Look for further increase in interest rates by Fed

SUNDAY OUTLOOK

January 22, 1995|By Ross Hetrick

The Federal Reserve's policy-setting Federal Open Market Committee meets on Jan. 31 and Feb. 1 to consider raising short-term interest rates for the seventh time since last February. A few weeks ago a rate increase was considered a sure thing. Since then expectations have seesawed back and forth. An unexpected drop in December retail sales, for instance, fueled a market rally early last week as investors bet the Fed would hold rates steady. But a surge in industrial production fanned fears of another increase. What is the liklihood that the Fed will move rates up again? Have rising interest rates dampened economic growth? How much is enough?

Paul W. Boltz

Chief economist, T. Rowe Price Associates Inc.

Our view is that, in scanning across the economy, the Federal Reserve will on balance conclude that the economy still is growing too quickly, and we do expect that the Federal Reserve will tighten at their Jan. 31-Feb. 1 meeting.

The rising capacity utilization rate -- now over 85 percent -- is particularly significant for them because in the past, these levels of capacity utilization have regularly led to higher inflation, even as recently as the 1988-89 period. I want to emphasize that point because a lot of people think that is out of date. But I don't think the world has changed that much.

So far, the rises in interest rates have had only a small impact on the economy, mainly concentrated in construction activity. The rest of the economy, certainly the industrial sector, is booming.

To be sure, it takes times for rises in interest rates to affect the economy and we never expected the economy would instantly slow down. But these levels of interest rates in the past have not been associated with sharp slowings of economic activity.

As to how much is enough, that is a very difficult question because it is influenced by so many things. And our working hypothesis is that the federal funds rate [currently around 5.5 percent] will probably peak out at around 7 percent. But it's a forecast subject to revision.

Thomas J. DiLorenzo

Professor of economics, Loyola College

No one can forecast, but I'd bet money -- not a lot of money -- that they're going to increase rates some more. I don't think they're all finished.

And I think, yes, some parts of the economy certainly are more interest-sensitive than others -- housing and construction in particular and related industries. I think it is undeniable that a couple of percentage-point increases have harmed at least those sections of the economy.

As far as the third question [how much is enough], I'm not so sure about it. As an economist, I'm kind of befuddled by the whole idea that people think there is a trade-off between inflation and unemployment. That was taught in the '50s and the '60s in economics. But if you look at the data, there is no clear trade-off at all. This deep concern that if the economy is growing it will necessarily cause inflation just isn't consistent at all with the past 15 or 20 years of data on inflation and unemployment. But everyone in the media is always talking about the economy heating up too much. It's an over reliance on the demand side of the economy. The economy is growing. That means we are producing more stuff and that pushes prices down.

Rob Brown

Market strategist, Ferris, Baker Watts Inc.

The mood has changed from manic to mellow, in my opinion, about the Fed.

The pivot point was the retail sales report last Friday. It shocked a lot of people, it was so soft. November and December were adjusted way down and it changed the tone of the market. Even though we've had a couple of reports since -- like capacity utilization and industrial production -- that came out stronger than expected, I believe now that the consensus is the Fed is on the right track, that they will raise rates, 50 basis points [half a percent].

The big surprise could be that this might be the last one. If you look at consumer debt, it's gone up 14 months straight. The consumer, in my opinion, is tapped out. And I think you are going to see a slowdown faster than most people think.

Laurence M. Ball

Professor of Economics, The Johns Hopkins University

It could go either way. I think that either raising them a little bit more now or waiting to see what happens for another month or two would be a reasonable course. I say it's 50-50 which they'll do. I doubt they would raise them by a large amount. The most likely outcome would be no raise or an increase by a quarter point.

I think the effect so far has probably been fairly small, but that it will have a substantial effect over the next year or so. I think they probably need to go at least a little bit higher. The economy now pretty clearly is too strong to maintain stable inflation.

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