
ment debt over the past few weeks shows that investors are bet-
ting that the Fed will move quickly to tighten credit next year,
boosting short rates in several steps.  But an article appearing
Wednesday in The Washington Post appeared to contradict expecta-
tions of Fed credit tightening.

In the article, on- and off-the-record quotes from Fed officials
seemed to support the argument that the Fed would not object to a
fiscal stimulus package given that inflation is low, unemployment
is high, and more stimulus is needed.  Although no explicit link
was made to any possible fiscal package, Boston Fed President
Richard Syron said he would welcome a healthier economic
recovery.  "That is the challenge I hope we have to face. That
would be all to the good," Syron told the Post.  The strongest
quote supporting the newspaper's assertion that the Fed has given
the "go-ahead on growth" and "won't block Clinton initiatives,"
was a partial sentence from a speech that Cleveland Fed President
Jerry Jordan gave earlier this week.  "There's room in there for
him to have some new spending programs," Jordan said.  Off the
record, senior Fed officials were quoted saying that the Fed
would not be worried about two or three more years of rapid
growth as long as it is not driven by excessive money growth that
would heat up inflation. The Post interpreted this as meaning
that the Fed is not about to flood the banking system with cash
if Clinton should request it.  The senior, unnamed officials said
that, "The issue is not the Fed," according to the Post. Instead,
the issue now is where the Clinton administra- FED SEES ROOM TO .
. . SPEND?!?

tion thinks the payoff is on economic policy - an allusion
presumably to how aggressive their fiscal program will be -"and
how the Fed relates to that." These anonymous officials say that
the real problem now is to get long-term interest rates down. To
do that, Clinton must reassure the bond market on such issues as
reducing the budget deficit, his Cabinet appointments, the terms
of his economic package and his commitment to long-term deficit
reduction.  These remarks, and the tone of the article, stand in
stark contrast to remarks attributed last week to a senior Fed
official by the Reuters news agency.  In the article, another un-
named Fed official said he saw signs the U.S. economy was picking
up and warned President-elect Clinton against rushing out with a
stimulus plan to boost growth.  "It could be that we're going to
be starting the year with a more solid rate of growth than we've
seen," Reuters quoted the official as saying. "There are enough
uncertainties that people should not jump to conclusions about
the efficacy of fiscal stimulus at this time."

This official also singled out the importance of long-term in-
terest rates, which determine crucial lending costs like mortgage
and corporate bond rates, in fueling or curbing the economy.  But
this Fed official argued that a more aggressive fiscal package
would boost interest rates and the dollar, too, both of which
would dampen economic activity, not boost it.  Speaking last week
in New York, Fed Vice Chairman David Mullins seemed to stake out
a middle ground, trying to preserve the Fed's image of a tough
inflation fighter and at the same time counteract the possibility
that it be painted as ready to head off the impact of a fiscal
stimulus plan before it even gets out of the chute.  "The true
test is ahead of us," he told a group of private economists. "Our
job is not complete even though inflation points to . . . price
stability." At the same time, he said there is room for the econ-
omy to grow at a 4% to 5% rate "before we run into real con-
straints." He said: "I do not believe that monetary policy should
approach it (fiscal policy) with any preconceived notion of a
response." For some, these scattered assurances that the Fed is
going to tolerate more fiscal stimulus and economic growth are
enough.  "I'll take what I read at face value," said Joseph Liro,
chief economist at S.G. Warburg & Co. in New York, referring to
The Washington Post story. "I will take Mullins at his word: They
will not make a pre- emptive strike on fiscal policy." In fact,
Liro believes that the domestic economy may prove to be so weak
as the year draws to a close that the Fed will find itself forced
to cut interest rates another notch, especially with sagging
overseas growth.  "I have a problem with the Fed acting to pre-
empt (fiscal stimulus) when we just had an election where people
in effect voted that we need more growth," he added. "It would be
counter-democratic to refute what people just voted for."

