Fed faces confusion on economy Factories and workers are busy, but inflation is at 'a 31-year low'

What will Greenspan do?

Decision on whether to raise interest rates is coming Tuesday

March 23, 1997|By Jay Hancock | Jay Hancock,SUN STAFF

Talk about mixed signals.

Over here is the green light: an accelerating economy spewing products and jobs.

And here, at the same crossroads, is the 6-foot-4 cop with both hands raised: half a decade of meek inflation.

What's a central banker to do?

Tossed salad is common fare for the Federal Reserve when it sorts through economic indicators. But rarely are the signs as contradictory as they will be Tuesday, when top Fed officials next meet to set interest-rate and money-supply policy.

The U.S. economy is buzzing into its seventh straight year of growth. It sped up last fall. It hasn't looked back. And "it's certainly stronger than the Fed thought it would be," said Patricia de Blank Klink, president of Advisers Capital Management Inc. in New York.

That's normally a cue for the Fed to go -- to raise short-term interest rates and smother the inflation which, for 40 years, has sprung from fertile economies and then threatened to kill them.

But there is no worsening inflation. Nor is there sign of it. Nor, against numerous and repeated warnings to the contrary, has there been any sign of it all through this long expansion.

"Core inflation is at a 31-year low," said Bruce Steinberg, an economist with Merrill Lynch in New York. "Inflation has never been so low at such an advanced stage of a cycle, and we expect it to be little changed during 1997."

Stop? Or go? Do nothing and let the economy ride? Or raise rates, hurting businesses and consumers, on the chance that inflation might stir and cause problems later?

"The Fed is going to have a very difficult decision to make," said Joseph Sullivan, senior vice president for fixed income at Legg Mason in Baltimore.

"The problem is, the old rules have gone out the window. When you see this kind of sustained economic growth, you expect to see more inflation," Sullivan said.

What the Fed's Open Market Committee does Tuesday could affect everything from bank deposit rates to car loans to mortgages to business investment to unemployment. The Fed manipulates short-term interest rates through control of the money supply, and higher rates make borrowed money more expensive, slowing investment and spending.

But the Fed meeting will be more than just another monetary-policy confab.

In a way, it will be a poll of highly interested experts on whether the old rules have, indeed, gone out the window. For two years now, more and more economists have insisted that global competition has killed severe inflation, that the economy can grow very fast without sowing the seed of its own destruction, that companies can even give workers nice raises without boosting prices.

With the equivocal evidence of 1997's first three months, the debate comes into especially sharp focus now. Has America entered a new, golden economic era? Survey results arrive at about 2 p.m. Tuesday.

Many analysts believe that the Fed will move to tighten short-term rates -- by a quarter of a percentage point.

Fed Chairman Alan Greenspan has spoken publicly several times recently, and each time he has uttered the code words that supposedly presage a monetary tightening and higher rates.

The Fed likes to act "promptly -- ideally, pre-emptively" to keep inflation low, Greenspan said last week. The recent years of slow wage gains for workers are only a "transitional period."

The Fed doesn't eye "where prices are or have been but rather what is the state of of economy later this year and into 1998," he said.

"I think they have given us ample warning," said Mary Miller, head of the municipal bond department at T. Rowe Price Associates in Baltimore. "And this is a Fed that does give signals before they move."

As always, though, the oracle of Alan also emitted opposite signs.

"Inflation at this stage is clearly under control," Greenspan said. "Competitive pressures here and abroad should continue to act as a restraint on inflation in the months ahead."

And the consumer price index, behaved though it has been, actually exaggerates inflation, Greenspan has said.

But such tones were being ignored by many economists and bond investors last week. They think Greenspan will go ahead and boost rates anyway -- if not Tuesday, then in May. Why? Because he can. The economy is so strong now, the thinking goes, that a quarter- or half-point rate rise won't hurt it much.

A quarter-point tightening "is not going to slow the economy to a halt," said Eileen Neely, a senior economist for Fannie Mae in Washington. "If Greenspan can continue asserting his credibility an inflation fighter while not hurting the economy, why not do it? And I think that's what he's going to do."

Especially strong housing and retail reports recently should increase the Fed's inclination to twist the screw, analysts said.

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