Look for an increase in rates when the Fed meets next month

The Outlook

October 05, 1997|By Samantha Kappalman

Federal Reserve officials decided last week not to increase short-term interest rates because of data showing healthy, but not excessive, economic growth.

The economy grew strongly in the first half of the year, at an annual rate of 4.1 percent, pushing the nation's unemployment rate below 5 percent for the first time since 1973.

In the past, that's been a precursor to higher inflation. The cure has been to raise interest rates, which would slow growth and keep a lid on prices.

An increase by the Fed would have slowed the economy by raising borrowing costs for consumers and businesses. The Fed last raised rates in March by a quarter percentage point.

Did the Fed do the right thing by not increasing interest rates? Do you expect the rates to be raised at all this year?

James Annable

Chief Economist, First Chicago NBD, Chicago

Yes, I think they did do the right thing because inflation continues to decline in this economy, and when declining, there is no need to slow down economic growth.

The November meeting will be a different meeting. The key is that this economy was expected to slow down this summer, but it didn't. It's a rapidly growing economy, but it puts the Fed in a difficult position. You've got this debate between being worried about it leading to inflation and those that won't slow down the economy until they see an increase in inflation.

The chances are 50-50 that in November the Fed will do a quarter-point increase; in that they would be unjustified. They don't have a reason to slow down economic growth, it's beneficial to our economy. Good things happen with economic growth. Central banks are inclined to lose sight of that.

I think the Fed's forebearance last year has been one of the best examples of monetary policy making in the post-war era.

As soon as they see inflation -- game over.

Patrick Bradley

Director of Economic and Investment Research, Mercantile-Safe Deposit & Trust Co., Baltimore

It's hard to say if the Fed did the right thing. We'll only know that in a year's time when we look at the evidence that the Fed was sifting through.

There is good economic growth, low unemployment, high consumer confidence, high levels of share prices and the Dow Jones is 50 points below 8,000. There is almost no inflation. The decision was justified.

My expectation is that they will increase at the next meetings [in November and December]. What the Federal Reserve will begin to see is stronger economic activity, and inflation might bump up a quarter of a point or so.

It was a prudent decision to leave policy unchanged.

Maureen Allyn

Chief Economist, Scudder, Stevens & Clark Inc., New York

I think it was a real close call. It probably would have been unjustified if they raised rates.

The performance of the stock market shows that there is plenty of money to fuel growth of the stock market, there is inflation in financial assets and in property markets as well.

I think one of the meetings will see an increase. Growth is strong and will be pretty strong by November. I would be surprised if they increased it more than a quarter of a point.

I don't know what the timing will be, but our experience is when we do have any kind of thing that makes credit less available or anything happens to the stock market, it will have very sharp repercussions.

That's why I would have gotten started early, but the Fed doesn't want to be the start of it.

Their track record has been very good.

Christine Chmura

Chief Economist, Crestar Financial Corp., Richmond

With the flat rate at 2.2 percent, the Fed has some leeway to wait. They could have increased rates for insurance reasons.

I think they should have raised rates against a potential acceleration in inflation. This economy is growing at a good rate. History would suggest that inflation will accelerate if the Fed does not raise interest rates, but it has been doing that for the last three quarters, and the labor market has been tight for a couple of years, and inflation has not picked up.

This suggests something is different this time, and maybe the Fed doesn't have to tighten as history suggests.

If the economy is growing faster than numbers suggest, then wage increases will not cause an increase in inflation like it has in the past. That's what the Fed is debating when deciding about raising rates.

I currently have a 25-basis-points increase in my forecast for the Nov. 12 meeting. My reasoning would be that it is for insurance rather than a series of tightenings. If we start to see inflation pick up, however, we can expect more tightening by the Fed. But at this time, signs don't point toward strong acceleration. The economy is doing great, unemployment is low and inflation is as low as it's been in many years.

Pub Date: 10/05/97

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