WASHINGTON — Federal Reserve Chairman Paul A. Volcker, holding out the carrot of lower interest rates if Congress accepts the stick of drastic spending cuts, predicted Tuesday that interest rates would be "lower than they would otherwise be" if the federal deficit is cut by about $50 billion next year from the current estimate of $225 billion.
Volcker, emerging from a breakfast meeting with a small group of Republican senators, gave the impression that the Federal Reserve would help push interest rates down if a major deficit reduction package is approved. Thus, he provided some reassurance to skittish legislators that the Federal Reserve will compensate for the depressing economic effects of huge spending cutbacks by easing its monetary policy.
"The more you do in reducing the deficit, the lower interest rates are going to be," Volcker said he told the Republican leaders. "As I've said before, a $50-billion cut this year is the first step."
May Aid GOP Crusade
Volcker's comments are likely to assist the crusade by Senate Republicans to slash the deficit by about $50 billion without a tax increase, primarily by imposing an across-the-board freeze on federal spending, including Social Security and the Pentagon. Some domestic programs also would be eliminated or cut deeply under the Senate GOP outline.
In talking to reporters after the meeting, Volcker said that he "can't help but feel encouraged" by the effort being organized by Senate Majority Leader Robert J. Dole (R-Kan.). Moreover, he gave his general support for the GOP senators' three-year goals of cutting deficits to less than $100 billion, saying that "if you're going to have a convincing program . . . some follow-through" is needed.
Senate GOP leaders have been on the defensive in recent days because of divisions within their own ranks over limiting defense spending increases, as well as objections by both Republicans and Democrats in the House to freezing cost-of-living increases for Social Security recipients. They are hoping to complete their budget plan by Feb. 1.
By contrast, President Reagan is expected to deliver a budget to Congress on Feb. 4 that would lower the deficit to about $170 billion in fiscal 1986, mainly by making deep cuts in domestic programs. But the Administration's budget is likely to fall as much as $50 billion short of Reagan's original goal of reducing the deficit to $100 billion by 1988.
Volcker's meeting with the Senate GOP leaders was the first of three sessions that Dole arranged to help push his deficit-reduction ideas.
'Going to Get Wet'
Senate Majority Whip Alan K. Simpson of Wyoming, who attended the meeting, warned that senators would not be deterred from making changes in Reagan's budget. "It's going to be COLAs (Social Security cost-of-living adjustments), it's going to be defense, and you can't mess around," Simpson said. "You're in it, and you're going to get wet all over."
After the Senate Republicans met with members of the Business Roundtable, an organization of top business executives, Prudential Insurance Co. Chairman Robert Beck echoed Volcker's remarks by calling for cuts in the deficit over the next three years.
"We've got to demonstrate we are taking steps in '86, '87 and '88," Beck said. "It would be a shot in the arm that would provide for continued growth."
But Senate Finance Committee Chairman Bob Packwood (R-Ore.) warned that deficit reduction could drag on for months as Congress struggles over where to slash federal spending.
"This whole process," he said, "is going to be a long bargaining session to determine what we can cut."
Meanwhile, most major banks dropped their prime rates to 10.5%, a move initiated late Monday by Manufacturers Hanover Trust Co. of New York, the nation's fourth-largest bank. The drop in the prime to 10.5% from 10.75% put the widely followed interest rate at its lowest level since August, 1983.
The benchmark interest rate, which was 13% as recently as late September, was last below 10.5% in October, 1978.
Among the large banks that adopted a 10.5% prime rate Tuesday were Bank of America, based in San Francisco; Security Pacific National Bank of Los Angeles; Citibank, Chase Manhattan and Morgan Guaranty Trust of New York and First National Bank of Chicago.