Volcker: don't look to Fed for lower interest rates

One of the most potent players this election year did not tromp though the snows of New Hampshire but stayed in a warm, well-guarded office in an imposing marble building here.

That political powerhouse is Federal Reserve Board chairman Paul A. Volcker, who was on Capitol Hill Wednesday holding Congress's feet to the budget-deficit fire.

In testimony before the Senate Budget Committee, Mr. Volcker warned of the danger in not taking prompt action to trim the deficit, cautioned that small reductions would not allay financial markets' fears of rising inflation and interest rates, and suggested that interest rates could rise later this year if strong economic growth continued.

Volcker's testimony also included a blunt warning to Congress and the White House that the Fed would not expand credit to bring down interest rates that budget deficits had pushed up. Such action is ''all too likely to be counterproductive,'' he said.

Volcker is a key player this political year because he has the power, shared with other Fed officials, to influence the direction of interest rates. That affects the fortunes of front-runner, dark horse and incumbent alike, because changes in interest rates exert a powerful influence on the course of the economy. With the power to move financial markets every time he speaks, Volcker has been using his considerable clout to put pressure on Congress and President Reagan to come up with a sizable deficit reduction plan.

As long as action is delayed, ''with each passing month we take more and more risks,'' he said.

A deficit reduction plan of the type proposed by the President - $100 billion over three years - ''is better than nothing,'' Volcker said. But he added that the nation ''would be better off with $200 billion'' in deficit reductions.

And White House and congressional plans to backload deficit reductions - with cuts starting small and growing in later years - earned Volcker's scorn. ''The most critical part is what you get on the front end,'' he said.

When considering how much a plan will calm the financial markets, ''Don't expect drama from a nondramatic program,'' he told Sen. Dan Quayle (R) of Indiana.

The senator complained about comments the Fed chairman made Tuesday saying that $100 billion in deficit reductions would not be impressive if little action were taken in the first year of the program. Those comments from Volcker helped push the Dow Jones industrial average down 22.82 points that day.

The stock market is not alone in worrying about what Volcker may do. White House political allies have worried out loud that Volcker may try to slow the growth of the money supply, nudging up interest rates. Such a move would slow the economy, which has been growing briskly and showing some signs of renewed inflation. Further evidence that economic growth will continue came Wednesday when the index of leading economic indicators rose 1.1 percent in January. (See story, Page 15.)

At his press conference last week, however, the President said that ''the Federal Reserve right now is on a path of money supply increase that is consistent with a sound recovery without inflation.''

Volcker says that in meetings with White House officials ''they don't seem to find any great difficulty'' in the Fed's targets for money-supply growth this year. But he adds that ''election years are nervous and difficult.''

Volcker did drop several hints that he expects interest rates to rise later this year, hurting the recovery. ''If the economy is exceptionally strong, that risk exists,'' Volcker noted. ''I have not forecast higher rates, but I am sure this budgetary situation does not help.''

A key reason interest rates might rise is that to finance the federal debt, the Treasury is absorbing a sharply rising share of the total private savings available to be borrowed. ''The question is whether other sectors will get enough funds, at reasonable interest rates, to support the balanced, higher investment expansion we want,'' Volcker said.

He also noted that getting funds to finance the deficits by borrowing from foreigners ''is a tenuous and risky way to finance domestic growth.''

The high US interest rates that make such borrowing possible weaken the nation's ability to export.

A number of analysts say the Fed will be forced to tighten credit slightly, perhaps by next month. But the consensus is that such a move will not make a major dent in the economy by Election Day.