Fed-watch countdown under way

Few will applaud if the central bank raises rates Aug. 24

Many do expect a nudge up

Others say inflation isn't at a point to warrant tightening

August 15, 1999|By Sean Somerville | Sean Somerville,SUN STAFF

To understand the task facing fiscal policy-makers, think of the U.S. economy as a car in a very long race and the Federal Reserve Board as its pit crew.

The sleek American model is running well in the ninth year of an economic expansion, a blur compared with other cars on the track. The challenge is how to keep it going at a strong, steady pace without burning it out.

The Fed is expected by many to raise rates for a second time this year on Aug. 24 to keep inflation in check. But economists looking under the hood see very different things.

Arguing against a rate increase, Aldona Robbins, a former U.S. Treasury economist, said inflation is below 2 percent and productivity is increasing annually by between 2 percent and 3 percent.

Perhaps most important, the economy grew during the second quarter by 2.3 percent, a marked slowdown from 4.3 percent in the first quarter.

"I don't see any reason why the economy can't grow at 4 percent without inflation," said Robbins, now a senior fellow with the Institute for Policy Innovation. "I don't see the inflation flare-up. There's a little of an uptick over last year, but nothing to be concerned about as of right now."

Mark Zandi, chief economist for Regional Financial Associates in West Chester, Pa., sees a labor shortage, higher oil prices and a falling dollar that will result in higher import prices.

To him, that's more than sufficient to justify an increase. "What matters is not inflation today or yesterday," he said. "What matters is inflation tomorrow. It would be a shame to conduct policy by looking into the rearview mirror."

Disagreements over Fed policy are largely a battle of the "pre"s -- those who think an increase is a necessary part of sound pre-emptive fiscal policy, and those who think a rate increase would be premature.

Some economists said Federal Reserve Chairman Alan Greenspan left little mystery about which camp he was in last month, when he told Congress members that he would move "promptly and forcefully" at the first signs that tight labor markets are generating inflationary pressures. But the mystery remains for others, who think Greenspan might have been using his words to cool off the economy.

"It appears that Mr. Greenspan is trying to be much more pre-emptive, and his comment to act `promptly and forcefully' at signs of inflationary pressures is a little stronger than a vow to remain vigilant against inflation," said Gary Thayer, senior economist with A. G. Edwards.

Many economists believe that the Fed will raise the federal funds rate -- the interest that banks charge each other -- by a quarter point Aug. 24. Such a move would mark the second increase this year; the Fed on June 30 nudged up the rate a quarter point to 5 percent. Some economists believe that another quarter-point increase will follow in October.

But some economists are less sure of an increase. They say a lower-than-expected 0.2 percent increase in the Labor Department's Producer Price Index released Friday might persuade the Fed to leave rates unchanged.

Moves in the federal funds rate are important because banks move to match Fed increases by raising their prime lending rate, the benchmark for millions of consumer and business loans.

If the Fed raises rates Aug. 24, it will be trying to cool down an economy that doesn't appear to be all that hot, said Thayer, the A. G. Edwards economist. "The news out there is mixed," he said. "We're seeing the economy cool off and, historically, the Fed probably wouldn't raise rates in this environment."

During the 13 rate increases since 1984, the average economic growth rate was 4.5 percent -- much higher than the second-quarter GDP growth of 2.3 percent, Thayer said. Only one of those 13 increases occurred when growth was as low as it is now. That was in 1989, when inflation was running at 5 percent -- more than double the current 2 percent.

Among the statistics cited by Robbins, the former Treasury economist, are only mild increases in the GDP deflator, which measures changes in the prices of domestically produced goods, and the consumer price index, or CPI. The GDP deflator is up about 1.3 percent over the last year. CPI is up by about 2 percent.

"If we start to see some consistent creep up in the GDP deflator or with the CPI, then I think we need to ask the Fed if there are too many dollars in the system," she said.

Dave Huether, director of economic analysis for the National Association of Manufacturers, said another indicator that an increase is not necessary is that factories are running at about 80 percent of capacity -- short of the 85 percent that suggests rising demand, which can lead to inflation.

Huether also said productivity improvements, largely driven by technology, have contained inflation. Put another way, companies are getting so much out of computers, software and other technology that they can raise wages without boosting prices.

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