Fed gave up tight policy in August Low inflation caused neutral view on rates

September 25, 1993|By New York Times News Service

WASHINGTON -- Concluding that economic growth was sluggish and inflation was abating, the Federal Reserve announced yesterday that it had decided last month that there was no need for it to lean toward raising interest rates.

In a surprise to many economists, the Fed took the action unanimously at its Aug. 17 meeting, and most economists said they believe the Fed embraced a similar neutral stance at its meeting on Tuesday, meaning that it was not leaning toward either raising or lowering rates.

According to a report released yesterday about the August meeting, Fed officials believe that "economic growth did not seem particularly robust" and that "more favorable performance of key measures of prices in recent months had tended to relieve earlier concerns about a possible worsening of inflation."

Concerned about a spurt in inflation earlier this year, the Fed's policy-making committee, the Federal Open Market Committee, adopted a bias toward higher rates in May. Such a bias meant that the Federal Reserve was likely to raise interest rates if there was a month or two of renewed inflation.

By tradition, this meant that the Fed chairman could raise short-term interest rates by a quarter of 1 percent without consulting other members. But Fed officials said Chairman Alan Greenspan does not usually act without consulting his colleagues.

"They moved to a neutral position because of the obvious softness in the economy and the slower price increases in the summer," said Jay Woodworth, vice president and chief domestic economist at Bankers Trust. By tradition, the neutral position means that Mr. Greenspan will have to consult his colleagues before raising rates, although he could act on his own in an emergency.

In a letter released yesterday, President Clinton reaffirmed the central bank's independence by stating that he opposes a proposal under which the president would nominate the heads of the Fed's 12 district banks.

Federal Reserve officials have been wary of that proposal, pushed by Rep. Henry B. Gonzalez, a Texas Democrat who is chairman of the House Banking Committee, because, they say, it would reduce the central bank's independence from political pressures.

At present, the presidents of the 12 district banks are chosen by their boards, which are dominated by local bankers and business executives. Mr. Gonzalez has argued that elected officials, rather than bankers, should appoint the regional presidents, who help determine the central bank's monetary policy.

The regional presidents hold five of the 12 votes on the Federal Open Market Committee, which helps determine policy on short-term interest rates. The other seats are held by the Federal Reserve Board's seven members, all of whom must be nominated by the president and confirmed by the Senate.

In a letter sent to Mr. Gonzalez on Sept. 20, Mr. Clinton said that the proposal had merit but that there were also arguments on the other side. "I am disinclined to seek a change in the Federal Reserve Act at this juncture," the president wrote.

In what economists construed as praise for Mr. Greenspan, Mr. Clinton said the Federal Reserve System "is functioning well and does not need an overhaul just now."

"Changing the way bank presidents are elected at this time," he added, "runs the risk of undermining market confidence in the Fed."

In the Fed's summary of the August meeting, the central bankers said several factors argued against changing rates in the near future: slow economic growth in the first six months, the drag on growth associated with the president's deficit-reduction efforts

and the encouraging inflation statistics of recent months.

Nonetheless, the central bankers made clear that a rate increase was inevitable eventually. They again expressed concern that inflation might pick up steam because real interest rates -- interest rates minus the inflation rate -- were zero and sometimes negative in recent months.

The summary stated, "This conclusion was seen as reinforcing the view that monetary policy probably would have to move in the direction of restraint at some point to resist any incipient tendency for inflationary pressures to intensify."

David M. Jones, chief economist with Aubrey G. Lanston & Co., said he was surprised by the Fed's abandonment of its bias toward higher rates. He said there was a chance that the central bank returned to its tilt to higher rates at Tuesday's meeting because of some signs of stronger growth and because the August rise in inflation of three-tenths of 1 percent was slightly larger than expected.

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