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Reserve Board Tightening Monetary Policy

May 1, 1987

WASHINGTON (AP) _ The Federal Reserve Board, facing up to the continuing fall of the dollar on world money markets, has moved to tighten federal monetary policy, and some economists predict more drastic intervention by the board may come soon.

Chairman Paul A. Volcker told a House subcommittee on Thursday that the board has engaged in ″a somewhat less accommodative policy ... a slight snugging″ in response to economic conditions.

In market jargon, a ″slight snugging″ is a way of describing policies under which the Fed becomes more cautious in releasing its money to banks.

Volcker did not define the exact extent of the Fed’s action, which is aimed at affecting the money supply and, thus, the amount of money banks have to lend.

The tighter monetary policy has contributed to the recent increase in interest rates, Volcker said. He encouraged foreign central banks, particularly in Japan, to lower their interest rates in response.

Japanese Prime Minister Yasuhiro Nakasone, in Washington for talks with President Reagan and members of Congress, announced about the same time that he was directing the Bank of Japan to move toward lower short-term interest rates.

But Volcker declined to comment on speculation that the Fed also will move soon to raise the discount rate, the fee the Fed charges to make loans to U.S. financial institutions, in an even more drastic step to bolster the dollar in the world economy.

Economists have predicted that an announcement of a discount rate increase could come as early as today.

If the Fed does move to raise the lending rate, it would be the first increase in three years and follow seven consecutive cuts.

Increasing the discount rate would increase the cost of money to banks, pushing up interest rates. That makes the dollar stronger on world markets by making U.S. debt more attractive to foreign investors. But it carries the risk of slowing the economy and perhaps tipping the nation toward recession.

Michael Evans of Evans Economics Inc., a Washington economic forecasting firm, predicted quick action by the Fed to raise the discount rate.

But Allen Sinai, chief economist for Shearson Lehman Brothers in New York, suggested any action may be delayed while the board evaluates the changing conditions.

″The Fed will want to have a good look at this,″ he said.

Sinai said the Japanese move to lower interest rates, ″at least in the near-term, relieves the pressure in the currency markets and the pressure on the Fed to tighten the dollar. But in the longer run, it’s not clear the lower (Japanese) interest rates and the slight snugging up here will be sufficient.″

There has been speculation that Fed action was involved in the rising interest rates of recent weeks, but Volcker’s comments were the first public confirmation that the central bank had stepped in.

Volcker, while acknowledging that the Fed was in part responsible for rising rates, also said he expects the policy to help stabilize the markets and, over the long run, to lower interest rates.

The fact that someone is ″minding the store″ on inflation should help ease market fears. Those fears, along with uncertainty about the trade bill being debated by Congress, have fueled volatility in interest rates, he said.

The Fed chairman also said the dollar has ″absolutely and fundamentally″ fallen far enough on world money exchanges. The dollar stands at a post-war low against the Japanese yen.

″In recent days, we have been more cautious in the Federal Reserve in providing reserves to the market,″ Volcker told the oversight subcommittee. ″Perhaps we could be described as having a somewhat less accommodative policy, reflecting in part the weakness of the dollar, a slight snugging approach in some of the market jargon.

″All of that is in line with the basic policy that was described to the Congress earlier,″ the Fed chairman said.

″Let me say as well that under the present economic situation it would be entirely reasonable for complementary action in the opposite direction abroad,″ he added.

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