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In recent years, both the way people save and the way the Federal Reserve does its job have undergone radical changes that help explain what is happening to interest rates. A decade ago, the typical American saver was content to earn 4½% or less in a passbook account, which was the maximum allowed by law. In the 1970s, double-digit inflation arrived, and the passbook account became a bad deal. Money quickly lost its purchasing power when it was saved at 4½% interest while prices rose at a 10% clip.

As a result, savers began demanding higher returns. They flocked to new money-market mutual funds, which pooled deposits as small as $1,000 and paio out yields of up to 18%. To help banks anc savings and loan associations keep their deposits, the Government began loosening interest-rate regulations and allowing these institutions to offer accounts that paid higher interest. All this was bad news for borrowers; since banks and savings and loans suddenly had to pay much more for deposits), they had to charge much more for loans. Those 8% mortgages and car loans became as outdated as Ozzie and Harriet.

Corporations as well as individuals suffered. Up to then, companies had been financing new factories and equipment by issuing long-term bonds paying well under 10%. By the late '70s, however, the pension fund managers, insurance company executives and other moneymen who bought the bulk of the bonds began demanding interest of 15% or higher to make sure that the value of their investments was not eaten away by inflation. Not willing to pay 15% on a long-term basis, most companies turned to the banks for short-term loans.

Those explanations for high interest rates were understandable as long as inflation was unchecked, but they are less convincing now. Why have rates not responded to the good news on prices? The President told his eighth-grade audience that money managers fear that inflation will come roaring back. Says Harvard Professor Martin Feldstein: "After being burned for more than a decade, it's not surprising that these guys don't rush out and gamble on long-term bonds."

What causes these financial jitters is primarily the mammoth size of projected budget deficits. Experts now generally predict that the Government will run perhaps $500 billion in the red during the next four years. Investors are fearful that the Federal Reserve will be forced to accelerate its expansion of the money supply to meet the Government's borrowing needs and thus rekindle inflation.

The fear-of-inflation hypothesis is a good explanation for why long-term bond and mortgage rates are high. It does not fully explain, however, why banks are charging 16½% on short-term loans, at a time when no one is predicting that inflation is about to reignite. Many analysts, ranging from Liberal Economist Charles Schultze of the Brookings Institution to Conservative Congressman Jack Kemp, argue that short-term rates are high in large part because the Federal Reserve is not providing enough money to the banks. Over the past month the money supply has been growing at an annual rate of 5.6%, which is at the upper end of the Reserve Board's target range of 2.5% to 5.5%. The critics contend that the targets must be raised if the economy is to recover fully.