Fed chief to testify on rising rates

February 22, 1994|By New York Times News Service

WASHINGTON -- Federal Reserve Chairman Alan Greenspan will deliver his semiannual report on interest rates to a congressional panel today against a backdrop of pressure from financial markets for a second increase, a move the Fed is believed to be trying to avoid for now.

The pressure from bond traders, who are steadily pushing up long-term interest rates, is only one reason why Mr. Greenspan's testimony could scarcely come at a more awkward time for the nation's central bank.

The Fed's last increase, a 0.25 percentage point rise in the federal funds rate for overnight loans among banks, was made on Feb. 4 and was intended to hold down long-term rates.

But it has had the reverse effect in the bond market. Long-term rates have also risen, to a yield of 6.62 percent on the 30-year Treasury bond Friday, with most of that increase in the last several days.

U.S. financial markets were closed yesterday for Presidents Day.

"There are some congressmen and senators that are regular Fed-bashers, and this is an opportunity for them to do some bashing," said Laurence M. Ball, a macroeconomist at Johns Hopkins University.

White House economists count themselves among those who had not expected the recent increase in long-term rates from daily trading.

"This has caught us by surprise, just as it has caught most people by surprise," said Alan S. Blinder, one of three members of President Clinton's Council of Economic Advisers, adding that long-term interest rates now slightly exceed administration estimates for this year.

Mr. Blinder, reportedly the leading candidate to take the No. 2 post at the Federal Reserve, said investors were overreacting to recent signs of the nation's improving economic health and the resulting possibility of inflation. "That is no reason for the kind of interest-rate creep we have," he said.

Many economists, including some with close links to the Fed, predict that Mr. Greenspan will tell a House Banking subcommittee that the nation's economy will grow about 3 percent this year and conclude that such a growth rate can be sustained, at least this year, without fueling inflation.

But they nonetheless expect Mr. Greenspan to repeat his many warnings that the Fed would be ready to change direction quickly if prices do begin to rise.

"I do not expect to see any change in the federal funds target in the next several months," said Andrew F. Brimmer, a former Federal Reserve governor.

The Fed's defenders say an increase in long-term rates may be inevitable, given the widespread perception that a strengthening economy can lead to higher inflation and lower bond prices.

"The Fed acted responsibly -- it was the correct thing for them to do," said Michael J. Boskin, chairman of President George Bush's Council of Economic Advisers.

"If the Fed had not done this, there would have been a much larger adjustment down the road."

Other economists say the recent sharp drop in the value of the dollar against the Japanese yen may have hurt speculative traders, who then pulled back from the American bond market.

The dollar's fall, and the possibility of further declines given Japanese-American trade tensions, made dollar-denominated investments less desirable to international investors, and thus interest rates needed to rise to attract those investors.

The most common explanation among economists of why short-term rates sent long-term rates upward is that the Fed's action on Feb. 4 changed investors' expectations of future inflation.

By raising interest rates, the Fed signaled that it was worried about inflation, and that persuaded many investors that they should also be worried, Johns Hopkins' Mr. Ball said. "I suspect that the Fed's action had some effect on the psychology of the market," he said, "and that had the effect of pushing long-term interest rates higher."

Gene B. Sperling, a senior White House economic adviser, sought to present the bright side of recent interest-rate increases, pointing out that "30-year bonds are still a point below where they were when Bill Clinton was elected." These bonds yielded 7.65 percent on Nov. 3, 1992, the day after the election.

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