Some found irony in Fed officials suddenly saying publicly that
they would be willing to tolerate considerably higher growth
rates just two weeks after President Bush lost the presidential
race.  They argued that had the Fed signaled a willingness to
tolerate fiscal stimulus and a rising federal budget deficit as a
means of boosting the economy when Bush was still in office, it
might have encouraged the incumbent to take actions that could
have made a difference in the election.  "How come these people
(Fed officials) weren't saying these things when President Bush
was trying to get re-elected?" said one Wall Street economist.
"They're not just saying now they won't tighten. It's like they
are saying a bigger deficit is okay." Not everyone is convinced,
of course, that the Fed is about to sit on the sidelines and let
the Clinton administration have its way with fiscal policy.  "The
key point here is that there is a very widespread divergence
within the Fed over this issue of whether fiscal stimulus is ap-
propriate," said David Jones, chief economist at Aubrey G. Lans-
ton & Co. and the author of two books on the Federal Reserve.
"There is no consensus on this." Jones pointed out that Greenspan
said as recently as July in his semiannual Humphrey-Hawkins tes-
timony to Congress that he opposes fiscal policy as a means of
boosting the economy.  Greenspan said that he believes monetary
policy in the form of the Fed's many short-term interest rate
reductions over the past two years will eventually get the econo-
my growing.  But he has also warned repeatedly that any fiscal
boost will come on stream when the business cycle is on the upsw-
ing, thereby sowing the seeds for an overheating economy and a
surge in inflation.  In addition, Jones noted, "Mullins' remarks
on zero inflation imply he would also be against old-fashioned
pump-priming and big federal spending," of the kind that Jones
says he fully expects Clinton to pitch.  On the other hand, Jones
said that the Fed wants a "soft takeoff' of 2.5% to 3% growth in
real gross domestic product. He said there is no doubt another
group among Fed officials arguing that monetary policy failed to
produce this level of growth "and it is necessary now for the
Federal government to pick up the slack."

Some analysts detected a political motive in the Fed's latest
series of comments - an attempt to deflect renewed criticism that
a too-tight monetary policy has been a chief culprit behind the
economy's ills.

"We have a new administration, and a lot of talk by Democrats in
Congress on restricting the autonomy of the Fed," said Brian Wes-
bury, chief economist at Griffin, Kubik Stephens & Thompson in
Chicago. He said he interprets some of the Fed's statements of
willingness to work with the Clinton administration as an attempt
to protect its independence.  But because Wesbury is worried that
inflation could creep back up above 4% in 1993 as the economy
continues to revive, he is concerned that the Fed's latest com-
ments mean it will wait too long before it starts tightening
credit.

"The bond market is saying it sees a lot of liquidity out there
already, and eventually it's going to show up in higher infla-
tion," he said.

Lawrence Kudlow, chief economist at Bear, Stearns & Co., also ex-
pects better economic growth in 1993, predicting real GDP expan-
sion of 3% to 4%.  Kudlow does not expect inflation to be a prob-
lem next year. And although he expects the Fed to make a few
"snugging" steps in the months ahead, "I don't think the Fed will
take any measures for at least a year that would restrain econom-
ic growth," he said.  On the other side of the fence are those
who are not reassured, because they think the economy could use
more help in the form of monetary, not fiscal, stimulus.  "The
Fed won't tighten early because they won't want to sabotage
Clinton's plans . . . on his first day in office," said David
Wyss, chief financial economist at DRI/McGraw Hill in Lexington,
Mass.

"But they won't just sit back and let the budget deficit get
bigger, and the question is, where does the tradeoff between ac-
commodating Clinton and curbing the deficit occur?" Wyss added.
"For the Fed to say it has done all it can do is wrong," he ad-
ded. "The economy hasn't responded to lower short-term rates but
is that because the Fed did all it could do or because it didn't
push hard enough?" Said Lacy Hunt, chief economist at the Hong-
Kong Shanghai Bank Group in New York: "I find it contradictory
for the Fed to say there is room for fiscal stimulus. If there's
room for that, then why isn't there room for the Fed to use mone-
tary policy to get money supply growth back up to the middle of
its target where the Fed has said it belongs?"

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