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Alas, for all the optimistic signs, the prospects for sustained growth with lower inflation are far from assured. They are, in fact, surrounded by so many dangers and uncertainties that some economists rate them as only a long shot. Much will depend on the policies of the Federal Reserve Board, which controls the U.S. money supply. With the strong support of Ronald Reagan, Chairman Paul Volcker has permitted only slow monetary growth. That policy has undoubtedly been the most effective part of the war on inflation, but it has also played a major role in jacking up interest rates and deepening, if not starting the recession. Now, with price boosts moderating, the board has been easing up. The Federal Reserve, which publishes some major decisions only a month after they are made, disclosed last week that its Federal Open Market Committee voted in July to let the money supply grow at an annual rate of 5% in the current quarter, vs. 3% earlier.
In a rare on-the-record interview, J. Charles Partee, one of the seven governors of the usually secretive Fed, told TIME Correspondent Gary Lee last week that the board hopes to continue promoting more declines in interest rates and a beginning of economic recovery. He called attention to Chairman Volcker's testimony to Congress last month, when he said that the board might even permit money-supply growth to exceed the 5½% upper end of the target range for a while, if it remains convinced that inflation is under control. If business starts raising prices to fatten its profit margins, says Partee, and "if one started to see wage contracts being reopened with wages rising, if one started to see the possibility of another oil shortage, the Federal Reserve would be very concerned." The implication of Partee's remarks is that the board believes that only a moderate recovery can keep price increases down. Moreover, the Federal Reserve seems ready to crack down on the money supply again to prevent a business boom that might accelerate inflation.
Partee also voiced concern about the level of Government borrowing that will be needed to finance the gargantuan budget deficits that the U.S. is likely to run in the next few years. His worries are shared by experts of every shade of academic and political opinion. They all warn that the U.S. cannot enjoy sustained growth unless the looming deficits are reduced sharply, and soon.
Gary Wenglowski, chief economist for Goldman, Sachs & Co., sketches two scenarios to illustrate what is likely to happen if the deficits continue to mount. The first is essentially stagnation. According to this script, the Federal Reserve, ever fearful of renewed inflation if it pumps too much money into the economy, refuses to let the supply grow rapidly enough to accommodate the deficits. Government borrowing collides with demand for funds by business and consumers. The result: interest rates move back up and inflation perhaps stays moderate, but the economy sputters along for years with low growth and high unemployment.