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The nation's central bank denies that it is changing its policy course. It insists that the unprecedented free fall in interest rates is the predictable result of its success in getting a better grip on the money supply. Last fall, when Volcker switched tactics in the attack on inflation and decided to concentrate on controlling the growth of the money supply rather than the level of interest rates, he warned that the rates would rise sharply but then also fall rapidly. With less money available to meet loan demand, rates at first rise. But when credit demand falls off because loans have become so expensive, rates drop.
The declines were seen as confirmation of that prediction. Insisted one Federal Reserve governor last week: "Our strategy for fighting inflation is agreed on completely. We are focusing on money supply as the best way to combine growth with reduced inflation over the long haul. If that means broader swings in interest rates in the short run, so be it."
Interest rates are expected to sink still further, with the prime rate at perhaps 10% to 12% by year's end. This is due largely to the weakening economy. Alan Greenspan, former chief economist for President Ford, observes: "The U.S. has moved rapidly into a severe recession. The hopes that it would be mild and of short duration appear to be precisely that—hopes."
Gloomy businessmen are now bracing for an economic downturn as deep as any in the postwar period. They consequently see no need to borrow funds at the still relatively high rates so as to expand capacity or hire new workers. General Electric Chairman Reginald Jones predicts that the prime rate will sink to 12% or 13% before investment picks up. Explains Gilbert Heebner, chief economist at the Philadelphia National Bank: "It was like 20% was some magic threshold. Borrowers simply stopped borrowing. Even small independent businessmen like farmers chose to liquidate their crops rather than borrow money."
A number of savvy corporate treasurers anticipated the Fed's March credit restraints by borrowing heavily in January and February, thus stockpiling enough cash to see them safely through cold economic times. As a result, bank commercial and industrial loans, after going up at an annual rate of 27.6% in January and 26.8% in February, rose a scant .3% in March and then plunged 7.4% in April.
Bankers believe it will also take further drops in interest rates before consumers start taking out more loans. Says Robert W. Renner, chairman of the Citizens State Bank in Hartford City (pop. 8,000), Ind.: "I really think we're going to have to get down to the 12% to 13% range before the typical consumer comes back to see us." The Citizens State Bank last week made only one auto loan at 17.5% interest. A year ago, it was making twelve to 14 such loans a week at 12.5%.
Similarly, consumers are shying away from the mortgage market regardless of lower lending costs.
Jack Carlson, chief economist of the National Association of Realtors, says that the largest group of borrowers deserted the home-buying market when rates went above 14% and will not return until interest goes back below that level. Currently, mortgage money costs approximately 15% across the country.