Seeing good, bad of lowering rates

The Economy

November 13, 1995|By Jay Hancock

IF YOU HAVE an adjustable mortgage, you should heckle Alan Greenspan the next time you see him.

"Hey Greenspan," you should yell, "why is the funds target 500 basis points over the implicit GDP deflator?" That'll get his attention. "Your mother's a Keynesian," you can add.

If you have shares in a money-market mutual fund, you should kiss Mr. Greenspan. If you have both the mortgage and the fund, you should drape your arm on his shoulder, murmur about the burdens of monetary power and marvel at how bank problems in Japan can boost Marylanders' MasterCard payments.

This week, Mr. Greenspan and his peers on the Federal Reserve again will think about reducing short-term interest rates. As usual, in a profession where "on the other hand" is the favorite phrase, there are countervailing considerations.

Inflation is dead, to begin with, as Dickens might write at this time of year. There is no doubt whatever about that.

No doubt, at least, among some people who don't sit with Mr. Greenspan on the Fed's Open Market Committee. Like Scrooge counting Cratchit's candles, Mr. Greenspan carries price vigilance to what some perceive as a fault.

Wages are flat. Union power wanes. Oil prices are stagnant. So are those of most other raw goods. Nobody pays full retail markup anymore. And that's the way it is all over the world.

U.S. inflation has topped 5 percent only once in the past decade. It's 2.5 percent now.

"I don't see inflation doing anything but staying nice and tame," says Terry Rose, portfolio manager at Advisers Capital Management in New York.

"There is no inflationary pressure out there. None," says Charles W. McMillion, president of MBG Information Services, a Washington-based business analysis and forecasting service.

But there was Mr. Greenspan last week, sounding his usual self.

"So great has been the progress against inflation that some observers have said that the job is now complete and that central banks can relax," he told the Economic Club of Grand Rapids, Mich.

Then, sure as Fort Knox has gold, came the kicker: "However past successes will not count for much if we mistakenly let down our guard."

Mr. Greenspan's guard has helped propel the "real," after-inflation return on short-term debt investments to their highest levels in years.

Members of what used to be called the creditor class are often happy with a spread of a percentage point or two between inflation and the coupon on their notes. If inflation is 4 percent, investors will settle for a 5.5 percent interest rate -- a real return of 1.5 percent.

These days they're making three points. Wary that the economy will take off and inflation will ignite, Mr. Greenspan has kept the funds rate -- what commercial banks charge each other for overnight loans -- at 5.75 percent. That has helped press short-term rates well above inflation. For example, money-market funds -- filled with short-term corporate loans and T-bills -- pay well over 5 percent these days.

Short-term rates are so high that they're bumping up against long rates. Normally money lent for a long time commands a much higher price, reflecting the extra years of risk. But the government is making three-month loans these days at 5.5 percent and 10-year loans at 6 percent.

Holders of one-year adjustable mortgages, which are pegged to short-term rates, are paying more than 8 percent for their money these days, when low "teaser" rates are factored out. By contrast, you can get a long-term, fixed mortgage for close to 7 percent.

Translation: Long-term lenders are worried less about inflation than Mr. Greenspan is. Or, if you like: long-term lenders have faith that Mr. Greenspan will remain vigilant.

Either way, some people think the Fed is being too conservative. Unemployment is relatively low -- 5.5 percent. But liberals like Maryland's Sen. Paul S. Sarbanes think it could be even lower.

"There is no inflation problem now," Sen. Sarbanes said last week. "I'm in favor of having lower interest rates as a stimulus to strong growth. If you can have lower unemployment without any offsetting features, why wouldn't you want that?"

Unfortunately for Mr. Greenspan, his worries stretch far beyond U.S. unemployment and inflation.

Let's count the ways. The Mexican peso is reeling. By lowering U.S. rates, the Fed could help prop the peso up against the dollar.

On the other hand, keeping rates steady will help boost the dollar against the Japanese yen. That's good because it'll help Japanese exports. Their economy, with its teetering banks, needs a break.

On the other hand, a strong dollar hurts U.S. exports, and we've been booking record trade deficits this year.

On the other hand, our economy grew at a rapid, 4.2 percent annual rate in the third quarter. Isn't that fast enough? Won't easy money now set up the risk that, like Marley's ghost, inflation will haunt us later, eroding wages and loans alike?

On the other hand, U.S. job growth has been so-so, income and wage growth nonexistent. Don't they need the help that lower rates can give? And with Congress moving toward cutting the deficit, doesn't that decrease the risk of a rate reduction?

The facts are clear, Mr. Greenspan's choice obvious.

"If you forced me to choose, I don't think they will ease," Ms. Rose said.

"I think it's a close call," Mr. McMillion said. "My call would be to loosen. But I will not be surprised if this Fed does not loosen."

On the other hand.

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