Fed set to raise rates again

May 10, 1994|By Los Angeles Times

WASHINGTON -- Senior Federal Reserve officials confirmed yesterday that the central bank is poised to raise interest rates repeatedly in the months ahead, with some policy-makers embracing a controversial formula that could prompt them to call for rate increases whenever national unemployment falls below 6.5 percent.

Now that the recovery is picking up speed and the economy is generating hundreds of thousands of new jobs each month, Fed officials say they are convinced that short-term interest rates must go considerably higher to prevent inflationary pressures from building.

If the Federal Reserve waits until consumer and producer prices begin to accelerate, they say, it will be too late for Fed policy to have much of an impact.

Last week's report of strong employment growth in April and a decline in the jobless rate to 6.4 percent -- just below the 6.5 percent target used by some Fed officials -- only served to reinforce the view within the central bank that it is time to apply the brakes before the economy begins to overheat.

While Wall Street analysts and economists have speculated about the likelihood of further rate rises by the Fed, the virtual certainty of a continuing series of future increases was confirmed for the first time in interviews with senior Fed officials.

The exact timing and scope of future rate increases is uncertain, but several officials say another upward adjustment could come as soon as the next scheduled meeting of the central bank's policy-setting panel, the Federal Open Market Committee, next Tuesday.

Moreover, a few Fed officials say they are being guided in their decisions by statistical benchmarks, suggesting that the unemployment rate already has fallen too far and that the economy is expanding too rapidly to keep inflation in check.

Although other Fed insiders, including Chairman Alan Greenspan, dismiss those formulas as too simplistic, their use suggests that at least some Fed officials might be willing to raise interest rates considerably higher than the Clinton administration believes is warranted.

One Fed official said that such informal targets lead those who adhere to them to the conclusion that, given current conditions, the Fed should raise the benchmark federal funds interest rate to at least 4.5 percent, and perhaps as high as 5 percent. The rate currently stands at 3.75 percent.

If the anti-inflation hawks are able to dominate policy-making, the central bank could impose as many as five more quarter-point rate boosts within the next year.

The Fed has raised interest rates three times this year, boosting the federal funds rate by 0.25 percent each time. The rate is what banks pay each other for overnight loans, typically to keep up reserves.

Aftershocks from the rate boosts continue to reverberate throughout the economy: Stock and bond prices have declined sharply and borrowing costs have risen on everything from credit cards to home mortgages.

Treasury Secretary Lloyd Bentsen has said publicly that he expects the federal funds rate to rise to 4 percent, suggesting that the White House is willing to accept one more quarter-point increase. But some Fed insiders predict that even higher rates appear likely.

"We are not there yet; we have more to do," said a member of the Fed's board of governors. "How many more, I don't know."

The economic targets being used by some Fed officials have become a source of debate within the Fed. Their adherents say they involve two basic calculations. One target suggests that the Fed should strongly consider raising rates when unemployment falls below 6.5 percent. The other calls for consideration of rate boosts if the pace of economic growth exceeds 2.5 percent.

Based on the latest statistical readings, both thresholds already have been crossed. The government reported that the economy expanded at an annual rate of 2.6 percent in the first quarter of 1994 and April's unemployment rate fell below 6.5 percent.

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